November 22, 2004
by Irwin Stelzer
There is indeed something new in financial markets: overseas followers of the Bush administration's so-called "strong dollar policy" are learning the meaning of the American colloquialism "Snow Job." As America's traders know, that means deception, accomplished by burying the listener under a meaningless flow of what Eliza Doolittle contemptuously called, "words, words, words."
When treasury secretary John Snow last week once again assured the world that the U.S. is devoted to "a strong dollar," traders snorted "Snow Job," and continued to sell dollars. In China, long lines formed at banks as depositors withdrew their dollar accounts and converted them to euros, yen or even China's own currency. The few dollar bulls that can be found think the decline will end soon, because they expect China to respond to the pressure that President Bush is exerting in an effort to get that country's authorities to relax the yuan's peg with the dollar, allowing the American currency to rise against its Chinese counterpart. My guess is that the Chinese authorities will continue to say the right words about their long-run intentions, and might even allow a tiny adjustment. But it will not be of a sufficient magnitude to have a major impact on currency markets.
So Europe will continue to find itself hit by a double whammy, the "brutal" effect on Europe's already sclerotic economies that has Jean-Claude Trichet, president of the European Central Bank, so upset. The euro is bearing almost the entire weight of the falling dollar, making euroland exports dearer in America. Meanwhile, the Chinese currency falls along with the dollar, giving China's exporters an even greater competitive edge in Europe's markets. This is not all bad. As Nicholas Garganas, governor of the Bank of Greece, told the Financial Times, the strong euro is offsetting the inflationary impact of higher oil prices, since it now takes fewer euros to buy the dollars that are used to pay for oil.
Europe's politicians have serially found excuses for their nations' stagnation, rather than reforming their labor and product markets, and lowering the crushing burden of taxation. But even for them it is stretching things to blame the euro's climb against the dollar for their economies' failure to grow and persistently high long-term unemployment. After all, so far this year the euro has risen only 3.5% against the dollar, the smallest increase in the past three years. And eurostagnation preceded the recent dollar dip.
By contrast, the American economy is powering ahead. Industrial production rose in October, and was 5.2% above last year's level. Housing starts in October were 6.4% above the prior month, and 2.2% above the October 2003 level. Retail spending was up sharply last month. Consumer confidence is up, partly as a result of the improving jobs market, and partly because the widely anticipated post-election delay in naming a winner just didn't happen. Share prices are so buoyant that a New York Times headline read "It Feels like the 90," and one in The Wall Street Journal referred to the "Current Mood of Euphoria."
Indeed, we hear less talk that the Federal Reserve Board's monetary policy authorities, having raised interest rates to 2%, might stop there. Not only is the economy doing well, but inflation picked up last month. Wholesale prices rose in October by 1.7%, the largest increase in fifteen years. Energy prices led the parade: no surprise there. But food prices (+1.6%), floor coverings (+0.8%), and construction machinery (+2.7%) also jumped. At the consumer level, food, housing and apparel prices were up in the past three months at annual rates of 3.4%, 2.6%, 2.3%, and medical care prices rose even more, by 3.9%.
It is not at all certain that this recent past is prologue. Industrial production may be up, but part of the increase "appears to reflect a partial bounceback from the restraining effects of the recent hurricanes," says the Fed. Housing starts may be up, but the number of building permits, a predictor of future activity, is running 1.5% below October 2003 levels. The price indexes may be up, but gasoline prices are easing, and food prices should come down when production returns to pre-hurricane levels. And the index of leading indicators, which is supposed to predict future economic activity, was down last month.
Still, it is hard to see how the economy can do anything but continue to move ahead at a rate somewhere between 3% and 4% -- or more. The fiscal deficit continues to provide a substantial stimulus, interest rates remain low, even after recent increases, consumers are feeling -- no, are -- richer as share prices rise to their highest level since March. The economy is creating something like 10,000 jobs every day, and the uncertainty surrounding the election is behind us. Business Week's tally of earnings at 900 companies shows that third- quarter profits were up 19%, below the 41% rise in the previous quarter, but still respectable. And the falling dollar is helping to stimulate exports.
All of this ignores the 800-pound gorilla sitting in the corner, as policy is being made in the re-energized White House: the budget deficit. Bush has promised not to raise taxes, but left himself some wiggle room by saying that he would consider closing some tax loopholes. "Closing loopholes" is political-speak for raising taxes. And his promise to press for a major reform of the tax structure, shifting the burden from incomes to consumption, may prove difficult to keep, given the president's recently revealed priorities.
Talk in Washington is that the president plans to move ahead first with reform of the social security system, and then turn to reforming the legal system to reduce the power of tort lawyers whose aggressive representation of victims of medical malpractice, Bush alleges, has driven up health-care costs. Meanwhile, he will appoint a commission to consider tax reform. By the time it reports, and especially if congress is unwilling to rein in spending, mounting deficits might produce pressure to combine only modest reforms with a few stealthy increases in taxes -- "loophole closing" and "revenue enhancement" by any other name smell like tax rises.
But not before Christmas, which should leave consumers plenty of spending money with which to snap up the inevitable bargains.
A version of this article appeared in The Sunday Times (London).
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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