The dollar
By Irwin Stelzer
The Sunday Times from London
American Account - Irwin Stelzer: The dollar will weaken but it won’t fold
THE United States slaps tariffs on imported steel, and the EU responds by threatening to do to the same to goods made in states important to President Bush's electoral prospects. The US hits Canadian lumber imports with a 29% duty, and the Canadians respond with a 71% duty on American tomatoes. PresidentBush might not like it, but the mounting US trade deficit is forcing him to appease certain angry constituencies. As he sees it, he has to destroy some trade in order to push his broader free-trade agenda through Congress.
Americans persist in buying more from foreigners than they sell to them, piling up a huge trade deficit. This is good for consumers, since the lower-priced foreign goods raise their purchasing power and put a lid on the prices domestic producers can charge. But it is not so good for workers in the steel, textile and other industries. They find their wages depressed or their jobs wiped out by the flood of goods from overseas.
So these workers, and their unions, and the industry associations representing many companies, last week trooped up to Congress to demand the government make it easier to sell abroad, and more expensive to import foreign-made goods, by driving down the dollar. Some in Congress and in the administration are sympathetic. “We’re unwilling . . . to continue to let other countries export their unemployment to the US,” says Grant Aldonas, under-secretary of commerce for international trade. Administration officials are telling Japan and the EU to reform their own economies, eliminate labour and product-market rigidities, lower taxes as Bush has done, and get their economies growing so that they can buy more goods from America and lower the US trade deficit.
That deficit is now becoming something of a worry. For a long time America has offset its deficit by being so attractive to foreign investors that the excess dollars sent abroad have come back as investments in US assets — shares, bonds, property and government securities. That demand for dollars by investors has prevented the dollar from falling, which it would otherwise have done as the trade deficit widened.
Not a bad thing, from the vantage point of the office of Federal Reserve Board chairman Alan Greenspan. The inflow of cheap foreign goods helps dampen inflation, and makes it easier for him to keep interest rates low so as to maintain the pace of a recovery that some observers, including Greenspan, see as still fragile. Greenspan does not want to add to chief executives’ reluctance to invest in new plant and equipment by raising interest rates, which puts him on the side of those who would not like to see a rapid and inflation-inducing decline in the dollar.
Unfortunately for him, there were three developments last week that suggest the day of the strong dollar may be ending. First, the mounting deficit has got the attention of investors around the world who are holding dollar assets. It is a rule of thumb that when a nation’s trade deficit exceeds about 5% of GDP, its currency will fall in value. And America is headed toward that dangerous territory.
Second, American companies know consumers will not tolerate price rises. That, plus a post-Enron wave of more realistic profit calculations, is creating a profitless recovery and a lack of buoyancy in share prices. So foreigners have begun to look around the world for other places to put their money, which means they don’t want as many dollars as Americans are shipping abroad to pay for their imported cars and T-shirts.
The third factor increasing pressure on the dollar is the American treasury secretary, Paul O’Neill. The markets believe that since the days of Clinton’s treasury chief, Bob Rubin, America has had a “strong dollar” policy. But O’Neill refused to use those magic words in Congress last week, and instead confessed that finance ministers cannot affect the value of currencies except in the very short term. Investors, he said, will put their money in whatever country provides the best opportunities for profit — meaning they will buy the currency of that country to fund their investments.
This is what makes it so difficult to guess where the dollar is headed. The recent and, it seems, now-completed slowdown in the American economy did not dampen enthusiasm for foreign wares, and a robust recovery should make Americans send even more dollars overseas. Meanwhile, the Japanese economy remains in the doldrums, and the EU’s largest economy, Germany, shows no sign of perking up, making them poor markets for made-in-America goods. So America is likely to continue exporting a lot more than it imports.
Which means the dollar will weaken unless foreigners use the dollars earned in trade to invest in American assets to the tune of more than $1 billion every day. But foreign investors, surveying the dreary landscape that is the American market for shares, are showing less enthusiasm. If they continue to put their funds elsewhere, dollars will be in oversupply and their price will fall — gradually, if America is lucky, or precipitously if the pessimists are right. That, say the gloom mongers, will unleash inflation, force the Fed to raise rates, and abort the fledgling recovery.
That scenario depends on a crucial assumption: that investors can find venues much more attractive than America. Japan? Not likely. Euroland? Perhaps, but not unless major reforms drive up productivity and scrap regulations, neither of which seems likely. Latin America? Argentina stands as a warning to those who are tempted by the apparent stability in countries other than Chile. Emerging economies? Attractive to investors with short memories, but not to others.
So the likeliest scenario is that investors will continue to find America a relatively attractive place, although perhaps a bit less so than in the past. That, combined with the continued propensity of Americans to buy more from abroad than they can sell overseas means that the dollar may well weaken. But a collapse just doesn’t seem likely.
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