Uncertainties of a De-Valued Dollar

Uncertainties of a De-Valued Dollar

The U.S. dollar is not what it used to be.

Dr. Paul Freedenberg

Vice President-Government Relations, AMT—The Association For Manufacturing Technology

In the mid-1980s, while I was serving as an economist with the U.S. Senate Banking Committee, I was called by a reporter from the Economist magazine who asked if I thought that the dollar and the British pound would achieve parity with one another.

At that point the pound was selling at $1.03. Today it takes more than two dollars to buy a pound. The euro, which hit a valuation of $0.82 in summer of 2002, is now selling for more than $1.45.

Americans are justifiably concerned about what this will mean for their economic well-being.

No one can be sure of the direction that a currency will head, but with the U.S. current account deficit approaching $800 billion, about 6 percent of gross national product, it is likely that we are in for a further fall in the dollar’s value before things turn upward.

Fred Bergsten, the president of the Peterson Institute and former Assistant Secretary of the Treasury for International Affairs, predicted recently that we are likely to see a further 20 percent devaluation in the dollar before the current trend is reversed.

The rest of the world is becoming less confident that we can pay our $6 trillion (and growing) foreign debt, and our interest rates are not high enough to justify the additional risk that is entailed in purchasing dollar assets.

The Chinese government, one of our most important creditors, did not help matters when they announced that they were going to further diversify their foreign exchange currency portfolio and move away from dollar dependency.

That caused a 360 point drop in the Dow Jones industrial average.

“The Dow is measured in dollars not bananas,” noted an investment banker. “As the dollar loses value, U.S. stocks lose value.”

The news is not all bad.

With a less expensive dollar, exports are up this year, and that trend is expected to continue (particularly in durable goods). Indeed, export growth has been what has kept the economy from slipping into recession as a result of the credit crunch after the sub-prime mortgage collapse.

Surprisingly, the economy grew at a 4.9 percent pace in the third quarter. That trend is good for the readers of this magazine, so long as the credit and housing woes do not overwhelm the positive news.

The growth in exports should continue with the European Union and with Canada, our largest trading partner. Those countries allow free trade of their currencies.

The devaluation of a national currency is what is expected when a country buys more goods than it sells.

But the self-correcting foreign exchange mechanism is not working in Asia, where there is massive intervention in the currency markets by the national governments and their central banks.

The central banks of China and Japan hold approximately $1 trillion of our currency as reserves, and they are continuing to intervene monthly at a rate of tens of billions of dollars in order to keep their currencies cheap.

Apparently, both the U.S. and the Chinese governments see a benefit in China’s inexpensive currency, which is why there has been no change in policy over the past six years as the bilateral trade deficit has grown almost fourfold.

Thus, our bilateral trade deficit with China is likely to be a record $250 billion this year. If you add China to our soaring petroleum demands, the two account for well over half our overall trade deficit.

Clearly, the current path is unsustainable.

But if Congress attempts to legislate a solution to the problem with one of the many pending bills that sanction China for its mercantilist behavior, they are likely to make the situation worse.

There are not enough votes to pass such legislation over the President’s certain veto. But the resulting uncertainty from such a confrontation would spook both the U.S. and the world markets. Watch this issue closely. It should make for an interesting 2008.

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