Dollar's drop delivers a shock to our system

America's pre-eminence is at risk, some experts fear.

December 05, 2004|By Michael Hill | Michael Hill,SUN STAFF

At first glance, the recent precipitous drop in the value of the U.S. dollar looks like one of those classic bad news-good news stories.

The bad news is that your dollar is going to buy fewer things that are made in other countries, a particular pain if you happen to be on a trip to Europe or, for that matter, to Wal-Mart, where most everything on the shelves is made in another country.

The good news is that other countries' money will buy more of your things.

But many think that the dollar's plunge -- down 9 percent since August -- is a bellwether indicating that this country's profligate ways are finally getting a reality check. It suggests that the United States is like someone so deep in debt that the banks are saying they are not going to approve that next loan.

In the short term, that could mean a rise in interest rates. In the long term, some fear that, without fundamental economic adjustments, it could mean a permanent decline of American power in the world.

The fall of the dollar might be the beginning of those adjustments, or the first indication of a more serious shock ahead.

"We have been living beyond our means and borrowing abroad to finance it," says Edwin M. Truman, a senior fellow at the Institute for International Economics. "The exchange rate acts like someone cutting up our credit card."

Says Wendy Takacs, an economist at the University of Maryland, Baltimore County, of the dollar's decline: "It's bad for anyone who is trying to buy goods internationally because -- since you will have to pay more dollars per unit of foreign currency -- foreign goods coming into the United States will cost more. But it is good news for anyone who is trying to export goods made in the United States and compete in world markets."

So, while you might not be able to afford as many bottles of that French wine you like, people in France can buy more bottles of California wine. The same will be true of automobiles, T-shirts and high-tech equipment. The weaker dollar should put more people to work in the United States, while making the things that they buy with their new paychecks more expensive. This should reduce our international indebtedness.

But to some, such adjustments look like a Band-Aid on an economic cancer that threatens America's future -- a huge accumulated debt, trillions of dollars owed to foreign nations, steadily weakening the U.S. economy and possibly endangering America's status in the world.

Peter Morici, an economist at the University of Maryland's Smith School of Business, says the Chinese expenditure of billions of dollars to finance our borrowing keeps China's export-oriented economy humming but comes at the expense of the American economy, particularly the industrial sector.

"What we are doing is exporting to China the very substance of the American economy, and we are doing it not on the basis of competitive advantage but on the basis of financial engineering," he says. "This is not about economics, it is about power and diplomacy, it is about imperialism.

"If China de-industrializes the United States and builds up this economy of great wealth and influence, it can change the rules of the game of the global economy. It can dictate that it be less market-oriented," Morici says. "We are playing into their hands. It's like giving them the maps to your harbors."

Sustainable, for now

For now, this situation is sustainable, keeping Wal-Mart stocked with cheap DVD players and China employing more and more of its huge population. The question is how long this can continue. The dollar decline could signal the beginning of the end.

Two deficits are involved here. One is the trade deficit, now known in economic circles as the current account deficit. That is how much more we import than we export. When we're running a current account deficit, we are essentially shipping that many dollars abroad.

Countries receiving those dollars have to do something with them, and many are used to buy U.S. Treasury bonds, which means they are financing the other deficit -- the government's budget deficit.

If the dollar gets weaker, those bonds aren't worth as much. So instead of buying them, people with dollars will look for other, more stable currencies, perhaps investing in euro-denomination financial instruments.

The only way to get them back into U.S. bonds -- which, since the government keeps running a deficit, we have to do -- is by raising their interest rates, to make them more attractive. That would raise the interest rates throughout the U.S. economy, making the purchase of a car or house more expensive. That's one of the ways the dollar's decline cuts up the credit card.

But wait, there's more!

Complicating the picture further is the fact that the dollar is not declining relative to all currencies.

Morici says that from Jan. 2002 until today, the dollar is down 14.3 percent. But against the currencies of major industrialized countries -- mainly European -- it's down 27 percent.

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