|This is the kind of thing I've been ranting about for months -- years! --
and represents one of the bigger of the Three Bears that have been
threatening the "Goldilocks (low inflation/low unemployment) economy" to an
increasing extent. (The other Big Bear is consumer indebtedness -- see the
most recent LBO for Doug's [not me] analysis of this, which sounds a bit like mine.)
I thought I was going to get a popular article on this stuff published in
DOLLARS & SENSE but they seem to have fumbled my ball, so if it actually
does get published it might well be after the Bears chase Goldilocks back
into the woods -- or eat her.
If the Norris scenario plays out, it doesn't just mean that the Fed faces a
conflict between domestic goals (cutting rates to stimulate the sagging
economy) and international goals (protecting the US$'s vaunted status). A
rapid fall in the US$ -- which is quite possible given the rapid cuts in
rates and falling faith in US financial markets -- would mean a sudden
increase in the cost of imports to the US. That encourages inflation, which
would encourage the Fed to reverse rate cuts -- or even to hike them. Rate
hikes would fit with the visceral fear that Greenspan and other central
bankers have -- of inflation. A fall in the US$ would also encourage a
surge in the demand for US exports, which again would shiver Greenspan's
timbers. Luckily for the US, the vast majority of its external debt is in
US$ terms, so we wouldn't see a rapid fall in the financial system's net
worth. But a lot of the interest payments to the rest of the world are
fixed contractually (in US$), which means that there would continue to be a
big demand to convert those payments into Euros or whatever, despite the
fact that current interest rates are falling. That represents a further
pressure for the US$ to fall. It's true that a fall in the US$ eventually
would help the US trade deficit (and thus the deficit on the current
account) to improve, but the J-curve effect suggests that it'll get worse
before it gets better. (Even if trade moves seriously toward balance, the
current account deficit will persist because of the outstanding US external
debt and the resulting interest payments.)
Ways out include Dubya's proposed tax cut plan (which might moderate or
stop the recession while encouraging domestic interest rates to rise all
else equal, with the added benefit of handsomely rewarding Bushbaby's
friends) and international co-ordination of monetary policies to prevent
recession. A coordinated cut of interest rates might do the trick. I'll
have to check to see the extent that this has already happened (I think I
remember that the European Central Bank has emulated Greenspan's cuts to
some extent). The problem is that even coordination won't restore the
special status of the dollar that has kept it so high (as Norris suggests).
So the falling dollar is likely to happen anyway, encouraging an
inflationary shock to the US. Junior's tax cut also encourages Greedspan's
inflationary nightmares. So, quo vadis?
>NY Times, February 23, 2001
>The U.S. Trade Deficit Now Matters
>By FLOYD NORRIS
>Only a year ago, as the United States trade deficit set a record, there
>were warnings that something had to give. Surely the United States could
>not continue to buy $723 million a day more than it sold. The dollar would
>have to decline, it was said.
>The warnings were wrong. In 2000, the trade deficit grew an astonishing 40
>percent, to $1 billion a day. And the dollar rose against every major
>So we'll say it again. This can't go on forever. This is the year it will
>Not that many appear to be worried now. Wednesday's announcement of the
>record 2000 trade deficit got relatively little attention, and some even
>proclaimed it to be good news. "The trade deficit is not a problem to be
>fixed, but a symbol of America's global economic strength, a Good
>Housekeeping seal of approval from the world's investors," said Daniel
>Griswold of the Cato Institute.
>After all, he said, the flip side of a huge trade deficit is equally large
>foreign investments in this country. "Expanding trade deficits are almost
>always a sign of economic expansion and robust investment."
>The trade deficit has dipped a bit in recent months as the American economy
>slowed, but there is little chance it will decline substantially this year.
>The question is whether foreign investors will continue to send cash to
>this country to finance it. If they don't, Mr. Griswold said, "You'd see
>the dollar fall." He declined to guess how big the decline might be.
>Last year investors the world over were eager to invest in the so-called
>new economy, which was concentrated in this country. "More than 40 percent
>of investment in U.S. corporations by foreigners has been in high-tech
>areas, particularly telecom," noted Greg Jensen of Bridgewater Associates,
>a money management firm. By and large, those are investments the buyers now
>If equity investments in America look less enticing, how about bonds?
>Foreigners now own 38 percent of outstanding Treasuries and 20 percent of
>corporate bonds. But their incentive to buy more is not being increased by
>the Federal Reserve's efforts to lower interest rates.
>The dollar is now being supported not by the attractiveness of American
>investments, but by the unattractiveness of the competition. Japan
>continues to suffer more than a decade after its bubble burst. The euro has
>recovered some ground, but Europe's unemployment remains high and
>investment opportunities are limited. Still, it is hard to believe that the
>competition is ugly enough to keep $1 billion a day flowing into declining
>If the United States fell into a severe recession, the trade deficit would
>decline, but foreign investments would probably decline more rapidly. Would
>the Fed raise rates to support the dollar, or cut them to help the economy?
>Would Congress pass ill-advised protectionist legislation?
>Alan Greenspan would not like to find out the answers to those questions.
>So he is trying to sound confident about the economy while slashing
>interest rates. But the markets are not cooperating. Nasdaq's best day in
>history - a 14 percent gain - came the day the Fed first slashed interest
>rates. Now all major stock indexes are lower than they were before the Fed
>moved. Wall Street optimists are forecasting another "surprise" rate cut.
>The strength of the dollar has reflected belief in the new economy. As that
>belief unravels, so will the dollar's value. The Good Housekeeping seal is