The Diviners Say: Let It Fall
Figuring out where the economy is headed often seems like a modern version of haruspicy--the Roman practice of using animal entrails to divine the future. But for much of the Clinton era, it appeared that the experts had things figured out. The economy was, by and large, a nonpartisan issue. The consensus seemed clear and compelling: Give Federal Reserve Chairman Alan Greenspan a free hand. Reduce the budget deficit. Avoid massive tax cuts.
No longer. The economy has wobbled badly and become a political football as well. One by one the old verities have been smashed. Tax cuts are back. Deficit spending looks like it’s returning.
The latest sign of turmoil is the slump in the dollar. After reaching a peak against the euro and other currencies, the dollar has been losing ground since early July. Good. The dollar has been overvalued, and it’s about time it came down. The “strong dollar” policy is one Clinton administration policy that the Bush administration should abandon.
It was Clinton Treasury Secretary Robert E. Rubin who touted the strong dollar. The idea was that the U.S. would be the engine leading the world economy, soaking up goods and excess demand from around the globe. Not coincidentally, a strong dollar meant that interest rates and inflation would stay low in the United States because foreigners would be buying up our debt and because imported goods remained cheap.
But the good times didn’t last, and the downside of the Rubin approach was that the U.S. ran record trade deficits because American goods became increasingly expensive in proportion to the rise of the dollar. Additionally, American corporations with large holdings abroad got whacked by the disadvantageous exchange rate when they tried to bring profits back home. Now, as the U.S. economy slumps, businesses such as General Motors Corp. are pressuring the Bush administration to back off its own declared support for a strong dollar.
There are three approaches that the administration could take. The first would be to stick to its support for a strong dollar. The second would be for Treasury Secretary Paul H. O’Neill to signal that the U.S. is not averse to a lower dollar. The third, and most far-reaching, would be to intervene in U.S. and foreign currency markets to adjust the dollar’s value.
The second approach is the correct one. The administration does need to be careful not to provoke a meltdown in the value of the dollar, which would result in foreigners bailing out of the American bond and stock markets, but the overvalued dollar has been punishing American manufacturers and hurting the economy. Unfortunately, O’Neill has backed himself into a corner. O’Neill said in February that he believes in a strong dollar and that if he decides to change he’ll rent Yankee Stadium and some brass bands to announce a shift. It’s time for a change. Strike up the band.
