Losing Respect : With the...

Walter Russell Mead, a contributing editor to Opinion, is the author of "Mortal Splendor: The American Empire in Transition" (Houghton Mifflin). He is now working on a book about U.S. foreign policy

Bored.

That, frankly, is the way many Americans felt about last week's crisis on the trillion- dollar- a- day international currency markets.

The dollar at historic lows against the yen? The peso at historic lows against the dollar?

Big deal, yawned many Americans. Bad news for American tourists in Tokyo; good news for tourists in Tijuana. So?

Those bored Americans have a point. We've had dollar scares before. Ever since President Richard M. Nixon took the greenback off the gold standard in 1971, the dollar has been sinking to one "historic low" after another: 360 yen to the dollar, 200 yen, 150 yen, 100 yen and now 90 yen. But what does it mean?

Pessimistic economists keep forecasting inflation, and optimistic economists always forecast an end to the U.S. trade deficit with Japan. But the dollar has been falling for 24 years, inflation isn't up and the trade deficit is bigger than ever.

Enough already, most Americans say at this point. Can we please stop talking about international currency markets now, and go back to something interesting, like Brian (Kato) Kaelin's acting career?

Fair enough, but hold on a minute. Last week's crisis on world money markets wasn't just meaningless noise. The world turned a corner, and it wasn't by coincidence that it all started with the Mexican peso. When the Mexican currency collapsed and the Mexican economy went haywire, the United States announced a bailout. At first, investors cheered: Uncle Sam to the rescue.

But then came the second thoughts. Up until the Mexican devaluation, the United States thought that the Mexican economy was stable. If the United States government had no warning of the crisis, what made Uncle Sam so qualified to fix it? And what about America's vast budget and trade deficits? Where was all this new money coming from, petty cash? Suppose the first $20 billion didn't fix the Mexican problem? Suppose the political situation in Mexico continued to deteriorate? What would the United States do then--and how much would it cost?

It gets worse. Back when Carlos Salinas de Gortari was president of Mexico, the U.S. political and economic leadership couldn't praise him too highly. Salinas, our leaders kept telling the nation and the world, was a genius. He was turning Mexico into a modern economy with a healthy democracy and a stable currency. Salinas did such a good job in Mexico, according to Washington, that he was the most qualified person in the world to run the new World Trade Organization, the powerful successor to the General Agreement on Tariffs and Trade.

The "Mexican miracle" is a sick joke today, and Washington insiders are busy ripping Salinas' phone number out of their Rolodexes and pretending they never heard of him. But three months ago, both Republicans and Democrats considered him the greatest thing since fresh salsa.

Uh-oh, thought the rest of the world. Mexico is America's most populous neighbor, and the North American Free Trade Agreement was the most hotly debated economic issue in the United States during the last five years. If the political and economic leaders of the United States don't understand Mexico, the world's investors and money managers ask, what do they understand?

It's a good question--and the more people look at it the queasier they feel. If the U.S. policy Establishment could be so wrong about Salinas and Mexico, how can anybody believe that same Establishment is intelligent, responsible and awake enough to handle the persistent budget, trade and social problems of the United States? Just what kind of clothes is the emperor wearing?

The more people think about questions like this, the less they want to hold dollars. They don't want to buy the IOUs of a government they don't respect, and they don't want to keep their savings in a currency they don't trust.

The result, in the first place, was the fall in the dollar--another stage in the historic decline of the greenback from the world's most trusted currency to a worthless scrap of paper-- el peso del norte .

But it wasn't just that the dollar fell. The yen and the deutsche mark rose. In previous currency crises, investors fled to the dollar as the safest currency in a troubled world. Now, when things get tough, the tough get going--out of the dollar into German and Japanese money.

This changes the economic balance of power in the world. The cheap dollar and the high prices of the yen and the mark mean that American companies--and the U.S. government--will lose influence around the world to their competitors from the hard-currency countries. Attractive East Asian investments will be cheaper for Japanese companies than for U.S. firms; German companies will have similar advantages over their U.S. rivals in important emerging European markets, such as the Czech Republic.

U.S. foreign aid won't go as far. It will be more expensive to maintain our armed forces overseas. As European and, ultimately, Asian bases become more expensive and budgetary pressures continue to grow, there will be increasing pressure on the United States to reduce its commitments overseas--whether or not those commitments make sense.

Ultimately, the United States will begin to lose control over both the international and domestic economy. Countries with strong currencies often set the economic agenda for countries with weak ones. Thirty years ago, the Federal Reserve Board set interest rates around the world. Ten years from now, the German Bundesbank may set interest rates in the United States. This won't be good for us; the U.S. economy--entrepreneurial, small-business oriented and historically dependent on cheap credit--needs lower interest rates than most European economies to prosper. The Bundesbank won't care.

The Germans and the Japanese will enjoy the new buying power their strong currencies give them, but the collapse of the dollar doesn't make either country happy. Both countries depend on their exports, and neither wants to take on America's global financial responsibilities. The collapse of the dollar and the strains on the international financial system are bad news for almost everyone. As the ripple effects from the dollar crisis spread throughout the world, more and more countries will suffer painful and expensive side effects.

In the first place, the Mexican crisis moved like wildfire into other emerging markets around the globe, as panicked local and foreign investors dumped stocks in fear of the "tequila effect." While markets throughout Asia were hit, the worst effects have been felt in the Western Hemisphere. Brazil and Argentina have been plunged into economic crises as a result of the Mexico shock. Even Chile, which many consider the best-managed economy in the hemisphere, has seen a massive selloff in its stock market.

But the effects of the crisis were not limited to developing countries. The Japanese stock market swooned at the thought of what the falling dollar meant for the profits of Japanese exporters. Germany shuddered as the monetary turmoil spread to Europe. Spain and Portugal were forced to devalue their currencies; France and Italy faced new economic strains as they attempted to keep order in their currency markets. The result was another setback for the European Union's hopes for monetary union before 2000.

Almost nobody wants a weak dollar. Almost nobody wants the United States to fail. Latin America and East Asia need a strong United States so that they can grow; Western Europe needs a strong United States to preserve the stability and order that the development of the European Union requires. Russia and other former communist countries need a healthy global economy that can absorb their exports and help them finance their transition and growth.

All these good things depend to some degree on the strength of the dollar. And the dollar depends, more than ever, on the confidence that U.S. leadership inspires around the world.

The United States must get its act together. That is the message--more in sorrow than in anger--that the world's money markets are sending the U.S. government and the American people. The question is, will we listen?*

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