As Dollar Drops, Economists Worry
But some say it’s a minor blip that will soon disappear
May 31, 2002
By Martin Wolk
— A recent decline in the value of the dollar has raised alarm bells among some economists, who fear it might signal the beginning of a steep slide that could put the nascent U.S. recovery in jeopardy.
SINCE LATE JANUARY the dollar has fallen 9 percent against both the euro and the Japanese yen, at least in part because of doubts about the strength and sustainability of the U.S. economic expansion. Even amid rising tensions between nuclear-armed rivals India and Pakistan, the dollar has continued slipping, hitting its lowest level in 15 months despite its usual role as a safe haven in times of political and economic uncertainty. The dollar rebounded a bit Friday, boosted by positive U.S. economic data and a wave of intervention by Japanese central bankers eager to cap the yen’s rally.
To be sure, the dollar’s decline comes after a remarkable seven-year run that has seen its value rise by 30 percent or more against the currencies of big industrialized nations. Even after the four-month slide, it costs only about 94 cents to buy one euro, compared with $1.18 when the currency was introduced in January 1999.
But the dollar’s unexpected decline just as the economy seems to be turning up has caused several of Wall Street’s most influential economists to raise the question of what if, as in, “What if the dollar collapses?”
“A sharp dollar slide appears almost inevitable at some point,” said Bill Dudley, chief U.S. economist for Goldman Sachs. “The timing, of course, is highly uncertain.”
Dudley argued in a published commentary to clients that the dollar is overvalued in terms of trade competitiveness and will come under increasing pressure as the already-large U.S. trade deficit grows even larger over the next year or so. And he notes that a sharp decline in the dollar makes sense considering the dollar’s huge run-up during the economic and stock market boom of the 1990s.
The euro has gained about 9 percent against the U.S. dollar since late January, provoking concern amongst some economists.
“Although that boom is over, the dollar is still strong,” he said. “Thus, the next stage is deflation of the dollar bubble.”
A modest decline in the dollar could be beneficial to the economy as it could help spark demand abroad for U.S. manufactured goods and other export products. But while a weaker dollar makes U.S. goods cheaper overseas, it makes imported goods more expensive for American consumers. And of course the U.S. imports far more than it exports, running a trade deficit of more than $1 billion a day in recent years.
“A falling dollar will make imported goods more expensive and at the same time will provide some umbrella coverage for domestic producers to raise prices,” said Paul Kasriel, chief economist for Northern Trust. “I think it’s a vote of no confidence in our economy, and I’m not sure it’s exactly what policy-makers and political leaders would want.”
He suggests that some of the dollar’s recent weakness might be explained by wealthy Arab investors shifting their money out of the United States into euros and gold for easier access in case of another major terrorist attack. That would also explain a recent surge in the price of gold, although other analysts call this theory fanciful.
Most analysts say the dollar’s recent decline should not cause anyone to lose sleep, calling it a minor blip that will disappear once the U.S. expansion gains momentum.
“It seems a real curious time to believe the dollar is about to collapse,” said Jim Glassman, senior U.S. economist at J.P. Morgan. He pointed out that the U.S. economy has bounced back much faster than most observers would have imagined in the aftermath of the Sept. 11 terrorist attacks. “I think what we’re seeing here is really minor — a modest pullback that we’ve seen many times before,” he said.
At least part of the decline stems from the fact that the Federal Reserve has kept short-term interest rates low much longer than previously expected. After adjusting for inflation many investors figure they can get better returns elsewhere.
“As long as the decline is slow and orderly it won’t worry investors or the Fed too much,” said Tony Crescenzi, chief bond market strategist for Miller Tabak & Co. “What people worry about is a rapid decline that causes it to feed on itself, and people bailing out of U.S. assets.”
That can happen awfully quickly in a world where money moves rapidly around the world, changing hands in the foreign exchange market at an astonishing rate of $1.5 trillion per day.
Tough times
The U.S. economy entered its 10th postwar recession in March 2001, a panel of economists declared in November. Past recessions have averaged about 11 months each.
|
Recession
|
Duration
|
Peak jobless rate
|
| Nov. 1948 to Oct. 1949 |
11 months
|
7.9 percent in Oct. 1949
|
| July 1953 to May 1954 |
10 months
|
6.1 percent in Sept. 1954
|
| Aug. 1957 to April 1958 |
8 months
|
7.5 percent in July 1958
|
| April 1960 to Feb. 1961 |
10 months
|
7.1 percent in May 1961
|
| Dec. 1969 to Nov. 1970 |
11 months
|
6.1 percent in Aug. 1971
|
| Nov. 1973 to March 1975 |
16 months
|
9 percent in May 1975
|
| Jan. 1980 to July 1980 |
6 months
|
7.8 percent in July 1980
|
| July 1981 to Nov. 1982 |
16 months
|
10.8 percent in December 1982
|
| July 1990 to March 1991 |
8 months
|
7.8 percent in June 1992
|
| March 2001 to ? |
?
|
6 percent (as of April 2002)
|
“There is always this view among economists that these things will work out in a nice smooth orderly, fashion but they typically don’t,” warns Kasriel. “We always underestimate how rapidly market prices can change.”
Stephen Roach, chief global economist for Morgan Stanley, said a sharp decline in the dollar of 20 percent or more is unlikely but “would have a devastating impact on U.S. financial markets,” causing both stocks and bonds to lose value. Foreign investors would seek to cut their exposure to dollar-denominated assets, U.S. investors would shift more assets overseas, and consumer confidence would suffer a brutal blow, Roach said in a Web site comment.
The dollar still holds the inarguable benefit of being the currency of record in the world’s biggest and most liquid financial markets. But the collapse of the tech stock bubble in 2000 and the more recent accounting scandals have raised questions about the long-term returns for dollar-denominated investments. And the Sept. 11 attacks demonstrated a previously unsuspected U.S. vulnerability, even though the Federal Reserve did an admirable job of keeping the nation’s financial system up and running.
Treasury Secretary Paul O’Neill has said he believes in a strong dollar, but some believe he signaled a subtle shift recently by saying he does not believe in government intervention to support the currency.
Among foreign investors, there is growing disappointment with Bush administration economic policy, including decisions to boost farm subsidies and raise tariffs on imported steel. On foreign policy the report card is mixed at best as the U.S. juggles three highly explosive situations in the Middle East, the Indian subcontinent and the global war on terror.
“Suddenly, the bloom is off the rose,” said Roach.
Or, as Kasriel put it: “We’re not as safe a haven as we used to be.”
http://www.msnbc.com/news/759981.asp