TAX CUTS: HOW THEY MIGHT AFFECT YOU : Dollar Traders See Deficits Ballooning, but Markets Don’t
Searching for the reason du jour that the dollar is slumping, some economists on Thursday pointed to the perennially easy target: the United States Congress.
By passing a $189-billion tax-cut package on Wednesday night--the financing of which is dubious at best--the House of Representatives in effect decided that federal budget deficit reduction doesn’t matter after all, critics say.
House Republicans argued otherwise, of course. They claim they’ll pay fully for tax cuts with offsetting spending cuts. Unfortunately, the latter have yet to be identified. And given the federal government’s 20-year track record of living well beyond its means, it’s understandable that foreigners would assume 1) we’ll never balance the budget and therefore 2) we’ll flood the world with trillions of new dollars.
Thus the dollar hit yet another record low against the Japanese yen on Thursday. And the call again went up from some fearful analysts for the Federal Reserve Board to raise interest rates to defend the slumping U.S. currency.
But if it’s Congress that investors fear--and if the Fed holds the only solution to the dollar’s woes--that isn’t readily apparent from the direction of U.S. stock and bond markets.
Short- and long-term U.S. bond yields have been falling all week, suggesting absolutely no possibility of a Fed credit-tightening move in the near term. In addition, blue-chip stocks are hitting record highs.
Even allowing for the support that bonds would be getting from dollar-buying binges by central banks (they’d be putting dollars into Treasury securities), it’s evident that U.S. markets aren’t losing much sleep over the dollar’s plunge or over any negative implications of the House’s tax plan.
How can stock and bond investors stay so sanguine? Maybe because there’s a rising wave of sentiment on Wall Street (and perhaps on Main Street) that the current “dollar crisis” isn’t that at all, but rather a yen crisis and a German mark crisis.
According to that school of thought, the dollar hasn’t been going down this year; instead, it’s the yen and mark that have been going up. And therefore, the countries whose currencies are moving--Japan and Germany--bear the burden of restoring order in foreign exchange markets.
Granted, this may seem counter-intuitive. The United States is the sovereign state running massive budget and trade deficits, not Germany and Japan. Everyone knows how “irresponsible” America has been with its finances and its propensity to put consumption ahead of savings.
Fed Gov. John LaWare reiterated on Thursday that “as long as we are generating huge deficits, the world is awash in dollars.”
True. But virtually undiscussed anymore is that the federal budget deficit has been falling for two years.
Nor is it mentioned much that one reason for the nation’s rising “current-account” deficit is that many foreigners are investing directly in U.S. assets--and that they’re earning a handsome return.
The nation’s merchandise trade deficit, meanwhile, admittedly has been widening. But is that solely America’s fault for consuming too many foreign goods--or is it also Japan and Germany’s fault for being unwilling to allow economic growth to reach a level that could raise the appetite for U.S. exports?
As Japan’s economy has deflated in recent years, its government has maintained a relatively timid approach to fiscal and monetary stimuli that could jump-start business activity.
Europe, meanwhile, is beset by excess industrial capacity and high unemployment. Yet Germany, as the central European power, has maintained policies in recent years that have helped keep European interest rates higher and economic growth lower than otherwise might have been--even as inflation has been contained.
Darryl McLeod, professor of economics at Fordham University in New York, says the actions of the dollar, mark and yen today are all about “who has to change course” in economic policy.
The U.S. government, and the Federal Reserve, are making it clear that “we would rather not change course” abruptly, McLeod says. “The United States is where it wants to be,” with the economy near full capacity, inflation still low and the rise in interest rates last year having apparently slowed growth to a more sustainable pace.
If Japan and Germany, in contrast, aren’t where they want to be--and see their economic livelihoods threatened by their too-strong currencies--they will have to decide how to change that, McLeod and others say.
That may mean lower interest rates and-or other stimulative steps in Japan and Europe, the effect of which should be to raise demand for U.S. exports.
“If the Japanese don’t want to recycle the capital they’re accumulating, then their currency is going to be strong,” says Joseph Carson, economist at Dean Witter Reynolds in New York.
The message may be sinking in. Last week, Germany eased its official lending rate to banks and Japan guided money-market rates to record lows. More such moves should be forthcoming--and would probably mean more for the dollar’s revival than would an unwarranted Fed rate hike.
And what about the U.S. House’s proposed tax cut? What stock and bond markets seem to be saying is that they don’t believe tax cuts will come without spending cuts. Carson, for one, believes Congress will make true progress on the latter this year.
And if that happens, the surprise for the dollar may be that its next big move is up, not down.
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Raise U.S. Rates? Why?
Some Wall Streeters are calling for higher U.S. interest rates to bolster the dollar, but U.S. short-term rates are already sharply above those of Germany and Japan--against whose currencies the dollar is weakest.
Central bank lending rate:
Canada: 8.47%
Italy: 8.25%
Britain: 6.75%
United States: 5.25%
Germany: 4.00%
Japan: 1.75%
Source: Bankers Trust
