A declining dollar means trouble
A weakening currency threatens the boom
BY PHILLIP J. LONGMAN
Americans have had a great game going these past few years. Workers abroad toiled to produce everything from automobiles to wine, cheese, and toys, and dutifully sent container ships full of the stuff to our shores. In return, we offered them slips of paper, with words like "Treasury bond" and "stock certificate" printed on the top. And the really amazing part was, the more of this paper we created, the more cool stuff–from Lexus GS 400s to bottles of cuvée–foreigners were willing to trade for scraps of paper.
In the first three months of 1999, Americans consumed $68.6 billion more in foreign-produced goods and services than they shipped abroad, creating an all-time-record trade deficit. Yet the United States also managed to sell foreigners $238 billion in corporate bonds and stock certificates, more than making up the cash shortfall. Why were foreigners so eager to make such a trade? Because like all the bulls on Wall Street, they believed in the promise of America's "new economy." Foreigners were so eager to acquire U.S. financial assets that they bid up the price of the dollar over the past 41/2 years, even though under normal conditions, a country running a huge trade deficit is punished by a depreciating currency.
The recent declines in the value of the dollar suggest that the United States finally may be paying that price. Since early July, the dollar has fallen sharply. The greenback is down some 7 percent against the European Community's euro and off 5.5 percent versus the Japanese yen.
Why is this happening, and what could it mean for the U.S. economy? Most market observers believe that the dollar's decline stems from two fundamental changes. First, inflation, rising interest rates, and high stock prices in the United States are making investment in U.S. financial assets increasingly risky. Second, recovery in Asia and Europe now means there are more-promising returns available from investments in those regions. The falling dollar is a strong signal that not only foreigners but Americans themselves are starting to pull money out of the U.S. stock market and put it to work elsewhere.
Vicious cycle. Notes David Jones, chief economist for Aubrey G. Lanston & Co., the decline in the dollar may signal a turning point for the U.S. economy and for the stock market. Stocks were "priced to perfection in large part because of the strong dollar," says Jones, and because investors expected money from abroad would keep flowing into U.S. equities, supporting ever higher prices. The weakening dollar calls this assumption into question. Moreover, the decline itself could set off a vicious cycle, since it also gives foreign investors an extra reason for not investing here: A drop in the value of the dollar against their home currencies can wipe out any returns they realize here.
The dollar's weakness is also ominous for Americans on Main Street. If a declining dollar triggers a sell-off on Wall Street, consumer demand would severely contract. And with foreigners no longer so willing to trade real goods and services for financial paper, Americans will have to either dramatically reduce their consumption of imports or ship much more domestic production abroad. Either way, if the decline in the dollar continues, it will cause a dramatic shift in the U.S. economy.
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