The Case for the dollar
Part ONE
Commentaries: The Case for a Falling Dollar
Letting the greenback drop will narrow the yawning U.S. trade deficit
BW OCTOBER 6, 2003
Judging by the initial reaction of global financial markets, the call by the U.S. and its Group of Seven partners for more flexible currency rates was a disaster. Stock markets from Tokyo to New York nosedived on Sept. 22 as investors took fright at the dollar's fall after the G-7 meeting in Dubai.
Hold on. From a longer-term standpoint, the G-7 agreement -- and the weaker dollar it has already helped bring about -- is good for the U.S. and world economy. Provided it doesn't turn into a rout, the dollar's drop should spur U.S. economic growth and help bring down the bulging trade deficit by making U.S. exporters more competitive on world markets. It should also put any lingering fears of deflation to rest by raising prices of imports, giving hard-pressed U.S. manufacturers sorely needed pricing power. What's more, by helping to narrow the trade gap, the G-7 pact can head off mounting protectionist pressures in Congress, including a call by some members for tariffs that could prompt trade wars.
Despite a lot of loose chatter in the currency markets, the G-7 agreement is not a replay of the 1985 Plaza Accord, in which the U.S. and its allies agreed to sell the dollar aggressively to drive down its value. In some ways, the latest agreement is just the opposite. The G-7, led by U.S. Treasury Secretary John W. Snow, wants the markets -- not governments -- mainly to determine exchange rates. That's hard to argue with, given the history of official attempts to manage currencies. Remember then-Treasury Secretary James Baker's ham-handed management of the dollar in 1987 that led to the Oct. 19 stock-market crash? And what about the Asian Tigers' efforts to peg their currencies to the dollar that led to a region-wide crisis a decade later?
Still, the G-7's advocacy of more flexible exchange rates is tantamount to acceptance of a weaker dollar. Why? Because the countries that are trying to manage exchange rates -- Japan and other export-driven economies of Asia -- are massively intervening in the markets to keep the dollar high against their own currencies. China, which has the biggest trade surplus with the U.S., has pegged its currency rigidly at 8.3 yuan to the dollar since 1994.
During the go-go years of the late 1990s, a strong dollar was in the U.S. interest. Cheap imports helped keep inflation down and fill demand from consumers that U.S. companies couldn't meet because they were already running their plants flat-out. Now, the situation is reversed. Inflation is virtually nonexistent: Excluding volatile food and energy costs, consumer prices have risen just 1.3% over the past year. Indeed, the Federal Reserve is worried about deflation, not inflation. And U.S. factories are running at three-quarters of capacity, a 40-year low. A weaker dollar would give hard-pressed U.S. manufacturers some relief from low-priced Asian imports, especially from China. And by boosting U.S. exports, it would also give a welcome fillip to U.S. growth. William Dudley, chief economist at Goldman, Sachs & Co., says a 10% dollar drop would boost growth by about a half percentage point in a year.
Indeed, thanks to the gradual decline of the dollar that started in February, 2001, U.S. exports are already on the rise and in July hit their highest level in two years. Much of the U.S. gain abroad has come at the expense of European companies, courtesy of a 35% drop of the dollar vs. the euro. If Asian nations allow their currencies to appreciate more against the dollar, that would spread the pain that would accompany the reduction in the U.S. trade deficit. If it also spurred those countries to cut interest rates and ease fiscal policy to boost demand at home to make up for the lost exports, so much the better.
One possible downside: A shift in Asian currency policy could lead to higher interest rates in the U.S. Japan, China, and other Asian nations invest in U.S. Treasury securities, using the dollars they buy to support the greenback. The yield on the key 10-year Treasury note ticked up on Sept. 22 on expectations of reduced Asian purchases.
But the impact of any such cutback is likely to be muted by the Fed's determination to keep short-term interest rates super-low to ward off even the remote risk of deflation. What's more, it's not in Japan's or China's interest to force U.S. rates sharply higher by dumping Treasuries. The last thing they want to do is hurt the economy of their largest export market.
Global trade is out of whack. After the collapse of trade talks in Cancún, Mexico, flexible exchange rates are probably the best tool big economies have to try to right the balance. In Dubai, the G-7 took an important step toward putting the world economy on a firmer footing. They should be applauded, not jeered.
