U.S. dollar slide sounds warning
By BARRIE McKENNA
From Saturday's Globe and Mail
Washington — The greenback is about to lose its signature hue in a historic makeover designed to foil counterfeiters.
But the colour change, set to be unveiled next week by U.S. Treasury Secretary John Snow and Federal Reserve Board chairman Alan Greenspan, will do little to save the mighty U.S. dollar.
The dollar is in the throes of a dramatic and potentially cataclysmic slide against most major currencies — including the euro and the loonie — that is sending shivers through financial markets.
Since January, 2002, the dollar has lost 17 per cent of its value on a trade-weighted basis against a basket of other major currencies. The slide has been even more pronounced against the surging euro, which has gained 36 per cent in the past two years to $1.15 (U.S.) — its highest level since its launch in January, 1999.
Even the long-suffering Canadian dollar is up 15 per cent from its lows of recent years, at nearly 72 cents.
Investors, corporate executives, traders and central bankers are now watching anxiously to see whether this is just a healthy correction, or a fundamental post-Second World War realignment that could wreck the U.S. economy and shift the epicentre of growth.
"Every time currencies move up or down people fret because it's the most fundamental price in a market economy," explained economist Peter Morici, an international business professor at the University of Maryland.
The U.S. dollar's fall from grace was probably inevitable, and not entirely unwelcome, at least for the stalled U.S. economy. A cheaper dollar makes U.S. exports cheaper and its workers more efficient, helping to unwind the colossal trade deficit it built up with the rest of the world over the latter part of the past century.
"Barring a crash landing, a weaker dollar is exactly what a dysfunctional global economy needs," suggested Stephen Roach, chief economist at Morgan Stanley. "An unbalanced world is in increasingly desperate need of a rebalancing — less domestic demand growth in America and more elsewhere around the world. A weaker dollar may well be the only way to achieve such a result."
Even Mr. Snow and Mr. Greenspan are probably quietly rooting for a weaker dollar. Concerned about possible deflation at home, a lower dollar has the effect of importing inflation from the rest of the world by making foreign cars, electronics and everything else more expensive here. With relatively little room to inject more interest-rate relief into the U.S. economy, Mr. Greenspan can get much of the same benefit via a cheaper dollar, including an economic lift and a counterweight to falling prices.
The Fed's own models show that every 5-per-cent decline in the dollar can deliver the same economic punch as a half-a-percentage-point cut in interest rates.
In spite of some quiet U.S. glee, the benefits of a weaker dollar are a lot less clear for the rest of the planet — at least in the short term. Europe, already suffering a deeper economic slump than the United States, will face an even tougher time selling its products on world markets. The same is true of export-dependent Japan, whose central bank has been vigorously fighting the yen's appreciation, as it battles its own deflation woes.
And clearly, the greenback's retreat also hurts Canada, which generates nearly a third of its economic activity exporting cars, paper, energy and the like to the United States.
A rare exception to the trend is China, which although responsible for a large chunk of the U.S. trade deficit, has its currency, the yuan, pegged to the dollar.
There's no doubt that it's been a good ride for the dollar since the end of the Second World War. During that time, the dollar has emerged as the dominant world currency. Half of all exports, most oil transactions and nearly 70 per cent of all foreign central bank reserves are in U.S. dollars.
Because the U.S. dollar is the foreign currency reserve of choice, the United States has enjoyed what amounts to an unlimited line of credit with the rest of the world, argued Virendra Singh, a senior economist at forecaster Economy.Com. This has allowed Americans to buy goods and services from the rest of the world, and pay for them in dollars. The foreign sellers, likewise, have invested their profits in dollars, helping to finance the U.S. deficit and debt.
"So, in theory, the U.S. can keep borrowing and spending ad infinitum as long as the rest of the world uses the dollar for international transactions," Mr. Singh said.
And that's where the story of the dollar becomes tricky. The world could easily adjust if the U.S. dollar gradually found a new level of equilibrium. But a freefall is what makes people nervous.
"The free ride may be coming to an end," Mr. Singh suggested.
With its global line of credit, the United States has amassed a huge current account deficit — the gap between the foreign assets Americans own and the U.S. assets owned by foreigners. It hit a record of more than $500-billion in 2002.
If foreigners repatriate their money in a panic, the dollar's slide could soon look more like a fall off a cliff. That would have disastrous effects for U.S. financial markets and could jeopardize the international financial system.
Just as likely, however, a lower dollar will make U.S. assets appear more attractive and affordable to foreigners. And that's just what happened in 1995, the last time the dollar slumped.
"Foreign investors were lining up to buy U.S. companies," said Carl Weinberg, chief economist at High Frequency Economics in Valhalla, N.Y.
Interestingly, it is the rise of the euro, as much as the fall of the dollar, that is threatening to remake the world financial order.
The euro's emergence has provided a stable alternative, particularly for central banks. Several countries, including Canada, have switched a greater share of their reserves into euro-denominated assets since 1999.
Oddly, one of the first countries to begin the switch to the euro was Iraq, which converted roughly $10-billion of its oil revenues in late 2000 into euros just to stick it to the United States.
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