**** The US Dollar & immenient Global Crisis ****
... great, great article & bullish for Gold.
With Strong Dollar, Questions of Stability
_____Special Report_____
• U.S. Economy
By Steven Pearlstein
Washington Post Staff Writer
Wednesday, October 18, 2000; Page E01
The U.S. steel and paper industries are reeling from a flood of cheap imports. On world markets, U.S. agricultural products are so uncompetitive that government subsidies to farmers are expected to double. American households have stopped saving while stock markets teeter. And every day, Americans continue to spend a billion dollars more than they produce, chalking up the biggest trade deficit ever recorded.
In different ways, all these are manifestations of what economists say is now the largest and most dangerous imbalance in the world's economy. And at the center of it--in some ways a cause, in other ways a symptom--is the strong American dollar.
For nearly a decade, the stated view of the U.S. government has been that a strong dollar is good for Americans. It is, according to Treasury Secretary Lawrence H. Summers, a reflection of the strength of the U.S. economy and of foreigners' desire to earn a higher rate of return by trading their euros and yen for dollars and investing them in American companies. That investment, in turn, has made the companies still more productive and more profitable, attracting still more foreign capital.
Now, however, a wide range of economists has concluded that this virtuous circle has gone about as far as it can go and that the dollar has risen to levels that are distorting the world economy. Figuring out how to stop it--or whether even to try--has become a hot debate among policymakers in Washington and around the world.
Just this week, for example, William Duisenberg, president of the European Central Bank, took the unusual step of publicly suggesting that Summers try to "talk down" the value of the dollar by amending his "strong dollar" mantra to include the notion that an ever-strengthening dollar is not desirable. The next day, Summers delivered his answer in the form of a crisp "no comment," which spoke volumes about his lack of interest in presiding over a retreat of a currency that now bears his signature.
There are essentially three camps in this debate: the alarmists, calling for active intervention; the optimists, who argue that the dollar actually isn't overvalued at all; and the realists, who argue that even if the dollar is too high, there is no effective or politically palatable way to deal with it. Below is a brief primer on the camps and their arguments.
The Alarmists
This group starts with the proposition that a dollar has been priced well above its proper value by massive flows of speculative investment capital into the United States. As a result, they argue, stock prices have been driven to irrationally exuberant levels, American products are being priced out of world markets and American consumers have been encouraged to consume huge quantities of cheap imports, racking up a $2 trillion debt to the rest of the world.
For example, the high dollar has essentially priced many American agricultural commodities out of world markets, despite the higher efficiency of American farms. To compensate, the government is facing the prospect of spending an extra $10 billion next year on emergency farm aid and subsidies.
At the same time, the U.S. forest and paper industry reports that it has been forced to close 36 mills in the last few years and shed 23,000 manufacturing jobs as a result of a surge in imports encouraged by the strong dollar. And this week, the steel industry descended on Washington to demand that the government do something about a surge of imports that, even in the midst of a booming economy, has driven down prices and production, squeezed most profits out of the industry and sent stock prices of most steel companies down to a dollar or two per share.
"Its looking very bleak," said Barry Solarz, policy director of the American Iron and Steel Institute, where officials warn that several companies could face bankruptcy in the coming months if the situation doesn't improve.
Others in the alarmist camp warn that the big problem with the strong dollar is that when it finally turns, it will come crashing down, bringing with it not simply the stock market and the U.S. economy but much of the world economy as well.
"What we know from history and elementary logic is that the seemingly unquenchable appetite for U.S. investment will turn around--and when it does, it could be very painful," said C. Fred Bergsten, head of the Institute for International Economics in Washington.
How bad would a crash of the dollar be? An economic simulation run by the Organization for Economic Cooperation and Development found that a 30 percent fall in the dollar--enough to put the U.S. economy back into trade balance--would likely send inflation soaring, prompt the Federal Reserve to raise interest rates 4 percentage points, drag stock prices down 25 percent and cut economic growth in half.
But as the world learned after recent crises in Mexico, Asia and Russia, financial markets overshoot on the way down just as they do on the way up, with even more dire implications for the U.S. and world economies. Should that happen and the dollar fall more than 30 percent, analysts warn that the United States almost certainly would be dragged into recession, bringing with it much of Latin America and Asia, where economies remain heavily reliant on exports to this country.
