3 February 2004
Widespread concern over the fall in the US dollar has led many commentators to assert that the US dollar's weakness has not led to a loss of confidence in the US as Asian central bankers are continuing to support the currency. This buying should prevent a collapse in the currency and an economic crisis. However, this view presumes that the main threat to the US economy is a collapse in the currency. The irony is that failure of the US currency to weaken further also poses a threat to the US economy.
In December last year, Martin Baily, former US President Bill Clinton's economic advisor, pointed out in an interview given to The Wall Street Journal that "if you got an abrupt fall in the dollar, that would trigger higher interest rates, disrupt the stock and the housing market and put some pressure on financial institutions". He called it a "worrisome scenario" but an unlikely one, as foreign investors consider investment opportunities in the US as better than in their own countries.
In his 29 January article on BusinessWeek Online, economics editor Christopher Farrell wrote: "The main fear is that investors will lose confidence in the dollar, sending U.S. interest rates skyrocketing, disrupting international trade, and risking a global recession." However, he pointed out that the "dollar actually isn't down all that much compared to a more diverse basket of currencies that matter to American manufacturers and service companies", concluding that "it's clear that the dollar isn't a weak, let alone crisis-prone, currency".
It has been largely Asian central bankers who have been buying and supporting the US dollar to maintain their export competitiveness. This is despite the fact that such intervention exposes them to the risk of foreign exchange loss if the US dollar continues to decline.
Why are Asian central bankers willing to risk foreign exchange loss? Because it is the best way they know to deflect deflation from their own economies. There is a lack of demand in the world economy and Asian exporters are competing fiercely for whatever they can get.
The problem is that US businesses also need to compete for that same demand. In other words, the US economy actually needs a weaker dollar to improve its competitiveness and help create jobs.
The US job market has been suffering precisely because the dollar is not weak enough. Since August 2000, the US has lost 2.8 million manufacturing jobs. And despite overall economic recovery, December 2003 saw only a net creation of 1,000 jobs, while for the four weeks ending 24 January, the average weekly number of claims for state unemployment insurance benefits remained at a relatively high 346,000.
Nariman Behvaresh, chief economist at Global Insight, an economic forecasting and consulting firm in the US, told The Wall Street Journal in December last year that his own economic model found that the manufacturing sector would have shed 700,000 additional jobs since late 2001 without the dollar's fall. He said that US industrial production would have declined 2 percent last year, rather than risen an estimated 0.2 percent, if not for the weaker dollar.
The International Monetary Fund also recognises the benefits of a weaker US dollar. Yesterday, at a conference in Prague, its managing director Horst Koehler said: "So far, a stronger euro and correspondingly weaker US dollar are facilitating the needed global rebalancing of current accounts."
On the other hand, while a collapse in the US dollar may disrupt international trade and financial markets, the impact to its economy would not be as adverse as currency crises in most other countries. America's international debts are largely denominated in US dollars, so a decline in the exchange rate of the dollar reduces the real value of America's gross international debts.
Of course, what is good for the US is not necessarily good for other countries. If the exchange rate of the US dollar falls further, countries that have seen their currencies rise against the US – for example Europe – would suffer a further loss of competitiveness. Asian countries which have kept their currencies' exchange rates relatively little changed against the US dollar would have accumulated large reserves of the US currency and would suffer foreign exchange losses. Foreign investors of US financial assets would see the value of their portfolios fall in terms of their own currencies.
So exchange rate adjustments are double-edged swords and cannot be relied on to redress global economic imbalances by themselves, which is needed to put the ongoing economic recovery on a sustainable footing. Little wonder then that the Federal Reserve said on 28 January that it would be "patient" in raising interest rates. The world economy needs all the time it can get to put itself on a sustainable growth path.
Let us hope that the time is put to good use.
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