New York Times: The Dollar's Long-Term Direction: Down

The Dollar's Long-Term Direction: Down
By EDUARDO PORTER and ELIZABETH BECKER

New York Times

November 4, 2004

The election drove the dollar all over - down when it looked like President Bush would lose, up briefly when Senator Kerry conceded defeat.

But ultimately, the dollar's fate never hinged on the outcome of the presidential election. Now that the dust has settled, the currency is back on its long-term path: downward. According to most economists, it is likely to stay there over the next four years.

"There is a certain inevitability to the decline,'' said Alan Blinder, an economist at Princeton University who served as vice chairman of the Federal Reserve and was an adviser to President Bill Clinton. "I think the Treasury understands this. It would be nice if they would say so."

Managing this potentially painful move will be a pressing challenge for Mr. Bush's economic team. The nation's current account - the broad gap between the nation's exports and imports of goods and services - has reached a deficit of nearly $600 billion, almost 6 percent of the nation's overall economic activity. And it shows no signs of diminishing on its own.

Closing this gaping hole will overshadow the administration's trade policy, coloring its push for better access to foreign markets for American products, and adding urgency to its attempts to make China and other Asian nations revalue their currencies against the dollar so that American industry can be more competitive.

Today, the dollar is at the center of a delicate interlocking web of international financial imbalances. The United States imports much more than it exports. Asian countries - some of the biggest exporters - send the proceeds back into the United States by investing here, mostly in government bonds. That keeps interest rates low, fueling spending and leading Americans to import even more goods and services from the rest of the world.

Both sides benefit from this arrangement. The Asian money allows Americans to spend beyond their means. At the same time, dollar purchases by Asian central banks depress the value of Asian currencies, stimulating their exports to the American market.

An influential group of economists has argued that there is no reason that this imbalance cannot go on relatively undisturbed - if not forever, at least for a very long time. But most mainstream economists argue that, at a minimum, the unraveling of this web would send the dollar lower and squeeze American consumption.

Kenneth Rogoff, a professor of economics at Harvard, said that to smoothly and significantly narrow the current account deficit requires a depreciation of at least 20 percent in the dollar, making it much more costly for Americans to buy imported goods and travel abroad.

The imbalance is fueling a stupendous buildup of foreign debt in the United States. At the end of last year, the nation's net financial deficit - broadly, what Americans owe the rest of the world minus what the rest of the world owes to the United States - amounted to nearly 30 percent of total output. And both sides are digging themselves deeper into holes, with American debts mounting and foreigners acquiring ever greater piles of depreciating paper assets.

Economists who speak of the current account deficit often quote the economist Herb Stein: "If something cannot go on forever, it will stop.''

So what will it take for the brakes to be applied? Barry Eichengreen, a professor of economics at the University of California, Berkeley, argues that Asian policy makers are going to force a change. He contents that as they move away from their present export-led growth strategies, which require cheap currencies, to focus monetary policy on managing internal demand, Asian governments will support the dollar less, buy fewer Treasury bonds and shift some of their foreign reserves to other currencies, like euros.

Indeed, China's decision to raise interest rates last week put upward pressure on the yuan and indicated a willingness to take market-based measures to cool its galloping economy.

"Asian policy is changing," Mr. Eichengreen said. "The end is growing increasingly near."

This suggests that President Bush's efforts to maintain open markets will increasingly be up to others. The United States' leading trade partners - Europeans, Asians and even Canadians - are promising more challenges to Washington on trade issues, bringing disputes to the World Trade Organization and going after new markets as well.

A cheaper dollar would stimulate American exports but would create some conflicts with other countries. And a dollar depreciation, on its own, would do little to curb the nation's dependence on foreign money. For a devaluation to work effectively, economists explain that other measures to reduce the nation's excess spending are needed as well.

The situation, some suggested, is analogous to the problems faced by Ronald Reagan early in his second term, when the United States, despite robust growth, suffered from an expensive dollar, weak exports and big deficits.

In 1986, the administration negotiated the Plaza Agreement with six other major industrial powers, helping pave the way to a manageable, if sometimes rocky, 40 percent decline in the value of the dollar.

"We have to do something similar to get the value of the dollar down and not wait for a market adjustment which could be more damaging to the economy," said Robert E. Scott, of the liberal Economic Policy Institute in Washington.

The strategy worked for Mr. Reagan because he also pushed through a couple of tax increases that helped narrow the budget gap. Economists are not very confident, however, that a second Bush administration would be prepared to do something similar.

That could leave the economy vulnerable to a more painful adjustment, with the dollar falling rapidly and interest rates rising fast. The result would almost certainly lead to a recession and perhaps a collapse in the real estate market.

"There is a real possibility,'' Catherine Mann, an economist at the Institute for International Economics, wrote in a study earlier this year, "that the entanglements created by this co-dependency cannot be undone by anything short of a global economic crisis."