The Economist last week added to the growing drumbeat of warnings that the time has come for a real honest-to-goodness tanking of the U.S. currency.
Most economists, and this newspaper, have been fretting about America's huge current-account deficit and predicting the dollar's sharp decline for years. The trouble with crying wolf too often is that people stop believing you. After slipping 14% in broad trade-weighted terms since 2002, the dollar had stabilised this year, even as the current-account deficit continued to grow. This has encouraged some economists to offer theories explaining why America's current-account deficit does not matter and why the dollar need not fall further. But the dollar has now started to slide again: this week it hit $1.28 against the euro, within a whisker of its all-time low of $1.29. Trust us, the wolf is real...
Economists at UBS estimate that the dollar's trade-weighted value might need to fall by another 20-30% to trim the deficit by enough to stabilise the ratio of America's external liabilities to GDP. Though it might seem unthinkable, that could imply a rate of around $1.70 against the euro.
A similar concern was discussed in a column by David Wessel, that appeared in the Thursday October 28 edition of The Wall Street Journal (page A2).
... there are fresh warnings. After a brief respite, the dollar is sinking against the euro and yen. Foreign purchases of U.S. stocks and bonds have slipped to a monthly average of $70 billion from the $89 billion pace of early 2004.
The next president, no matter who wins, can't count on continuing what amounts to "low-cost finance for America at a time when savings are low" coupled with "strong exports for those who are providing the finance," as Harvard University President Lawrence Summers put it in a recent International Monetary Fund lecture.
Of course, there are dissenting voices. The Economist notes an argument made by Michael Dooley, David Folkerts-Landau and Peter Garber at Deutsche Bank who have suggested that current circumstances are sustainable for as far as the eye can see.
Asian economies, they argue, have chosen to link their currencies to the dollar at undervalued rates, supported by heavy purchases of dollar reserves. Asian countries want to keep their exports cheap to support rapid growth and are in consequence happy to keep acquiring dollars indefinitely. In turn, by buying Treasury bonds, they reduce interest rates, which supports spending and ensures that American consumers keep buying Asian goods.
And Wessel notes that
The "Why Worry" school sees the flood of foreign money as a sign of American strength: The U.S. is a country that capital is trying to get into.
But Wessel (echoing a point made in class by XP-75er Marcos Nogues) pooh-poohs the "Why Worry" position that investors have a taste for U.S. capital that just can't be sated.
It would also be more comforting if private global investors were putting money in the U.S. But more and more of it comes from Asian central banks, parking huge dollar reserves in U.S. Treasury debt.
And the Economist article emphasizes arguments that, contrary to the Dooley, Folkerts-Landau, and Garber claim, China and other countries will not be willing to absorb Treasury debt at the current pace forever. They conclude with this cheery passage.
In the three years from 1985, the dollar fell by 50% against the other main currencies. Inflation and bond yields rose and, in October 1987, the stockmarket crashed. America's current-account deficit is now almost twice as big as it was then, so the total fall in the dollar—and the fall-out in other financial markets—could well be larger. The wolf is licking his lips.