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Economic AnalysisThe Dollar Is Down, but Should Anyone Care?

November 16, 2004



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


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


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


"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


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


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."


Copyright 2004 The New York Times Company

Dollar's Decline Is Reverberating

Sun Nov 14, 755 AM ET

By David Streitfeld Times Staff Writer

During a routine sale of U.S. Treasury bonds in early September, one of the essential pillars holding up the economy suddenly disappeared. home page

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Foreigners have been regularly buying nearly half of all debt issued by the U.S. government. On Sept. 9, for the first time that anyone could remember, they stayed home.

"Thoughts of panic flickered out there," said Sadakichi Robbins, head of global fixed-income trading at Bank Julius Baer.

The foreigners returned in force at the next Treasury auction, and Sept. 9 was quickly dismissed as an aberration.

But the episode demonstrated how much the U.S. economy is dependent on other countries to bankroll its free-spending ways. That fragility is becoming even more precarious because of recent declines in the U.S. dollar to multiyear lows, some economists say.

Amid worries about bulging U.S. budget and trade deficits, the greenback dropped last week to a record low against the 5-year-old euro, a 12-year low against the Canadian dollar and a nine-year low against an index of major currencies. Many analysts don't see anything that will stop the decline.

A cheaper dollar reduces the value of American securities, making them less attractive to foreign investors. That could eventually precipitate what Robbins called "the doomsday scenario"  Japan and China not only refusing to buy U.S. bonds, but selling some of their $1.3 trillion in reserves.

The only way Uncle Sam could then find new customers for its IOUs would be by raising interest rates. And although higher rates are good for savers, they would be disastrous for a country weaned on cheap credit.

"Sometime soon, the falling dollar is going to show up in rising inflation, rising interest rates and a falling standard of living," said Harry Chernoff, an economist with Pathfinder Capital Advisors. "The housing and mortgage markets, which benefited the most from declining interest rates over the past few years, are likely to feel the most pain."

Not everyone agrees that suffering is imminent. The National Assn. of Manufacturers calls the dollar doomsayers "all but hysterical." Manufacturers and produce growers like a cheap dollar because it makes their products more affordable in foreign markets.

Even some foreigners like the low dollar. China has pegged its currency to the dollar. A weak greenback means a weak yuan, making Chinese goods cheaper in foreign markets and fueling the nation's economic boom.

To most American consumers, a falling dollar is more an annoyance than cause for alarm. It raises the price of a cup of coffee to outlandish levels during a Paris vacation, and may cause second thoughts about buying a more expensive Volkswagen.

But a number of economists and academics say there are real reasons for concern. If the dollar falls too far too quickly, they say, those all-important foreign investors will abandon the U.S. in favor of stabler places.

Indeed, there are signs that such an exodus might have already started.

In August, the most recent period for which there's data, foreign private investors sold $2 billion more in U.S. stocks than they bought, the Treasury said. Meanwhile, they dumped $4 billion more in government bonds than they purchased.

"A run for the exits could happen any day, that's for sure," said C. Fred Bergsten, author of "Dollar Overvaluation and the World Economy" and director of the Institute for International Economics, a Washington think tank.

Such a prospect creates a tricky balancing act for policy makers. As long as the dollar devalues in a slow and orderly way, and doesn't trigger panic selling of American securities, Bush administration officials appear to be comfortable with the fall. As they see it, the benefits of boosting the economy through higher exports outweigh the drawbacks.

The administration approach could work out fine in the short run, economists say. But eventually the slide must stop. Few countries can maintain strong economies with a debased currency.

Indeed, if a weak currency was the prescription for long-run economic health, countries like Argentina and Mexico  which have suffered massive currency devaluations in the last decade  would be financial titans.

Ultimately, these economists say, the solution is for the U.S. government to reduce its massive budget deficit. That would curb the need for Uncle Sam to issue so many Treasury notes. And the dollar would rise on its own, because the deficit is the main reason it continues to fall.

