[Mb-civic] NYTimes.com Article: Economic Analysis: The Dollar Is Down, but Should Anyone Care?

Tue Nov 16 08:27:32 PST 2004

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Economic Analysis: The Dollar Is Down, but Should Anyone Care?

November 16, 2004
 By EDMUND L. ANDREWS 

WASHINGTON, Nov. 15 - It sounds eerily like the worst
economic nightmare for President Bush's second term. 

Bogged down in a costly war that shows no sign of ending,
the United States faces a gaping budget deficit and
ballooning foreign indebtedness. The dollar plunges against
other major currencies, while turmoil in the Middle East
sends oil prices soaring. The rest of the decade is plagued
by rising inflation, increased joblessness and sky-high
interest rates. 

But the president under fire was Richard M. Nixon - not
George W. Bush. The war was in Vietnam, not Iraq. And the
dollar crash was in 1973 rather than 2005. 

Could it happen again? With the dollar down more than 40
percent against the euro since 2002, and hitting new lows
since Mr. Bush's re-election, economists are debating
whether America's foreign indebtedness could lead to a
collapse in the dollar and a global financial crisis. 

The United States is spending nearly $600 billion more a
year than it produces, almost 6 percent of its annual gross
domestic product. Much of that spending has been financed
by Asian governments, which bought more than $1 trillion in
Treasury securities and other dollar assets in the last two
years to help keep the dollar strong against Asian
currencies. 

Many analysts expect the financing gap to widen and the
dollar to decline further. But there are at least three
schools of thought on whether a dollar collapse is likely
and, if it happens, what it would mean. 

One group, which includes the Federal Reserve chairman,
Alan Greenspan, contends that global financial markets are
awash in so much money that the United States can borrow
much more than seemed possible 20 years ago. 

The dollar may well decline in value, according to this
view, but the decline would be gradual and would help
reduce American trade imbalances by making exports cheaper
and imports more expensive. 

The Bush administration goes one step further, arguing that
America's huge foreign debt simply reflects the eagerness
of others to invest here. 

"Productivity has been remarkably high in the last few
years," John Taylor, deputy secretary of the Treasury, said
at a recent conference. "Foreigners want to invest in the
United States. That's what that gap illustrates." 

A second school of thought holds that foreign governments
like China and Japan will continue to finance American
borrowing and keep the dollar strong because they are
determined to sustain their exports and create jobs. 

But a third school, which includes officials at the
International Monetary Fund, worries about a collapse in
the dollar that would send shock waves through the global
economy. 

That group argues that the dollar needs to depreciate
another 20 percent against the other major currencies but
warns about a run on the dollar that could reduce its value
by 40 percent. 

A collapse of that size would severely affect Europe and
Asia, which have relied heavily on exports to the United
States for their growth. 

A steep drop in the dollar could lead to higher interest
rates for the federal government and American private
borrowers, as foreign investors demanded higher returns to
compensate for higher risk. And it could expose hidden
weaknesses among financial institutions and hedge funds
caught unprepared. 

"There is a school of thought that the U.S. can keep
borrowing forever," said Kenneth S. Rogoff, professor of
economics at Harvard University and a former chief
economist at the I.M.F. "But if you add up all the excess
saving being thrown out by the surplus countries, from
China to Germany, the United States is soaking up
three-quarters of it right now." 

For Mr. Rogoff and several other economists, the question
is not whether the dollar declines - but how fast and how
far the fall turns out to be. 

The United States current account deficit, which
encompasses annual trade as well as the balance of
financial flows, has gone from zero in 1990 to nearly $600
billion this year. The United States' accumulated debt to
foreign investors is $2.6 trillion, or 23 percent of the
annual output of the economy. 

But where foreign investors in the 1990's poured trillions
of dollars into American stocks and corporate acquisitions,
investment from abroad now comes mostly from foreign
central banks and goes heavily to buying Treasury
securities that finance the federal deficit. 

Catherine Mann, a senior economist at the Institute for
International Economics in Washington, said today's
financing gap could be expected to widen. Part of the
problem lies with Europe and Japan, which grow more slowly
than the United States and import less than they export. 

Higher costs of imported oil will aggravate the trade
deficit even more, Ms. Mann said, and the federal
government will be paying foreigners higher interest rates
on its rapidly growing debt. 

"You have a dynamic that links government deficits to
current accounts deficits more than has been the case
before," Ms. Mann said. "We are going to have a lot of
government securities out there, and a very high share of
those Treasuries are owned by foreign investors." 

But where Mr. Rogoff predicts that the dollar will slide
sharply over the next two years, Ms. Mann predicts that
Asian countries will continue to subsidize American
imbalances to keep their economies growing. A decline in
the dollar may be likely, but not a panicky flight by
foreign investors. 

The American dollar has been through several ups and downs
in recent decades. In 1973, it fell sharply against
Japanese and European currencies - the major industrialized
countries had already abandoned the system of fixed
exchange rates adopted at Bretton Woods after World War II.

The dollar rebounded strongly in the early and mid-1980's
in response to higher American interest rates, but then
plunged 40 percent after leaders from the United States,
Japan and Europe reached the so-called Plaza Accord in 1986
to nudge the dollar back down. The plunge after the Plaza
Accord caused few disruptions for Americans, and foreign
investors did not demand higher interest rates on
securities. 

"One theory is that investors were simply irrational," said
J. Bradford DeLong, a professor of economics at the
University of California, Berkeley. "Others said it was the
result of what Charles DeGaulle called the 'exorbitant
privilege' of being able to repay your debts in your own
currency." 

Some economists contend that the United States can postpone
its day of reckoning for years. Richard N. Cooper, a
professor of economics at Harvard, said the global pool of
savings was about 10 times the United States' appetite for
foreign capital last year and growing fast enough to easily
finance $500 billion a year. 

The wild card is that most of the money is coming not from
private investors but from foreign governments, led by
Japan and China. Rather than profits, their goal has been
to stabilize exchange rates and keep their exports from
becoming more expensive. 

Many economists contend that the Asian central banks have
created an informal version of the Bretton Woods system of
fixed exchange rates that lasted from shortly after World
War II until the early 1970's. 

The system collapsed after the imbalances between Europe
and the United States became impossible to reconcile. Rapid
growth is putting similar pressure on China, which has kept
its currency, the yuan, pegged at a fixed rate to the
dollar. 

The growing imbalances, in both China and the United
States, is one reason Mr. Rogoff is bracing for a jolt to
the dollar and the American economy similar to the one that
occurred in the early 1970's. 

Then, as now, the United States was running large budget
and trade deficits. Then, as now, the United States was
bogged down in a war costing billions of dollars a year.
And in 1974, a few months after the dollar plunged against
the German mark and Japanese yen, oil prices soared. 

"It's striking how many parallels there are between today
and the early 1970's," Mr. Rogoff said. "The loss of the
anchor of the dollar and fixed exchange rates contributed
to the inflation we saw in the 70's. It was the worst
period in growth we have had since World War II." 

http://www.nytimes.com/2004/11/16/business/16dollar.html?ex=1101622452&ei=1&en=76d7618f241c5b42

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