December 24, 2003
by Irwin Stelzer
“Down and down I go, . . . in a spin, loving the spin that I’m in . . .,” wrote Harold Arlen and Johnny Mercer some sixty years ago. Now, U.S. Treasury secretary John Snow has adopted that great old standard as his slogan for the dollar. In fact, there is very little that Snow can do to reverse the downward course of the dollar. Unless, of course, he intervenes in currency markets and buys prodigious amounts of dollars – which he is not prepared to do for the very sensible reason that such efforts are, in the end, doomed to fail.
The only other person who could take meaningful action is Federal Reserve chairman Alan Greenspan. Were he to raise interest rates, thereby increasing the return on U.S. dollar assets, he might induce some of the investors who are rebalancing their portfolios away from such assets to change course. But Greenspan has promised not to raise interest rates for a good long while, which the politically savvy take to mean not until after the presidential election in November. Having hurt the reelection chances of one Bush by failing to stimulate the economy in time to ward off Bill Clinton’s “It’s the economy, stupid” campaign, the Fed chief is reluctant to risk dampening the current recovery in the midst of George W.’s reelection campaign.
Until very recently, the dollars flowing out as a result of the huge trade deficits created by America’s appetite for foreign goods have been offset by a return flow of dollars invested in American assets. No longer.
To fund its trade deficit, Americamust attract about $47 billion in net foreign investment every month. In the first eight months of this year that target was met: net inflows averaged about $60 billion. In September that figure fell to $4.2 billion, the lowest level since 1988. A recovery in October brought net inflows to $27.7 billion, better, but not good enough to cover the trade deficit.
Investors are dumping U.S.assets. British investors were ahead of other nationals: whereas in 2001 their net investment in U.S. businesses and factories (but not shares) came to £24 billion, last year they pulled over £8 billion more from America than they put in.
Others are following suit, especially with their holdings of shares in U.S.companies. Last year, foreigners bought $49 billion more in U.S.equities than Americans invested abroad. In the first ten months of this year the flow has been reversed, with net outflows from U.S.shares exceeding $50 billion. Asiaseems to be one of the investment locations of choice these days.
Of course, the dollar is still being supported by China. To keep their economy growing fast enough so that some of the millions migrating to the nation’s cities can find jobs in export-led industries, the authorities continue to buy U.S. Treasury bonds with the dollars they earn by selling all manner of goods to America, although at a somewhat slower pace. Added support comes from Japan, which periodically buys dollars to keep the American currency from dipping too far against the yen. Which is one reason why the dollar remains stronger relative to the currencies of all of its trading partners than it has been for most of the past 25 years, as Snow proudly points out.
All of which means that Europeand Britainare bearing the brunt of the dollar’s adjustment. The euro is closing in on $1.30, and the pound on $1.80. So far, this has not hurt UKexporters, who report that orders are at a three-year high. It seems that the burgeoning worldwide economic recovery, combined with the cheapening of the pound against the euro, have more than offset the rise of sterling against the dollar.
Euroland is not so lucky. The euro is up about 50% from its low against the dollar in 2000, and over 20% this year. In a reaffirmation of the warning to be careful what you wish for, Europe’s ministers are reaping the harvest from the seeds they sowed at the G-7 meeting in September, when they agreed to a communiqué saying that “more flexibility in exchange rates is desirable.”
The higher euro is already causing serious problems for euroland exporters, especially those in Germany. German banks are also hard hit, as they are forced to write down the value of their dollar reserves. “I’ve no desire to see the euro appreciate because I think that we have already some difficulties,” says Romano Prodi, president of the European Commission.
Meanwhile, back in America, the White House is doing its best to conceal its glee at the dollar’s decline. As the politicians see it, the advantage accorded to export industries should add to job creation in coming months, and the higher cost of imports should dampen American consumers’ enthusiasm for made-anywhere-else goods, and quiet special interest demands for protectionism.
Anecdotal evidence suggests that the White House has got it right. Analysts I talk to say their client companies’ export order books are swelling. And British customers are swarming into New York’s stores to snap up the bargains created by the cheaper dollar.
Again, the pols better be careful what they wish for. A realignment of the world’s currencies, with the dollar gradually weakening, will indeed help to correct the trade imbalances that have persisted for so long. But the realignment will not be costless for America. Oil will cost more, as OPEC raises prices to make up for the declining purchasing power of the dollar. Other imports will also become more expensive, relieving some of the pressure that, along with ample spare capacity, has kept domestic producers from raising prices. Sooner or later, that means interest rates must rise.
Until then, American policymakers can remain under the spell of “that old black magic,” and ignore the price that will inevitably have to be paid. That price should prove tolerable, but it will not be the free lunch on which politicians prefer to dine.
This article appeared in London’s Sunday Times on December 21, 2003.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.
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