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The Falling Dollar and U.S. Workers

Working Americans rarely have any reason to check the latest foreign exchange rates. Minor currency fluctuations simply don’t have a visible impact on their lives. But the decline in the value of the U.S. dollar is now so acute that the effects will soon become apparent to all U.S. wage earners and consumers.

Although the Bush administration states that it continues to support a strong dollar, it is clear from its actions that the administration is attempting to use the falling dollar to make U.S. products more competitive, close the U.S. trade deficit and stem the loss of U.S. manufacturing jobs.

But this policy is not working. The trade deficit is too large to close with moderate currency adjustments and the largest deficits are with trading partners that are not affected by the dollar’s decline. The competitiveness issues that plague U.S. manufacturers and lead to lost jobs go well beyond currency values. Employment in manufacturing is down by 584,000 jobs since November 2002 despite the dollar’s consistent decline.

The failure of the Bush policy can be seen in the most recent trade data. The U.S. trade deficit in October was the largest monthly deficit on record. Exports increased 11.3 percent for the year ending in October, while imports rose 18.5 percent. Average import volumes are more than 1.5 times larger than export volumes, so exports will have to grow at 1.5 times the pace of imports just to prevent further deterioration.

The trade balance with regions that maintain floating exchange rates, such as the European Union and Canada, has improved. But the total deficit with China and other key Asian economies has continued to worsen because these economies peg their currencies to the U.S. dollar. The Bush administration’s soft dollar policy punishes Europe and Canada and enhances U.S. competitiveness with respect to these economies, but does nothing to address the trade deficit with China and other Asian nations.

The dangers entailed in Bush’s approach are two-fold. First, the damage done to the European and Canadian economies will eventually curtail their imports from all countries, including the U.S., and undercut global economic growth. Although some U.S. exporters have benefited from the lower dollar, these benefits will be short-lived. The dollar’s fall is already choking growth in Europe; Japan’s brief recovery is clearly cooling.

Europe is feeling the sharpest pain, with the euro up 33 percent against the dollar since January 2002. European companies are suffering as the price of their exports climbs and cuts into their competitive standing in the world economy. The dollar is already below what most estimates indicate is its fair value against the euro.

The British pound is up 24 percent against the dollar and forcing the UK into larger trade deficits. Canada and Australia are also suffering.

The second danger stems from the fact that a further decline in the dollar will force the U.S. Federal Reserve to jack up interest rates to hold on to the foreign investors who are financing the U.S. deficits.

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Full Story

[ 21 December 2004: Message edited by: robbie_dee ]

I found it kind of odd because even then it was apparent that the Bush policies would lead to a major depreciation in the US dollar, and that the Euro, and perhaps the Yen and the Pound, might then be seen as more "stable" currencies for international trade and investment.

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Originally posted by DrConway:
We must have a new Bretton Woods.

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It does indeed seem clear that notwithstanding the fall in the USD, it’s nowhere near enough to correct the imbalance on its own. At some point, Americans are going to have to start saving more, and the only way that will happen is if interest rates rise. There are some ‘soft landing’ scenarios, but there are also quite a lot of catastrophic ones as well.

There are some that say that what we’re seeing now actually is a version of how Bretton Woods worked. Asian countries – especially China - seem to be willing to absorb any amount of USD assets in order to maintain their exports to the US. For the US, that’s sort of like owing money to someone who has no intention of ever trying to collect.

But there’s no way that this is sustainable. Bretton Woods worked because the USD was a credible reserve currency – it had current account surpluses until the 1970’s. But when the current account went negative in 1971, the only way to deal with it was to devalue the USD – which meant increasing the exchange rates of every other country. That was too much, and so BW had to be abandoned.

What’s striking is the scale of what’s happening now. When the US current account deficit reached -0.5%, it was enough to kill Bretton Woods.

When it reached -3% in 1985, it was enough to cause the (then) G5 to coordinate their policies to bring the USD down.

In 2004:3, it reached -5.5%.

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We must have a new Bretton Woods.

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and who shall be the J M Keynes of our time?

What do you think raising US interest rates will do to the US housing and stock markets?

I think bush jr.'s advisors are going for a soft landing for the dollar, a calculated devaluation, to aid US manufacturers, but i don't think it's going to work.

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Originally posted by catje:
waitaminnit, that's how we wound up with the IMF and the World Bank . . .

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Originally posted by thwap:

What do you think raising US interest rates will do to the US housing and stock markets?

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That's part of the train wreck scenario. Interest rates up mean a decline in stock prices. And when mortgage rates go up, housing prices will tank as well (fewer people will be able to afford the mortgage payments, so prices fall). Consumer spending has to go down anyway in order to get savings rates back up, but the decline in asset values will only worsen things.

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I think bush jr.'s advisors are going for a soft landing for the dollar, a calculated devaluation, to aid US manufacturers, but i don't think it's going to work.

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I don't think it's calculated at all; I think 'hoping for' is a better expression, although there's also a significant probability that they simply don't care what happens.

Private sector (non-US) investors have already bailed out of the USD. The reason the it hasn't collapsed completely is that Asian central banks have - so far - been willing to accumulate US T-bills. Again, the scale of these things is amazing: China alone is accumulating USD reserves at something like the rate of 10% of GDP. It's the equivalent of China taxing their citizens and presenting it as a gift to US consumers. For now, the Chinese leadership seems keen on keeping up employment in their export sector, but at some point, they're going to realise that there are better things that they could be doing with their money than financing US consumption patterns.

And all it will take to provoke a crisis is for the Asian central banks to stop accumulating USD reserves. Not sell, just stop buying. And as the USD falls further and further, other sorts of reserves - especially the euro - start looking better and better.

Although the soft landing story (a gradual decline in the USD lifts employment in the export sector, which generates enough extra income to counter the loss of jobs that higher interest rates will bring) is theoretically possible, it doesn't seem probable. The trade-weighted USD exchange rate has declined by about 20% in the six quarters following 2003:Q1, but even that isn't enough: the current account deficit has gone from 4.25% of GDP to 5.5% of GDP.

I wonder what the people at the Bank of Canada are planning these days. We're in good shape, so we have more room to manoeuvre (sp?) than usual.

[ 14 January 2005: Message edited by: Oliver Cromwell ]

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Originally posted by Cougyr:

Both of those had admirable mandates. Over the years, corporate interests managed to co-opt the IMF and the World Bank to their own view of the world. The IMF and the World Bank of today look nothing like they were meant to.

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You tied up a bunch of strands i'd read scattered over the internet, and offered some timely new stuff.

... oh, and yes, you spelt "manoover" rite. [i chekt]

[ 16 January 2005: Message edited by: thwap ]