By Rich Miller
Part Two
Commentaries: The Case against the Falling Dollar
It'll scare off foreign investors -- and do zilch to boost inefficient industries
BW OCTOBER 6, 2003
For 8 years, Democratic and Republican Presidents alike have mostly followed a strong dollar policy. With manufacturing jobs draining out of the U.S. like sand from an hourglass, the Bush Administration has broken with that tradition by encouraging the dollar to fall against other currencies, particular those of China, Japan, and other Asian exporters. The hope is that a weaker dollar, by making imports more expensive at home and U.S. exports cheaper abroad, will close the trade gap and stop jobs from going overseas.
But a falling dollar could have serious negative consequences without actually fixing the problems that are causing the trade deficit to widen. For starters, a weaker currency could scare off foreign investors, depressing the stock market and sending interest rates soaring. In the short run, it will also force consumers to pay more for imports and drain off money they could have used for something else, thus dampening growth. What's more, currency manipulations will do nothing to fix the fundamental problem: Much of U.S. manufacturing has simply not been innovating and boosting productivity fast enough to compete effectively in the global marketplace.
Consider first the impact of a falling dollar on foreign investors. The U.S. depends on an enormous flow of capital into the country to fund everything from business investment to home construction to the government budget gap. Over the last year, for example, the U.S. has absorbed roughly $800 billion in foreign capital, with most of that going into corporate bonds, Treasury debt, and mortgage-backed securities.
Any drop in the dollar big enough to cut the trade deficit significantly -- say, 15% -- would also greatly reduce or eliminate the returns for European or Asian investors who put their money into U.S. securities. Moreover, the prospect of further declines in the dollar would encourage foreign investors to start pulling out their funds from the U.S. stock and bond markets. The outcome could be a spike in interest rates, much greater difficulty in raising money, and a squeeze on domestic growth.
What about the supposed benefit of reduced imports and increased exports? That certainly will happen eventually, but it takes time for exporters to gear up and for retailers to shift from foreign suppliers to domestic alternatives -- if, indeed, any exist for many products. As a result, in the short run, retailers will face higher costs when the dollar declines, which they will pass on to consumers as higher prices. That leaves less money for Americans to spend on domestic goods and services. In effect, higher import prices serve as a giant tax, hitting the U.S. economy just as it finally begins to recover.
Finally, and perhaps most important, the focus on the strong dollar as the cause of the trade deficit may miss the point. The trade-weighted level of the dollar is about where it was at the middle of 1998. The trade deficit today, however, amounts to almost 5% of gross domestic product, compared with just under 2% in 1997.
There are several reasons the trade deficit has expanded so much, including the consistent ability of the U.S. to grow faster than Europe and Japan. But surprisingly, one critical factor is that, outside of high tech, productivity growth in much of manufacturing has been a lot weaker than people realize. According to just-released data from the Bureau of Labor Statistics, fully half of the 86 manufacturing industries tracked by the government had annual productivity growth of 2% or less between 1995 and 2001. One-third had productivity growth of less than 1% annually.
Without strong productivity growth, it's hard for domestic factories in these industries to hold down costs and compete effectively in global markets. Moreover, the government's figures also suggest a lack of innovation in much of manufacturing. That makes outsourcing much easier, since it is a lot simpler to set up factories abroad in industries where the production techniques are well understood and not changing very quickly.
The BLS data show, for example, that output per hour in the electrical equipment industry rose at only 0.5% per year from 1995 to 2001. Not coincidentally, imports of generators, transformers, and other electrical equipment from China alone totaled more than $4.3 billion in 2002, vs. $2.8 billion on 1998. Other industries with low productivity growth are domestic producers of industrial and construction machinery, household furniture, audio and video equipment, and magnetic media such as videotapes and diskettes -- and all have made significant shifts of production overseas as well.
Expecting a lower dollar to boost puny productivity is like putting a Band-Aid on an amputated limb. Either no further innovation in these industries is possible -- in which case they will inevitably move to low-cost countries -- or U.S. manufacturers are simply falling down on the job. Either way, a weaker greenback won't help.
By Michael J. Mandel |
