WSJ: As Dollar Weakens, Hidden Strengths May Stave Off Crisis

[question everything]

Lesson in Values

As Dollar Weakens, Hidden Strengths May Stave Off Crisis

'Twin Deficits' Would Sink Other Currencies, but U.S. Is Clearly a Special Case
Brazil Takes Tough Medicine

By GREG IP
Staff Reporter of THE WALL STREET JOURNAL
January 18, 2005; Page A1

Up to a point, a falling currency is a blessing. After that, it's a curse.

The dollar has fallen 16% against a basket of its trading partners' currencies over the past three years. In theory, that should, with time, make U.S.-made goods more competitive with those made abroad, boosting U.S. growth and employment.

But a growing chorus warns that the U.S.'s gaping budget and trade deficits will lead to a crisis in which the dollar falls much more sharply, driving up interest rates and squeezing the economy.

There are plenty of troubling precedents. Over the past decade, a dozen smaller economies from Mexico to Thailand have gone from growth to deep recession when their currencies collapsed. Even rich countries like Canada have been forced to adopt austere budget policies to cope with currency-induced turmoil. "We are increasingly vulnerable to the kind of sudden stop, where the capital inflows dry up all at once, that's been the bane of emerging markets over the years," says Barry Eichengreen, an economic historian at the University of California at Berkeley.

Could it happen here? It certainly hasn't yet. In a crisis, foreign investors dump stocks and bonds, fearing depreciation will cause further losses. Yet U.S. Treasury bond prices, and thus long-term interest rates that move in the opposite direction, have changed little in the last year -- and stocks are higher. A review of past crises world-wide suggests the U.S. has enough going for it now to avoid a similar fate. Yet the magnitude of the imbalances hanging over the dollar is also without precedent, suggesting a crisis remains possible.

(snip)

Write to Greg Ip at [e-mail]

URL for this article:
http://online.wsj.com/article/0,,SB110599912104528146,00.html

[trezic]

1. Hmm

That's part truth and part wishful thinking.

1. Truth. It's unlikely countries like China and Japan would want to hurt their exports by allowing the dollar to drop precipitously. A further depreciation in the dollar is likely and might not be all bad. Granted, it would raise inflation, but higher inflation means today's debts get cheaper.

2. Wishful thinking. I would guess the biggest danger is like that of 1973. Due to rapid inflation and the shrinking of their assets, OPEC raised the cost of oil by 400% to make up the shortfall. Another oil shock is not inevitable, but isn't unthinkable either.

My conclusion...

It's time to raise taxes, apologize for reading 'How to break an economy,' and tattoo the phrase 'Overwhelming debt is a stealth tax, dumbass' on Bush's forehead. Likely? No. Can I dream? Yes.

[oecher3]

2. like the tattoo idea ...

Isn't there also the tie to foreign policy, so far countries in crisis or in need to show sincerity with getting their act together in monetary and fiscal sense either pegged their currency to the dollar, adopted the dollar as their currency, or heavily invested into government bonds as security to avoid loss of value due to inflation.

Now, assuming the dollar is losing more and more of its value. Won't countries now rather look at a strong currency to the rescue, like the Euro, perhaps. Isn't there still the notion that a strong currency is also the face of a stable economy and by devaluation we lose our face as a secure nation. And making all so many enemies around the world, countries probably don't mind investing their money into more "secure" and stable countries than the US, i.e. EU.
This might end up in a downward spiral of the dollar like Brazil and Argentina and flight of foreign investment, no matter how high the interest rates spike.

but the tattoo is a start! If only a dream!

[idlisambar]

3. Concerning "Truth"

The fact that our debt is in dollars is of some comfort, but it is not the debt obligations that are of greatest importance when it comes to the trade deficit. More interesting are the long run effects on our manufacturing base. It is interesting to ask at what point does it become so weak that even in the case of a huge drop in the value of the dollar (40-50% let's say) we continue to run substantial deficits. If this is the case, and we continue to insist that the value of the dollar is our only corrective lever we are in big trouble.

[Dover]

4. I'm out of my league with trying to make sense of this, but is this an

accurate generalization of the big picture?

What I sense is happening is that as a result of a movement toward
a global economy and the introduction of other trade/reserve currencies (the Euro for now and other currencies
and trading blocks to follow) it is inevitable that the dollar will decline
until the playing field levels off a bit. It doesn't seem that the U.S. is
going easily into it's new global role (no longer the sole leader) and wants
to maintain a grip on important resources and influence in certain areas of
the globe (for both the resources and the strategic positioning on other
fronts). We are in deep debt and continue to run up the bill like someone
who should have their credit card torn up (mainly in the area of defense
which is our main trump card). Defense and security industries (along with
the drug industry and a few other main financial arteries at the heart of
our economy) are our major industry and export which we sell while also
raising the fear factor globally to help it along. Bushco seems to be
trying to generate a new arms race to secure our global position and keep
the money flowing. I don't know what 'alternative' ideas are being tossed
around, but that is the one policy that seems to be in play.

But all this is a balancing act because those who hold our debt are getting
anxious that they will be left holding the bag, and they need our
import/export business as well, so wouldn't benefit all that much from a
very serious collapse of our economy. So the Central banks (and the
countries like China and Japan and Europe who hold most of our debt) are in
a quandry as to how quickly to reduce their holdings of our debt, bonds and
dollars, without tipping over the apple cart.
There are many balls in the air, and global factions and allies are shifting
too (all with their unique set of needs and circumstances) in order to
position themselves for this big change.
For now it seems the need for a 'middle class' has been greatly reduced as
long as there is cheaper labor elsewhere with no labor laws to deal with.
Corporations are streamlining their costs and doing merges in order to
weather the changes ahead and be in a position to purchase the small fry
that will die off and resources that become available (though there are many
alternative strategies for this problem, such as downsizing, that are also
being practiced). So what will happen? I don't know, but the dollar
doesn't seem to be the best thing to have right now. Something a little
more tangible might be a good choice (hard assets). Holding Euros might
have been a good idea if you got in a few years ago, but not now.

[idlisambar]

5. seems about right...

...except the part about about "Bushco" trying to generate a new arms race to provide a better climate for arms sales -- the weapons business is just not big enough to ever make a significant dent in our trade deficit. I doubt there is much economic calculation behind Bush's military adventurism. The real problem with Bush is that there is not much economic calculation behind any of his policies.

[DaedelusNemo]

6. Ever-shrinking circle of the privileged

Republicans used to be for the rich in general, and that at least had the effect of improving business somewhat. But now government representation seems to be shrinking to an ever-smaller group of insiders and consequently the actions taken are harmful to an ever-increasing majority of the economy. We may yet again (eventually) see a recurrence of the petty-nobles-revolting-against-the-greater-nobles scenario played out so often throughout history.

[porkrind]

7. only 16%?

The dollar has fallen 16% against a basket of its trading partners' currencies over the past three years

I thought it was more like ~40% (such as against the Euro). Are you sure about this number? It seems really low.