The dollar's decline is not yet cause for alarm
BY JAMES K. GALBRAITH
James K. Galbraith is a professor at the LBJ School of Public Affairs at the University of Texas at Austin and a senior scholar at the Levy Economics Institute in New York.
December 3, 2004
Since the election the value of the dollar has declined more than 3 percent against the euro to an all-time low - and it continues to fall. Today's dollar jitters are no surprise; the few Keynesians left in the economics profession have long thought them overdue. Here's why:
We have worn down our trade position in the global economy, becoming dependent for our living standard on the willingness of the rest of the world to accept dollar assets - stocks, bonds and cash - in return for real goods and services.
In the late 1990s, the U.S. position was held up by the glamour of the information-technology boom, which brought capital flooding in from more precarious perches in Russia, Asia and other parts of the world. But that too has turned to dust and ashes.
The concentration of our manufactures trade on China and Japan means that those two countries now hold preposterous dollar reserves, and their actions substantially determine the dollar's value.
Chinese and Japanese behavior is constrained by creditors' risk. If they sell too many dollars, the value of the remainder of their portfolio plummets and they inflict losses on themselves. This consideration prompts caution. But if one major player gets wind that others may dump, caution could end. This is exactly analogous to an old-fashioned run on the bank.
Reducing the budget deficit will not save the dollar, contrary to what many Democrats may think. A bank, hit by a panic, cannot save itself by cutting its advertising budget, raising its fees or firing its staff. And once a rush gets going, jacking up interest rates won't stop it either.
So now we hear rumors of Russia trading dollars for euro, of India diversifying its reserves, of China contemplating the same. The Morgan Stanley economist Steven Roach apparently told clients to gird for an "economic Armageddon." The dike, once solid, starts to crack; none can say just where or when it will break. But the little Dutch boy, Alan Greenspan, went to Frankfurt a few days back and plainly stated that he did not have enough fingers.
The most stunning aspect of these events has been President George W. Bush's insouciance about them. It's almost as if he realizes the awful truth: that the dollar's decline is mainly good for his friends, and bad for those about whom he couldn't care less.
The dollar's decline immediately boosts the stock market. Multinationals have earnings in the United States and in Europe. When the dollar falls, U.S. earnings stay the same but the European earnings go up when measured in dollars. Oil prices in dollars will stay up - at least enough to prevent the price in euro from falling. This too helps U.S. oil company profits, measured in dollars.
Meanwhile, prices of Chinese imports won't rise much, so Wal-Mart isn't badly hurt. The American consumer gets hit, but mainly on the oil price. Few will recognize the political roots of their problem.
Since the United States owes its debts in dollars, financial losses will fall first on China and Japan. Tough luck. Latin-American debtor countries will get hit on their exports, but helped on their debt service. Those (like Mexico) that export almost exclusively to us will get squeezed; others (like Argentina) that market to Europe but pay interest in dollars will be hurt less.
An unequivocal loser is Europe, which has been hoping for an export-led fix to its own, largely self-inflicted, mass unemployment. The Europeans can forget about that.
It's possible that Federal Reserve Chairman Alan Greenspan could change his mind, raise interest rates and inflict on us all the monumental folly of a "dollar defense." Sharply rising interest rates could cure both inflation and the weak dollar - as they did in the early 1980s. But the resulting slump would be even more disastrous than it was then, because debt levels are higher now than they were.
I don't expect it. I bet Greenspan will take a pass. That means that he will actually sit on his hands while oil and some other import prices rise. Given the alternatives, it's probably the right course of action. But let no one say, afterward and with a straight face, that our central bank takes all that seriously the bunkum it spreads about fighting inflation.
Thus the dollar could decline smoothly for a while and then, simply, stop declining. The dollar system could stay intact, so long as China and Japan remain willing to add new dollars to their depreciated hoards. A final panic could come later, set off perhaps by some new reckless military action. But for the moment, the theater has too few exits, too few spectators. Perhaps God really does look after children, small dogs and the United States.
Copyright © 2004, Newsday, Inc.