"The strong dollar is just beginning to go... As we write Europe's shared currency, the euro, is trading at a little over 92 U.S. cents."
This is what I wrote in UPI's "Au revoir, dollar!" Global View of May 17, 2002. Sixteen months on, with the euro up by a quarter at $1.145, the fall of the dollar may only have half begun.
One reason for saying this is that dollar weakness in the past eighteen months has been principally against the euro. Now it is beginning to be against the Japanese yen, which is flirting with a three-year high against the dollar.
Yet the appreciation of the yen against the dollar is still modest by comparison with the rally in the euro. The yen is up by about a fifth from its ultra-lows of early 2002 while the more volatile euro has soared by over one-third from one of its low points early in 2001. The Group of Seven industrialized country finance ministers (the United States, Japan, Britain, Germany, France, Canada, Italy) gave that strengthening yen trend a push at the weekend, with their statement as they emerged from a summit in Dubai.
"We emphasize that more flexibility in exchange rates is desirable for major countries or economic areas to promote smooth and widespread adjustments in the international financial system, based on market mechanisms," said the G7.
The way in which Japan and China and other Asian countries handle their currencies has become controversial of late as the United States worries about how to grow without running up a still larger deficit in the trade balance and in the current account -- the broadest measure of trade, including services and income payments as well as goods. The U.S. current account deficit is running at a record level of close to half a trillion dollars.
Japan and China are major exporters to the United States and import far less from it. In just the month of July, the United States recorded a deficit in trade in goods of $45 billion. Trade with China accounted for $11.3 billion of this deficit and trade with Japan for $5.9 billion, while trade with Western Europe accounted for $11.2 billion.
The U.S. government's view is that the value of China's yuan, which is controlled by the government, is artificially low. China is accumulating vast amounts of foreign exchange reserves because of its trade surplus. Japan, meanwhile, has followed a policy of talking the yen down and intervening directly in the foreign exchange market to sell yen and buy dollars when the yen has strengthened.
There is an element of beggar-your-neighbor in such policies. The total of global spending, or global demand for goods and services in economics-speak, must be shared between countries. A country that deliberately keeps its currency weak makes its exports competitive and prices other countries out of its market. It shifts demand to its products and away from those of other countries.
Now the G7, of which Japan is part, is calling for an end to this government manipulation of the currency market. Let exchange rates float is what they are suggesting: a view this correspondent would endorse. The global forex market took note and bid the yen up and the dollar down. China, which is not part of the G7, may be less tractable.
These exchange rate shifts are something the G7 called for but the overall tone of the statement was, as normal, positive on the state of the world. "Recent data indicate that a global recovery is underway. Equity markets have rebounded, confidence has increased, financial conditions have improved, oil prices are expected to remain stable and inflation is under control." That is the official line.
But the G7 statement did hint at some of the problems that should trouble us. "For growth to strengthen, be sustained and be less unbalanced," it said, "structural reforms must be accelerated." It is the "less unbalanced" that holds the key. The imbalance is double: imbalance built upon imbalance.
The first imbalance we have mentioned already: the global reliance on the United States to provide most of the growth in demand for goods and services-the reason, accordingly, for the mammoth U.S. current account deficit. But that reliance is made all the more dangerous by the imbalance of the U.S. economy itself.
More than half the U.S. economy's growth in the second quarter was supplied by defense spending-and the fiscal deficit is already a record in nominal terms. Another motor for growth is the refinancing boom created by low interest rates. In other words, rising household debt, backed by spiraling house prices, is funding economic growth. How safe is that? What if house prices fall?
Those are the dangers we see. The U.S. government's line, however, is sanguine. What it wants primarily is a little shift in currency alignments. John Snow, the Treasury secretary, still declares himself in favor of a strong dollar but, after a year and a half of marked weakening in the dollar, he wants some more. Then, if Japan and Europe take more U.S. exports, the U.S. economy will be bolstered and the trade and current account deficits curbed.
But our belief is that much more than a small currency shift is going to be required. The U.S. engine is running on dirty fuel again. Once that fuel was the stock market, now it is the housing market and government spending and tax cuts the government can ill afford. The fuel is going to be exhausted soon and will leave many contaminants behind.
Our expectation is that when the fuel runs out, U.S. growth will fall heavily -- and so, too, will the U.S. dollar. We would be surprised if the euro did not in 2004 climb to a value of $1.30, and probably higher. The yen, too, may rise, if there is, as now seems probable, no intervention, but probably by less. Japan's economy continues to rely heavily on exports and U.S. demand.
A weak dollar will not do either Japan or Europe any favors, but it will be part of the way in which the U.S. economy beings to rebalance and repair itself. A weak dollar will favor U.S. exports but may push up the interest rates on U.S. Treasury bonds. That would tend to tip the United States towards another adjustment it cannot do without: a recession.
Global View is a weekly column in which our economics correspondent reflects on issues of importance for the global economy. Comments to [email protected]