The alarmists hope that a combination of talk therapy and a few well-timed interventions by central bankers could nudge the dollar gradually back to where it belongs. That's how it was done the last time the dollar was too high, in 1985, and how the steam was let out of the Japanese yen back in 1998.
The Optimists
Countering the alarmists, the optimists respond with three arguments, each tinged with a bit of chauvinism.
The first is that the dollar is priced just about where it should be, considering the abysmal state of the Japanese economy and the slow progress Europe is making in restructuring its private economy. According to various Wall Street estimates, U.S. companies still offer an extra 5 percent return on investment when compared with companies in Europe, with an even greater advantage over Japanese firms. Until that advantage disappears--either because of a slowdown in U.S. productivity growth or a pickup in growth in the other major economies--there isn't anything anyone can or should do about the dollar, the optimists say.
"By our calculation, its the euro and the yen that are overpriced, not the dollar," said Paul Kimball, managing director of Morgan Stanley Dean Witter, reflecting an increasingly popular view on Wall Street.
Other optimists argue that even if the dollar is a bit overpriced, it's been a blessing because it has provided the fuel for the great American economic engine, which has kept the rest of the world's economy afloat over the last three years.
Where, they ask, would Europe's and Japan's economies be if not for the growth in exports to the United States that was encouraged by the strong dollar?
"The strong dollar right now is a blessing for Europe and a necessity for Japan," said Rudi Dornbusch, an economist at the Massachusetts Institute of Technology. "When the dollar weakens, believe me, it will be a big problem for both of them."
In the same vein, Ian Shepherdson of High Frequency Economics Ltd. notes that the U.S. economy could not have continued to grow so fast and absorb so many imports if not for the strong dollar, which has been a major factor in keeping inflation in check by holding down prices for goods that trade on world markets, such as clothes, cars and home entertainment equipment.
Finally, the optimists point out that while American manufacturers have lost market share and seen their profit margins squeezed as a result of the strong dollar, most are continuing to grow in spite of it.
"It's hurting, certainly, but we're not whining about it yet," said Paul Freedenberg of the Association for Manufacturing Technology, a McLean-based trade group representing machine-tool makers.
In the auto industry, for example, the strong dollar has helped foreign producers win an extra 3 percent of market share in the last two years. But the same dollar has also helped keep the economy so strong that consumers are buying record numbers of autos from U.S. producers as well.
"I'd be hard pressed to name more than a handful of industries that are on their backs because of the strength of the dollar," said G. Mustafa Mohatarem, chief economist at General Motors Corp.
The Realists
In the realist camp, probably the largest of the three, are those who acknowledge that the U.S. economy is running too hot and that an overpriced dollar is part of it. Their fear, however, is that whatever they might do to try to nudge the dollar down gradually either won't work or is politically unacceptable.
At the Treasury and the Fed, the general view is that it is a waste of money and credibility to intervene in currency markets by selling massive amounts of dollars and talking down the currency. This skepticism was only reinforced this week as the euro twice dipped below 85 cents, the point at which the United States, Japan and European central banks intervened last month in an attempt to halt its slide.
Theoretically, tinkering with interest rates would be another way to get the dollar down: If the Fed were to lower rates and Europe and Japan were to raise theirs, investors looking simply for the highest interest rates might be induced to sell their dollars and shift their money elsewhere.
But U.S. officials fear that, in the current environment, that would be riskier than doing nothing at all. In Europe and Japan, the higher rates could choke off whatever modest economic growth the countries are now experiencing. And here in the United States, lower rates would likely lead to an overheating of the economy, price inflation and eventually a crash of the bond and stock markets--precisely the outcome officials want to avoid.
There is, however, one technique that most economists agree would help bring the dollar to a soft landing: increasing the federal budget surplus. By raising taxes or cutting spending, the government would, in effect, enforce a savings regime on the profligate U.S. economy, reducing the amount of goods and serviced consumed. But at a time when presidential candidates of both parties are running on elaborate plans to cut taxes and spend the fiscal surplus, this would appear a most unlikely policy option.
"What politician do you know who is going to step forward and call for higher taxes or slower economic growth in order to satisfy some theoretical concern about a disorderly unwinding of the dollar?" asks economist Mohatarem at General Motors.
Bill Dudley, chief U.S. economist of Goldman Sachs Group Inc., sums up the realists' dilemma. "Once you review the options, you pretty quickly come to the realization that all you can really do is conduct good economic policy and keep your fingers crossed."
© 2000 The Washington Post Company |
