Fears of a steeper decline for the dollar
Daniel Altman The New York Times Friday, April 4, 2003
For many economists, the dollar's jagged yearlong slide is a side effect of an inevitable contraction in the huge U.S. trade deficit. But current economic and political conditions are making the process more perilous than it might otherwise have been.
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Recently, the dollar's exchange rates have bounced up and down with news from the Iraq war. But the dollar's overall trend in the past 12 months has been downward. Weighted by the volumes of trade with other countries and adjusted for inflation, an average of the rates dropped 4.4 percent from March 2002 to last month.
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A deeper decline could be on the way. The run-up to war hurt the U.S. economy, and fears of similar conflicts to follow could deter foreigners from holding dollar-denominated securities. With less demand for the securities, there would be less need for dollars.
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"If people believe that the events we've seen in Iraq are not one-off events, it will affect their investments," said Kermit Schoenholtz, chief economist of Salomon Smith Barney.
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The falling dollar has helped some U.S. companies to increase their exports, but not enough to counteract the effects of a middling global economy.
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"It's only offset part of it," said Frank Mendizabal, a spokesman for Weyerhaeuser, the paper and building materials maker in Federal Way, Washington. The company exported 18 percent of its sales last year, and the weaker dollar helped it to compete.
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Several forces may be combining to dull the effect of the exchange rate on exports. Schoenholtz said the weakness of incomes and demand abroad was "a very significant portion of the reason" that the deficit in international transactions had not narrowed more.
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Despite the decline in the trade-weighted value of the dollar, from October (when the dollar reached a peak) to January (the last month for which the Commerce Department has data), exports barely changed and imports increased by 5 percent, seasonally adjusted. At least in the short term, the dollar's movements appear to reflect foreigners' willingness or reluctance to hold U.S. securities more than the balance of trade.
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"The recent confrontation with Iraq may have convinced investors of a need to better diversify their investment portfolios away from dollar-denominated assets," John Lonski, chief economist at Moody's Investors Service Inc., said. Though he did not forecast any large-scale dumping of American securities, he said that "in view of the U.S.'s record-breaking current account deficit, it seems like some decline in the dollar appears to be overdue."
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Last month, according to a report by Morgan Stanley, foreign investors' demand for Treasury securities suddenly slackened. And well before the possibility of a war in Iraq began to concern investors, corporate scandals pushed foreigners to shift their portfolios away from American securities, said a senior executive of a major European bank.
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In addition to the changes in portfolios, the pace of foreigners' direct investment in the United States has slowed. The euro zone has outpaced the United States as a target for foreign direct investment for six consecutive quarters, according to figures compiled by Morgan Stanley. All U.S. companies could suffer if foreign capital being pulled out is not replaced by domestic savings. The Treasury also needs foreigners to stay interested in dollar-denominated securities. Estimates by the Bond Market Association, a trade group, foreigners hold about 35 percent of the nation's outstanding debt. The Treasury's borrowing requirements seem likely to balloon as a result of the Iraq war, the sluggish economy and President George W. Bush's tax cuts. If demand for that debt falls at the same time, interest rates could rise.
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Treasury Secretary John Snow called Thursday for Congress to approve Bush's tax cuts, saying they would "stimulate consumer spending and small business investment," AFX News reported from Orlando, Florida.
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