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The goddess of gold saves India and its people
By Edmund L. Andrews
The New York Times
Tuesday, November 16, 2004
http://www.nytimes.com/2004/11/16/business/16dollar.html?oref=login
WASHINGTON -- It sounds eerily like the worst economic
nightmare for President Bush's second term.
Bogged down in a costly war that shows no sign of ending,
the United States faces a gaping budget deficit and
ballooning foreign indebtedness. The dollar plunges against
other major currencies, while turmoil in the Middle East
sends oil prices soaring. The rest of the decade is plagued
by rising inflation, increased joblessness and sky-high
interest rates.
But the president under fire was Richard M. Nixon -- not
George W. Bush. The war was in Vietnam, not Iraq. And
the dollar crash was in 1973 rather than 2005.
Could it happen again? With the dollar down more than
40 percent against the euro since 2002, and hitting new
lows since Mr. Bush's re-election, economists are debating
whether America's foreign indebtedness could lead to a
collapse in the dollar and a global financial crisis.
The United States is spending nearly $600 billion more a
year than it produces, almost 6 percent of its annual gross
domestic product. Much of that spending has been financed
by Asian governments, which bought more than $1 trillion
in Treasury securities and other dollar assets in the last two
years to help keep the dollar strong against Asian
currencies.
Many analysts expect the financing gap to widen and the
dollar to decline further. But there are at least three schools
of thought on whether a dollar collapse is likely and, if it
happens, what it would mean.
One group, which includes the Federal Reserve chairman,
Alan Greenspan, contends that global financial markets are
awash in so much money that the United States can borrow
much more than seemed possible 20 years ago.
The dollar may well decline in value, according to this view,
but the decline would be gradual and would help reduce
American trade imbalances by making exports cheaper and
imports more expensive.
The Bush administration goes one step further, arguing that
America's huge foreign debt simply reflects the eagerness of
others to invest here.
"Productivity has been remarkably high in the last few years,"
John Taylor, deputy secretary of the Treasury, said at a recent
conference. "Foreigners want to invest in the United States.
That's what that gap illustrates."
A second school of thought holds that foreign governments like
China and Japan will continue to finance American borrowing
and keep the dollar strong because they are determined to
sustain their exports and create jobs.
But a third school, which includes officials at the International
Monetary Fund, worries about a collapse in the dollar that
would send shock waves through the global economy.
That group argues that the dollar needs to depreciate another
20 percent against the other major currencies but warns about
a run on the dollar that could reduce its value by 40 percent.
A collapse of that size would severely affect Europe and Asia,
which have relied heavily on exports to the United States for
their growth.
A steep drop in the dollar could lead to higher interest rates
for the federal government and American private borrowers,
as foreign investors demanded higher returns to compensate
for higher risk. And it could expose hidden weaknesses
among financial institutions and hedge funds caught
unprepared.
"There is a school of thought that the U.S. can keep
borrowing forever," said Kenneth S. Rogoff, professor of
economics at Harvard University and a former chief
economist at the IMF. "But if you add up all the excess
saving being thrown out by the surplus countries, from
China to Germany, the United States is soaking up
three-quarters of it right now."
For Mr. Rogoff and several other economists, the question
is not whether the dollar declines - but how fast and how far
the fall turns out to be.
The United States current account deficit, which
encompasses annual trade as well as the balance of financial
flows, has gone from zero in 1990 to nearly $600 billion this
year. The United States' accumulated debt to foreign investors
is $2.6 trillion, or 23 percent of the annual output of the
economy.
But where foreign investors in the 1990's poured trillions of
dollars into American stocks and corporate acquisitions,
investment from abroad now comes mostly from foreign
central banks and goes heavily to buying Treasury securities
that finance the federal deficit.
Catherine Mann, a senior economist at the Institute for
International Economics in Washington, said today's financing
gap could be expected to widen. Part of the problem lies with
Europe and Japan, which grow more slowly than the United
States and import less than they export.
Higher costs of imported oil will aggravate the trade deficit even
more, Ms. Mann said, and the federal government will be paying
foreigners higher interest rates on its rapidly growing debt.
"You have a dynamic that links government deficits to current
accounts deficits more than has been the case before," Ms.
Mann said. "We are going to have a lot of government securities
out there, and a very high share of those Treasuries are owned
by foreign investors."
But where Mr. Rogoff predicts that the dollar will slide sharply
over the next two years, Ms. Mann predicts that Asian countries
will continue to subsidize American imbalances to keep their
economies growing. A decline in the dollar may be likely, but
not a panicky flight by foreign investors.
The American dollar has been through several ups and downs
in recent decades. In 1973, it fell sharply against Japanese
and European currencies -- the major industrialized countries
had already abandoned the system of fixed exchange rates
adopted at Bretton Woods after World War II.
The dollar rebounded strongly in the early and mid-1980s in
response to higher American interest rates, but then plunged
40 percent after leaders from the United States, Japan, and
Europe reached the so-called Plaza Accord in 1986 to nudge
the dollar back down. The plunge after the Plaza Accord
caused few disruptions for Americans, and foreign investors
did not demand higher interest rates on securities.
"One theory is that investors were simply irrational," said J.
Bradford DeLong, a professor of economics at the University
of California, Berkeley. "Others said it was the result of what
Charles DeGaulle called the 'exorbitant privilege' of being
able to repay your debts in your own currency."
Some economists contend that the United States can postpone
its day of reckoning for years. Richard N. Cooper, a professor
of economics at Harvard, said the global pool of savings was
about 10 times the United States' appetite for foreign capital
last year and growing fast enough to easily finance $500 billion
a year.
The wild card is that most of the money is coming not from
private investors but from foreign governments, led by Japan
and China. Rather than profits, their goal has been to stabilize
exchange rates and keep their exports from becoming more
expensive.
Many economists contend that the Asian central banks have
created an informal version of the Bretton Woods system of
fixed exchange rates that lasted from shortly after World War
II until the early 1970's.
The system collapsed after the imbalances between Europe
and the United States became impossible to reconcile. Rapid
growth is putting similar pressure on China, which has kept its
currency, the yuan, pegged at a fixed rate to the dollar.
The growing imbalances, in both China and the United States,
is one reason Mr. Rogoff is bracing for a jolt to the dollar and
the American economy similar to the one that occurred in the
early 1970's.
Then, as now, the United States was running large budget and
trade deficits. Then, as now, the United States was bogged
down in a war costing billions of dollars a year. And in 1974,
a few months after the dollar plunged against the German
mark and Japanese yen, oil prices soared.
"It's striking how many parallels there are between today and
the early 1970s," Mr. Rogoff said. "The loss of the anchor of
the dollar and fixed exchange rates contributed to the inflation
we saw in the '70s. It was the worst period in growth we have
had since World War II."
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----------------------------------------------------
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