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Is the Dollar Finally in Trouble?

Commentary. Art Pine is a columnist for Bloomberg News. The opinions expressed are his own.

By Art Pine

Washington, Nov. 1 (Bloomberg) -- Is the U.S. dollar finally in trouble in the foreign exchange markets?

No one is ready to call that one yet, but recent rumblings in the markets are giving some analysts pause. The dollar's value has been declining in the wake of last week's reports showing that the U.S. economy is growing more slowly than had been expected. Experts are divided over what happens next.

``It's hard for anyone to know what is the rise in the (dollar) exchange rate that could be fully justified,'' Bank of England Deputy Governor Mervyn King said yesterday in a cautious assessment of the dollar's new shakiness. ``There could in the short-run be some reappraisal.''

Economists have been cautioning for months that the dollar could soon be at risk. The U.S. has amassed a current account deficit (a combination of trade and investment flows) that is expected to reach a massive $425 billion this year, or 4.3 percent of the nation's gross domestic product -- huge by any standard.

So far, the U.S. has been able to finance that drain because foreigners have continued to invest in the United States, believing that opportunities here were greater. The U.S. economy has been growing more rapidly than those of Europe or Japan, and America has had fewer regulations to impede business.

Investor Sentiment

Analysts have been warning, however, that investor sentiment could change -- abruptly. ``There has to be a limit as to how much of the world's savings our residents can borrow at close to prevailing interest and exchange rates,'' Federal Reserve Chairman Alan Greenspan told Congress last February.

If the dollar's value does decline substantially, it could have serious implications for the U.S. A falling dollar would exacerbate inflation here by making imports more expensive. That, in turn, could slow the growth more than policy-makers might like -- and weaken the global economy as well.

Even worse, a decline in the dollar's value could hamper the Fed's ability to cut interest rates if the U.S. economy fell into a slump. With the current account deficit so large, Fed policy- makers would be forced to keep rates steady -- or even raise them -- in order to attract the capital needed to finance it.

Not surprisingly, the potential fragility of the dollar poses a knotty problem for U.S. policy-makers. Treasury Secretary Lawrence Summers -- like his predecessor, Robert Rubin -- has asserted that the administration wants to maintain a strong dollar because it believes it's ``in the national interest.''

Symbolic Intervention

Pressed by America's European allies, Summers agreed in September to intervene in the foreign exchange markets to bolster the euro, but quickly returned to his strong-dollar posture, signaling that the brief departure -- and the intervention -- were only symbolic.

Underneath it all, there's little that policy-makers can do to prevent the dollar's decline -- or reduce the U.S. current account deficit. U.S. officials hope that as the U.S. economy slows, Americans will buy fewer imports and foreigners will buy more U.S.-made goods, but such adjustments take time.

To be sure, the U.S. currency may bounce back after investors finish reacting to the prospect of slower growth. Although last week's report on gross domestic product showed the economy slowing to a 2.7 percent annual rate in the third quarter, forecasters predict growth will average about 3.5 percent next year.

Neal M. Soss, economist for Credit Suisse/First Boston, Inc., BLP, dismisses any notion that the huge U.S. current account deficit may be about to exact its toll on the greenback. ``Why should it be true now when it wasn't true six months ago?'' he asked rhetorically. ``There's no good reason yet.''

Room for Greenbacks

Moreover, Catherine L. Mann, an analyst at the Institute for International Economics, said her studies show that for all the past year's flight to U.S. investments, international investors aren't yet overloaded with greenbacks and still have plenty of room in their portfolios to fill U.S. financing needs.

``I was a little surprised,'' she said.

Stephen Axilrod, once the Federal Reserve Board's chief economist and now an economic consultant, said the dollar's value will keep declining over the next few months as the U.S. stock market loses steam and investment opportunities in Europe improve, but he doesn't see a ``precipitous'' drop.

Once capital flows from Europe to the U.S. begin to ebb, ``that sets the stage of the dollar to drop off,'' he said. But he declines to peg the current flurry in the markets as the first sign of a dollar decline. ``It could be the first sign or it could be a blip. I'd hate to say whether this actually is the start.''

Indeed, some analysts argue that the dollar's decline will be gradual, with minimal pain for the U.S. economy. For all the hand wringing on Wall Street in recent days, they say, the economic fundamentals in the U.S. remain good, and it's still a relatively attractive place to invest.

``The dollar meltdown should have occurred three years ago, and it didn't,'' said Philippa Malmgren, a former Bankers Trust Co., currency strategist now head of Malmgren & Co., her own consulting firm. ``The big U.S. current account is only a problem if Europe and Japan start to outperform the U.S. sustainably.''

David Hale, chief economist for Zurich Financial Services AG, said the dollar's value also may change after next week's U.S. elections. ``The markets like Republicans,'' he said. ``If Bush wins, the dollar will go up. If the Democrats get Congress, the dollar will fall.'' But, he adds, ``it won't be a meltdown.''

Still, the huge U.S. current account deficit is hanging there, raising the prospect of a major plunge in the dollar's value, possibly sometime in the next few months. ``I think all this complacency is misplaced,'' Lawrence Chimerine, head of Radnor International, an economic consulting firm, said.

-- ($@.$.$), November 01, 2000