Paulson’s Playbook Not Likely to Boost Dollar, Shrink Deficit

It’s practically part of the job description: Henry M. Paulson Jr., President Bush’s choice for Treasury secretary, likely will soon find himself pledging to work on behalf of a strong dollar and a smaller government deficit.

After all, how could a Treasury secretary support a weak dollar and profligate deficit spending?

But circumstances are bound to conspire against Paulson, chairman of the investment house Goldman Sachs, whom Bush nominated Tuesday as his choice to replace John W. Snow.

Market forces are aligned to drive the dollar’s value down no matter how many administration officials talk it up.

The dollar is under downward pressure from several factors. For one, the enormous and growing U.S. trade deficit is creating a huge supply of greenbacks abroad as the United States ships hundreds of billions of dollars overseas every year to buy foreign goods. The greater supply of dollars reduces their value.

So far, foreigners have invested most of those dollars back in the United States. But economists warn that their appetite for American investments has its limits -- and that when those are reached, dollars will lose their appeal and their value.

The dollar also has been slipping because of expectations that economic growth is picking up in other countries just as U.S. growth is slowing. In response, other nations are beginning to raise their interest rates while rate hikes in the United States may be nearing an end. By increasing the yield on bonds and other securities, higher interest rates generally make a currency rise in value because they increase demand for bonds denominated in that currency.

“The day will come when China and the rest of the world will tire of lending Americans what they need to live well,” said Peter Morici, a University of Maryland business professor.

American consumers generally like a strong dollar because it makes imports less expensive. A weak dollar benefits some, however, among them U.S. companies that sell goods overseas.

Mostly, the administration has not bought or sold dollars in the currency markets to influence its value. That policy is likely to continue, some economists said.

“The Bush administration’s non-policy on the dollar leaves the new Treasury secretary with little to do in the currency arena,” said Carl B. Weinberg, chief economist for the consulting firm High Frequency Economics. “We wonder why Mr. Paulson gave up such a good job in New York for this one in Washington.”

As for the deficit, Paulson is signing up to work for an administration that has presided over huge tax cuts and record federal spending increases. Bush is committed to extending the tax cuts beyond their current expiration dates in about five years, and federal benefit programs are combining with the Iraq war to push spending upward.

Federal spending has already been growing at what Rea Hederman, a budget analyst at the conservative Heritage Foundation, calls record levels. Annual federal spending per household has averaged $21,101 during the Bush years, Hederman said. That is about $1,700 more than during Bill Clinton’s presidency.

If the Senate confirms Paulson in the next few weeks, he will take office in time to help shape the administration’s 2008 budget, which will go to Congress early next year. The budget will surely show the deficit on a path to be cut in half in the five years after its all-time high in 2004. But soon after that, the deficit will be fueled again by the baby boom generation’s retirement and its effects on such programs as Social Security and Medicare.

Hederman said he hoped Paulson would bring a new element of self-control to budget-making. “This administration and Congress,” he said, “have not been as conscientious as they should have been.”

Paulson, however, may have diminished powers because of the waning influence of a president who is late into his tenure.

Lewis Alexander, chief economist for Citigroup, said he hoped the appointment of so high-powered a Wall Street figure as Paulson signaled that the administration was placing a higher priority on economic policy. “But he’s coming in at a difficult time,” Alexander said. “The administration doesn’t have much time left or much political capital to spend.”