Let the Dollar Continue Its Fall : At Some Risk, the Slide Eggs Europe, Japan Toward Growth
Rushing from one summit to the next, finance officials are trying to shore up an increasingly fragile international trade and payments system. Traders believe that the dollar is overvalued, and daily they test the central banks’ resolve to keep the U.S. currency from tumbling. Official denials of the need for further dollar depreciation are becoming increasingly frequent and hence more difficult to believe.
This happened before, in the early 1970s when the fixed dollar parity of the postwar period came under attack and ultimately gave way to massive dollar depreciation. Any number of tricks stabilized the dollar for a while. But ultimately U.S. policy-makers recognized the political and economic handicap of living with an over-valued currency.
But in the early ‘70s, following a decade of expansion and negative real interest rates, the world economy was far away from the financial instability that we experience in our over-indebted markets today. Now the stakes in a realistic alignment of the dollar are much higher, and hanging on too long to an overvalued dollar offers real risks for the world economy.
The dollar now is barely back to the levels of 1980. Then we had balanced trade. But today we cannot expect that the 1980 exchange rate will deliver balance in our external payments. Foreign firms have entered our markets under the cover of our overvalued currency and they are here to stay. We have lost export markets in debt-ridden nations and in Europe. And a trade surplus is needed to earn the foreign currency that is needed for interest payments on our escalating external debt. What this adds up to is that now we must make up for past policy mistakes with further depreciation of our currency, putting American labor on sale to pay our bills.
Some argue currency depreciation cannot do the trick, others argue that further depreciation means shooting ourselves in the foot, if not the head. Neither argument is persuasive. Those who claim that dollar depreciation cannot work believe that exchange-rate movements are simply offset by extra inflation. When the dollar goes down, they say, our wages go up and thus undo any gain in competitiveness. The evidence runs counter to that theory. In the past two years the dollar declined by 50%, but wages increased by only 7%. If anything, the U.S. experience demonstrates how effective exchange-rate movements are in changing our competitiveness in world markets.
Our officials have fallen victim to the other myth, that aggressive depreciation of our currency could turn out to be a debacle. But how can we lose by selling more abroad? If foreign markets weaken because we sell more, too bad for them.
A more sophisticated version of the theory stands up better: Further declines in the dollar will cause a massive and cumulative collapse of business confidence in Europe and Japan. That loss in confidence will shrink investment and spending abroad far beyond the damage caused by our extra exports. And the very fact of declining income feeds on itself, sending the economies of Europe and Japan into a tailspin. In this depression scenario, any initial gain in our exports is soon overtaken by the impact of sharply declining incomes abroad. Our exports plummet and the U.S. economy is pulled down along with all the other countries in a 1930s-style world depression. Moreover, once the goods’ markets start sliding, financial markets will tumble.
All that could happen, but it must not deter us from seeking further dollar depreciation. The Treasury and the Fed should not allow themselves to be mesmerized into inaction by a scare designed to give Europe and Japan yet further rope to enjoy export-sustained growth, rather than contributing their share to a well-functioning world economy. Our policy-makers should join the game of chicken and call the foreign bluff. If we are in fact on the brink of a world recession, then expansionary monetary and fiscal policies in the currency countries with mammoth trade surpluses--Germany and Japan--are the essential remedy.
We cannot afford to underrate the ability of markets to lose confidence and of economies to collapse as governments stand by preaching Hoover-style balanced budgets. But there are lessons from the policy failures of the 1930s. The chief one is to use monetary and fiscal policy, early and vigorously, to blunt expectations of doom.
For some years now our officials have been preaching the need for growth policies in Europe and Japan. Their success has been nil. Pushing the dollar down is an effective means for loosening the strings on foreign purses. Then the burden is on them to avoid collapse and we can help with advice for supply-side tax cuts and reduced real interest rates.
In the past five years our budget deficits have fed worldwide growth. Now the initiative for growth in the world economy must shift from the United States to Europe and Japan. Budget correction in the United States, whether by higher taxes or reduced spending, will slow the world economy and that slack must be made up elsewhere. Vulnerable financial markets foresee a defense of an overvalued dollar by higher U.S. interest rates rather than by tax cuts and easy money abroad. That is a sure way to send the world economy sliding.
To forestall this possibility, a showdown with Europe and Japan over the dollar and growth policies is a constructive move. Sure, it is a beggar-thy-neighbor policy, but with our own budget-cutting ahead we have little choice, and we certainly cannot afford to wait passively for those mystical expansion programs abroad that always lie ahead and never quite happen.
