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Dollar Diplomacy
Saturday, February 7, 2004; Page B06
THE MEETING of finance ministers from the world's seven richest countries convened Friday amid widespread resentment of the dollar. Since the last G-7 meeting in September, the dollar has lost 10 percent of its value against the euro and 7 percent against the yen; the Europeans and Japanese worry that, as their firms' competitive edge is eroded, weak economic recoveries will be strangled. The result has been pressure for a G-7 statement signaling opposition to the dollar's continued fall, backed by the implied threat of coordinated central bank purchases of dollars. But the dollar probably can't be propped up by official intervention, at least not more than temporarily; nor, for that matter, should it be. If the Europeans and Japanese want their economies to grow more quickly, they must do more to reform them.
The last time the world tried to manage the dollar was in the 1980s, with the Plaza and Louvre accords. The first of these was supposed to drive the dollar down, and when that worked too well, the second was supposed to pump it up. When that failed, the whole system was abandoned. Since then the volume of capital sloshing around global capital markets has increased exponentially, making it harder for central bank intervention to affect markets. The yen's recent appreciation has occurred despite strenuous countervailing efforts by Japanese authorities, who sold $66 billion worth of their own currency in January.
The dollar will continue to fall until economic fundamentals -- or, more precisely, investors' readings of those fundamentals -- suggest it should stop doing so. Of course, the fundamentals point in contradictory ways. On the one hand, the U.S. economy is growing strongly and productivity is rising fast: Ergo, foreign investors will keep buying U.S. assets and the dollar will be strong. On the other hand, the U.S. current account deficit is running at a scary 5 percent of gross domestic product, meaning that Americans are consuming some $500 billion a year more than they earn and borrowing from foreigners to pay for their extravagance. If foreigners tire of lending all that cash, the dollar will head downward. Nobody knows which fundamental will win, because it depends on investor psychology. But the important thing, from a public policy point of view, is to reduce the danger that the United States' binge of foreign borrowing will panic investors and trigger a destabilizing dollar crash. A gradually falling dollar, which narrows the U.S. current account deficit and slows the accumulation of debt to foreigners, is a good thing, not a bad one.
The Europeans and Japanese have an interest in staving off a dollar crash as much as the United States does. But for years they have depended on the strong U.S. economy to buy more and more of their exports. Indeed, American demand has sheltered both Europe and Japan from the full consequences of their bad policies; the United States has provided an "economic umbrella" to match the oft-cited security one. It is time for the Europeans and Japanese to build on their tentative efforts to put their own houses in order: by cutting entitlements and deregulating labor markets in the case of Europe and by fixing sick banks in the case of Japan. A responsible U.S. administration would do its part by cutting the federal budget deficit, because government borrowing is a large part of what drives U.S. dependence on foreign capital. But half-baked attempts to manage the dollar are unlikely to help anyone.
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