Viewpoints : Must America Decline Along With Dollar?

Last week, the dollar continued to plunge against the German mark and Japanese yen, its fall worsened by rising interest rates in both Germany and Japan. Some say the low U.S interest rates that led to the falling greenback may help us get out of the recession. But at the same time, a weak dollar means American assets are all the cheaper for foreign buyers. For a discussion of monetary policy in the wake of the dollar’s fall, Sharon Bernstein had separate interviews with Robert A. Mundell, professor of economics at Columbia University; Paul R. Krugman, professor of economics at the Massachusetts Institute of Technology; John Rutledge, chairman of the Claremont Economics Institute, and Richard Rosecrance, professor of political science at the University of California at Los Angeles.

Where should the dollar be right now? Is it in the right place?

Krugman: It’s actually appropriate for the dollar to be quite low now. The world is not going to be prepared to continue to finance a large U.S. trade deficit. We need to have the dollar low enough to wind that down.

Rosecrance: The dollar is still too high. It’s got to be lower before we are to get any balance in our trade with Japan.

Rutledge: The argument that a low dollar will reduce the trade deficit is a very standard and very narrow-minded view. To me, trade balance is something that should only happen by accident. If you went through a 10-year period where it made sense to move capital goods from the United States to Germany, as I think the next will be, that would be recorded as a U.S. trade surplus and a German deficit. If those tools are more needed in Germany than they are in the United States during that period, then that’s a great thing to do.

For 75 years during the 19th Century, the United States was in a trade deficit because we were importing tools to take advantage of our investment opportunities. And that’s when we did our tremendous growth.

The dollar is far too low right now for long-term trade and purchasing-power sorts of considerations.

Mundell: Right now, our policy has to be dominated by the fact that we’re in a bit of a recession. We don’t know how deep it’s going to go, but we want to minimize the effect of the damage. We should let the dollar go down a little bit, but I think we need to stop it at some point. If it goes down too far, it will just breed trouble in the future--and inflation. It shouldn’t go down against the yen much lower than 120 yen. Against the deutschemark, it’s already hitting new lows. Wednesday, it hit something like 1.45 marks. There too we shouldn’t let it drop below 1.40 marks. I think we should make an agreement with the Japanese and Germans to peg it at those rates.

Are there dangers to having such a low dollar?

Mundell: If it goes too much lower, then inflationary pressure will build up. It also has another danger in that it underprices our capital assets, including not just stocks and bonds but also land and real estate and everything else.

Krugman: The only reason you would ever be concerned about a falling dollar is that it would set off a wave of inflation, which is not likely, given the current circumstances in the United States. The U.S. economy sliding into recession means that, if anything, there is plenty of room to increase our exports.

What about the argument that a low dollar makes it easier for foreign companies to buy American assets?

Mundell: It just invites takeovers. It has the same effect as a kind of fire sale. It’s really an unfortunate feature of the current exchange system.

Krugman: In the past, a weak dollar has meant more purchases of U.S. companies, but that’s not necessarily a bad thing. It means we get an opportunity to sell foreign companies our assets at a good price. Those are voluntary sales. They get the assets and we get the money. There’s no indication that foreign ownership of U.S. companies has been a bad thing for the economy.

Rosecrance: You can’t do one without the other. You can’t improve your trade balance without running the risk of making your assets so cheap that people will decide not to buy your goods but to buy your assets instead. But it’s very hard to imagine how we’re going to sell our exports abroad without a slightly lower dollar.

How are high interest rates in Germany and Japan affecting the dollar? Should we urge those countries to keep rates low?

Rosecrance: Interest rates are staying high in Japan and going up in Germany. People who want to place their money somewhere don’t want to put it in the United States.

Mundell: The Germans’ efforts to raise interest rates are not a helpful thing for us. But from the German point of view, they’ve just pumped a lot of money into East Germany, and they’ve got real problems of their own, and they feel they have to offset some of the inflationary pressure there. That creates problems for other countries in Western Europe, like Italy and France. They really cannot afford to have appreciation of the European monetary system, because their products and economies are really overpriced.

Krugman: Germany has got the reunification boom, and they’re having tight money to deal with that. The United States is in a recession, and we’re having loose money to deal with that. That’s the main reason for the dollar dropping right now. And that’s OK. The most important thing right now is that the Fed needs to get the U.S. economy moving. And the worst thing would be if they were to pull back from getting the economy stimulated because of worry about the falling dollar. Now is a good time for some benign neglect of the dollar and concentration on getting us out of the recession.

Rutledge: The world at large is in the middle or beginning-middle of a very large capital shortage. Two trillion dollars is needed for rebuilding Eastern Europe; the Russians need capital, the Japanese need it. It’s going to take $30 billion to rebuild structural damage in Kuwait, and Iraq is going to have to be rebuilt when this is all over, no matter how it ends. The world background is high interest rates. And the United States is out of sync with all of this.

The dollar is falling because monetary policy in the United States and Europe is going in two different directions. And they’re not going to be able to go in two different directions for very long.

It wasn’t so long ago that U.S. policy was specifically aimed at pushing the dollar down. Should the United States now try to increase the value of the dollar to be more competitive with Japan and Germany?

Rutledge: I think the job of the Federal Reserve ought to be to guarantee that we don’t have any inflation or deflation. And if they did that, the dollar would probably be stronger. I don’t think it’s a very sensible idea to try to stimulate an economy by pushing a currency around. The net worth of the American people goes down when the dollar goes down.

Rosecrance: I think what they need to do is what the Group of Seven is doing already, which is to buy the dollar. They should lean against the dollar as it goes down. It should go down more, but it shouldn’t go down in a free fall.

Does the fact that the dollar is falling hamper the Federal Reserve in its efforts to stimulate the economy?

Rosecrance: The real problem with the fall of the dollar is that interest rates have to be up to encourage investment, something that would increase the value of the dollar. But that would make it harder to get out of the recession because low interest rates are what stimulate borrowing and investment at home.

In one sense, you want to raise interest rates to keep people investing in the United States because a low dollar is not attractive to investors, but that cuts against what you want to do to stimulate growth to get us out of the recession.

Mundell: I think the Fed always has to look at the exchange rate and would worry if the exchange rate started to flop downward. It could go down very quickly. That’s basically why the current correction of the recession can’t be done with monetary policy alone. It has to be done through fiscal policy. One example of something that could be done through fiscal policy would be to cut the capital gains tax.

How is the war in the Persian Gulf likely to affect the dollar?

Mundell: It’s not hurting the dollar. Effectively, our military spending really amounts to exports. They are like exports in that they are being paid for by up to $40 billion by other countries. So it’s as if we were selling them the arms we’re using and the money we’re spending in Saudi Arabia and Kuwait.

Rutledge: It could affect the dollar, but it’s not likely.

This is the first mail-order war. It’s an Eddie Bauer war. The Japanese and Germans are sitting home looking at a catalogue. To get the cash to pay, they have to sell securities somewhere. The question is which securities they choose to sell. Whatever they sell would go down. But most likely they’ll take it out in proportion to what’s already in their portfolios, so it’s probably no big deal.