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  • From: "Marie McHarry" <mmcharry AT dtnspeed.net>
  • To: <homestead AT lists.ibiblio.org>
  • Subject: RE: [Homestead] Falling dollar
  • Date: Thu, 2 Dec 2004 19:04:12 -0600

This was published today on the American Prospect Web site. I think it's
available only to subscribers, so I post the whole thing for your reading
enjoyment (?).

The Amazing Shrinking Dollar
A serious recession may lurk just beyond the collapse of the dollar.
By Robert Kuttner
Web Exclusive: 12.02.04

I recently returned from Europe, where the dollar just hit a new low against
the euro. The European Union's new common currency, widely disparaged in
Washington as a bizarre idea that would never win acceptance, was worth
about 90 cents in 2002. Now it costs you $1.33 and is rising. The euro has
emerged as a worldwide rival to the greenback. It makes the United States a
bargain basement for visiting Europeans, while Europe is staggeringly
expensive for Americans.

What ails the dollar? Two things. Our trade deficit grows bigger every year,
as does our budget deficit. Both deficits require foreigners to supply
capital. The more capital they have to supply, the more nervous they get
about the dollar. Lately, private foreign investments in U.S. stocks and
bonds have both declined, leaving the United States precariously dependent
on two foreign central banks -- China and Japan -- to finance its twin
deficits.

The U.S. trade deficit is now close to 6 percent a year and rising. In
theory, a very cheap dollar should improve the trade balance by making
exports cheap and imports expensive. But it doesn't work out that way. For
one thing, many foreign producers, such as Japanese automakers, "price to
market." That means that when the yen rises against the dollar, they just
eat the cost in order to maintain their market share. So the dollar price of
a Toyota doesn't change and the trade deficit doesn't improve.

China, meanwhile, keeps its currency pegged to the dollar, so a cheaper
dollar doesn't improve our trade balance with the Chinese either. High oil
prices also worsen the trade deficit. Most oil transactions are priced in
dollars. As the dollar's value sinks, oil exporting nations just raise the
price of oil.

By continuing to increase the federal budget deficit, most recently with a
plan to privatize Social Security, the Bush administration only worsens the
problem. And there is a growing risk of a financial meltdown with the
following elements:

First, as foreign confidence in the dollar keeps shrinking, so does the
dollar. The Federal Reserve then has to raise interest rates defensively to
make investments in U.S. securities more attractive to foreigners.

But high interest rates slow U.S. economic growth, hurt the stock market,
and could contribute to a long-anticipated crash of housing prices.

We could face a serious recession with no easy cure, since the usual fix is
to run temporary deficits plus low interest rates. But in this case, overly
large deficits were part of the problem, and higher interest rates would be
necessary to prevent a further dollar collapse. But won't the Japanese and
Chinese central banks, whose economies rely so heavily on exports to the
United States, keep buying American bonds? Perhaps -- it's a kind of
co-dependency in which they willingly buy paper that is losing its value
because the exports help develop their real economies.

On the other hand, the United Staates is not just dependent on foreign
central bank purchases of bonds. Because our budget deficit eats up so much
domestic savings, our stock market and venture capital markets also are net
borrowers from abroad. In the past we have counted on the fact that the
American economy was so productive that foreigners, despite the trade
deficit, saw the United States as a smart place to invest. But if the dollar
is weak enough long enough, that investment starts drying up. U.S. financial
markets have been quavering lately because foreign investment flows are
dwindling.

How likely is this dire scenario? None other than Paul Volcker has said that
he thinks that the odds of a dollar crash in the next few years are
something like three in four.

The U.S. trade deficit has been a problem for more than a decade, but the
responsible fiscal policies of the Clinton years helped moderate it and also
led to a healthier dollar, which in turn allowed for lower interest rates.
In this virtuous circle, we enjoyed a period of sustained and balanced
growth.

What's remarkable about George W. Bush's immense deficits is how faint are
the voices of fiscally conservative Republicans and business leaders. The
Concord Coalition got immense publicity and respect during the deficit
crisis of George Bush Sr. and provided crucial business support for Bill
Clinton's efforts in 1993 to win a tax increase to reduce deficits. The
coalition still exists, but you hardly ever hear of it. It's as if business
is enjoying its tax cuts so much that the consequences be damned. It would
not be the first time that short-sightedness by a selfish financial elite
helped sink the U.S. economy.

Robert Kuttner is co-editor of The American Prospect. This column originally
appeared in the Boston Globe.

Copyright C 2004 by The American Prospect, Inc. Preferred Citation: Robert
Kuttner, "The Amazing Shrinking Dollar", The American Prospect Online, Dec
2, 2004. This article may not be resold, reprinted, or redistributed for
compensation of any kind without prior written permission from the author.
Direct questions about permissions to permissions AT prospect.org.





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