Having China decouple the yuan from the dollar also could help, economists say. It's a step the Bush administration has sought from Beijing, with little progress.

Under the best scenario, economist Bergsten sees China acceding to American pressure and easing or dropping the yuan-dollar peg by the end of the year.

Allowing the yuan to float upward would raise the price of Chinese goods in this country and reduce the U.S. trade deficit with the new Asian powerhouse, estimated to be $150 billion this year.

But if the Chinese resist, the euro will rise even further. It could move up from last week's $1.30 to $2, Bergsten said. Three years ago, it was worth 84 cents.

That ascent would upset the Europeans, whose exports would suffer and whose economies are already struggling. Central bankers usually speak in measured tones, but European Central Bank President Jean-Claude Trichet was moved last week to call the euro's rise "brutal" and "not welcome."

Neither the dollar nor the deficits became a hot-button issue during the presidential campaign, for obvious reasons. No politician has ever won an election by telling people their standard of living is going to go down, particularly at a moment when it's so easy to get a loan.

"The insidious thing about deficits is that they go on as long as the markets allow them to go on," said Maurice Obstfeld, an economics professor at UC Berkeley and author of many works on global capital markets.

"So people get lulled into the certainty they'll always be able to borrow at low rates, and that this is right and normal and an endorsement of their behavior," he said. "But it has to stop at some point."

A slump in the dollar also has been providing immediate benefits for some businesses, particularly multinationals but also smaller firms.

"There's all this scare stuff about the falling dollar, but it's allowing us to compete in the marketplace more effectively," said Stephanie Harkness, chief executive of Pacific Plastics & Engineering in Soquel, Calif.

Eighteen months ago, Pacific Plastics built a plant in Bangalore, India. It now employs 48 people there and 86 in Soquel.

"Our customers can save 50% when we produce molds for them in India rather than here," Harkness said. "My ideal scenario is not to have a plant in California at all."

If Pacific Plastics' bottom line is improving, the government's is steadily getting worse. The gap between what it spent and what it took in during the fiscal year that ended Sept. 30 was $413 billion, a record.

This week, Congress will have to raise the government's $7.4-trillion debt ceiling so it can borrow more money. According to the nonpartisan Congressional Budget Office (news - web sites), by 2008 nearly 10% of the budget will be devoted to interest payments.

President Bush (news - web sites) has pledged to halve the deficit by 2008. Many economists say that will be difficult, if not impossible, without raising taxes, something Bush has pledged not to do.

In his postelection news conference, the president said the economy could grow its way out of trouble.

"As the revenue streams increase, coupled with fiscal discipline, you'll see the deficit shrinking," he said.

The stock market soared on Bush's remarks, but the currency markets rendered a different verdict. The dollar continued to fall.

It's not only the government that is profligate. The U.S. current account deficit  the broadest measure of international trade, including exports, imports, services and investments  rose in the second quarter to $166 billion, up 13% from the first quarter.

Much of the second-quarter shortfall was in goodsfor every $20 in products American manufacturers sent overseas, U.S. consumers bought $36 in foreign electronics, cars and other items.

The current account deficit has risen from 1% of gross domestic product in 1990 to 5.4%.

That doesn't seem like much, and in the short term it isn't, said James Gipson, chairman of the $7-billion equity mutual fund Clipper Fund, in a letter to shareholders. But just like credit card debt, it compounds over the long term.

"A slowly and likely growing share of our output of goods and services will go to provide comfortable retirements for the residents of Tokyo, not Topeka," Gipson wrote.

One trouble with owners in Tokyo is that they may decide they want to own something in India or China instead.

That's why the Sept. 9 auction prompted concern.

Usually indirect bidders, which include foreign governments, are heavy buyers at Treasury auctions. This time, their purchases were less than 3%. Traders speculated that Japan was finally calling it quits.

What happened was never explained, but neither was it repeated.

"It turned out to be a fluke," said Kim Rupert, managing director for global fixed-income analysis at Action Economics, a consulting firm. "But at first blush, it was 'Oh my gosh.' "