Behind the Dollar’s Slide:
A World Economy Wildly Out of Balance

By Robert J. Samuelson

There’s been plenty of good news of late about the U.S. economy, so let’s start with that: employment is expanding (2.4 million new payroll jobs in the last year); inflation remains low (less than a 2 percent rate in the past quarter); the stock market is higher (up 11 percent on the Dow from its November low), and business investment is impressive (rising at a 14 percent rate in late 2004). Indeed, the recent news has been so good—a major exception being $50-a-barrel oil—that we’re hearing again of the “Goldilocks” economy, which grows fast enough to increase jobs and slow enough to muffle inflation. But beyond all the upbeat indicators lurks a potentially frightening problem that unsettles even the wisest and most seasoned economic observers. It’s not government budget deficits, a possible housing bubble or even $2-a-gallon gasoline. It’s the dollar.

If you’ve been following closely, you know that the dollar has been declining steadily against many foreign currencies. From recent highs—reached in mid-2001 or early 2002—the dollar has dropped 38 percent against the euro, 23 percent against the yen and 25 percent against the Canadian dollar. And most economists expect the slide to continue. By the year-end, the euro may rise to $1.45 from $1.34 and the yen to 97 from 104 (that’s 97 yen to the dollar), says economist Nariman Behravesh of Global Insight.

But, of course, you probably haven’t been following closely. For most Americans, the subject of the dollar—its value on foreign-exchange markets—is a yawner. A depreciating dollar makes foreign vacations more expensive, puts pressure on the prices of imported cars and shoes and (the good part) improves the global competitiveness of U.S. manufacturers. Normally, these matters aren’t high on our “must know” list. But now is not normal.

The significance of the dropping dollar is that it’s actually a symptom of a larger and more troubling development. For 15 years the American economy has been the engine for the world economy through ever-increasing trade and current-account deficits (the current account includes other overseas payments like travel and tourism). In 2004, the U.S. current-account deficit is estimated to have reached $650 billion, a record 5.6 percent of the economy (GDP). Other countries’ economies benefit from sending their goods to eager American buyers, and the United States in turn sends massive amounts of dollars abroad to pay for those goods. The trouble is that there are now more dollars than foreigners want to hold. If there’s a glut of anything—apples, computer chips, Beanie Babies—prices go down. So when surplus dollars are sold for euros, yen or pounds, then the dollar drops in value against those currencies.

If you sense a contradiction, you’re right; and there’s the dilemma. The world economy can’t get along without our massive trade deficits—and perhaps can’t get along with them, either. Americans’ consumption binge is propping up global trade and employment, but it’s also threatening a financial upheaval that could hurt global trade and employment. With their export earnings, foreigners have bought huge amounts of U.S. stocks, bonds and other investments: at the end of 2003, $1.8 trillion of corporate bonds and $1.5 trillion of stocks. The doomsday scenario, considered unlikely by most economists but not impossible, is that a crash of the dollar would trigger a broader panic. Foreigners would sell their U.S. stocks and bonds, driving down those markets and bringing massive losses to everyone. They would sell because a dropping dollar would make their American investments worth less in their own currencies. Consumer and business confidence would drop; a recession in the United States and abroad might follow.

What’s especially unnerving is that no one knows how to disarm the dilemma. If you think that some economist—or even Alan Greenspan—has a realistic solution, think again. We’ve entered an unmapped forest; no one has been here before. “We’ve never had the leading economic power with [such an international] debt,” says economic historian Barry Eichengreen of the University of California, Berkeley. The longer our huge trade deficits continue, the stronger the underlying financial pressures become. Foreigners either have to increase their holdings of U.S. stocks, bonds and other assets, or they have to sell their dollars. But the real problem is the dependence of so many other countries on the U.S. trade deficits for their own economic growth. Their surpluses are the mirror images of our deficits. In 2004, current-account surpluses were 3.7 percent of GDP in Japan, 2.3 percent in China, 2.9 percent in Germany, 6 percent in Taiwan and 7.8 percent in Belgium, estimates. Economy.com.

—Newsweek, March 21, 2005