Where is the Dollar Headed?

Where is the Dollar Headed?

Vice President-Government Relations, AMTThe Association For Manufacturing Technology

The world is awash in dollars. It has been for a long time.

We have run more than a $700 billion trade deficit, 5 percent of our GDP, for more than three years. Eventually the laws of economics catch up to you. If you keep printing greenbacks, sooner or later the rest of the world will place a lower value on them. That time is upon us.

The problem for the Federal Reserve in the short run, (and that is the only perspective that Chairman Bernanke is taking at the present time), is that the way to increase the value of the dollar is to raise interest rates.

But, depending on who you are talking to, we are either in the midst of a recession or dangerously close to “negative growth.” We are also in the midst of a credit crisis. From either perspective, this is not the time to raise interest rates.

Indeed, the Federal has lowered its Federal Funds rate 200 basis points in the past few months. That is not a helpful strategy when the dollar is at an all-time low against gold and the Euro. It is highly likely to make the dollar even less attractive to investors, inducing even greater flight from it.

So what will be the effect of the falling dollar?

We are feeling the effect every day, as we fill up our cars with gas. Since petroleum is priced in dollars, it is no surprise that price at the gas station has doubled during the Bush Administration.

Of course, a good deal of that price increase has been the result of an international economic policy that has allowed India and China to grow at a record-breaking pace and has led to the greatest increase in world economic growth in the history of the world over the past four years, creating greater competition for scarce resources.

The U.S. economy has benefited greatly from the inexpensive goods and services from those (and other) Asian countries, who in turn have premised their growth, in part, on keeping their currencies cheap relative to the dollar. But industries such as tool and die, moulds, and castings have suffered as well, as what amounted to a currency subsidy has made it impossible for certain companies to compete against their Asian counterparts.

Interestingly, since the Chinese currency is tied directly to the dollar, Chinese goods are even more competitive relative to their European competitors than they were just a few years ago, (further undermining the currency basis of the world trading system created at Bretton Woods after the Second World War).

What is to be done about this situation?

In the short term very little is likely to be done by the Treasury or the Fed, other than to reiterate the mantra that they are in favor of a strong dollar. We certainly are not going to suddenly become significantly more conservative about petroleum consumption, which accounts for more than half of the deficit. Indeed, the Congress’s modest conservation legislation is aimed at a time horizon a decade away.

Fear of a trade war and deleterious inflationary effects keep us from imposing tariffs on Chinese goods to reduce the $253 billion deficit that accounts for more than a third of our deficit. And, with a one-to-five export-to-import ratio with China, it is hard to believe that we are going to export our way out of our bilateral imbalance, despite the fact that exports are at an all-time high and likely to increase dramatically this year as the lag effects of the weak dollar kick in.

What is likely is that the dollar will weaken further. Exports will benefit greatly, particularly capital goods exports, and, concomitantly, as one would suspect, imports will slow. Whether that will be enough to keep us from a deep recession, no one can predict. But it is likely to provide significant impetus towards living within our means.

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