Despite the dollar's recent bounce, economic observers worry that if the dollar's value continues south unabated, it threatens to spawn an economic crisis like the one that rippled across Asia in 1997 and 1998. And that's prompting pressure on President Bush to reduce the U.S. government's widening twin trade and budget deficits-and to persuade China to devalue the yuan.
Over the past three years, the dollar has tumbled by 35 percent against the euro and by 24 percent against the yen-from a peak in early 2002. Though it rallied slightly in January amid optimism over U.S. manufacturing growth and signals from the Federal Reserve that it would raise the federal funds rate to 2.5 percent this month, economists agree that was a blip. The rate now stands at 2.25 percent, above the European Central Bank's main refinancing rate of two percent. Higher U.S. interest rates support the dollar by making U.S. bonds more attractive to investors.
"I can't tell you where or when the crisis will emerge, but it will happen if the dollar continues to decline," says Robert B. Cassidy, director of international trade and services at the Washington, D.C., law firm of Collier Shannon Scott. "This could be a financial crisis akin to the Asian financial crisis, the balances are so large now. This is not just a China issue, it's a global issue." China's foreign-exchange reserves, he says, top $500 billion, or over two-thirds of its GDP. About 13 percent of U.S. imports go to China.
Cassidy, assistant U.S. Trade Representative for China in 1997, is also a spokesman for the China Currency Coalition, a group of U.S. firms that says China's exchange rate is undervalued by about 40 percent (other economists suggest the range is between 15 percent and 80 percent) and warns that the U.S. deficit with China is likely to have reached $160 billion in 2004, a 28 percent increase over 2003. Though the group was shot down last year when it urged President Bush to take China to the World Trade Organization over currency practices, it continues to press for behind-the-scenes diplomacy to diffuse the crisis. "The governments of the world could work out a solution that could create a soft landing," Cassidy suggests, noting that the currency imbalance essentially subsidizes China's exports and taxes China's imports. Moreover, it helps draw foreign investment to that nation, which hit a record $53 billion in the first 10 months of 2004. Though a devaluated yuan would make Chinese goods pricier for Americans, it also would cool that huge economy and encourage neighboring nations to devalue their currencies against the dollar, too. China has agreed that devaluation is a good idea and has offered no deadlines. "It's only getting worse," worries Cassidy.
Economists also blame weak consumer demand from Europe and Japan for the dollar's woes, which they say gradually increases inflation in America through higher import prices. However, most of the finger-pointing has been reserved for President Bush, who has now reluctantly agreed to halve the federal deficit in the next five years. The current-account deficit hit a record $164.7 billion in the third quarter, which means the U.S. is adding to its foreign debt at an annual rate of $665 billion, or $5,500 for every household in the nation, according to Josh Bivens, an economist at the Washington, D.C.-based research group, the Economic Policy Institute. The U.S. foreign debt, about four percent of GDP in 1992, surged to 24 percent of GDP in 2003-and is on a trajectory to reach 64 percent of GDP by 2014.
The dollar's weakness "definitely worries me," says Bivens, who predicts its value will slip another 15 percent to 30 percent against the trade-weighted dollar, an index of 30 top currencies, before it stabilizes. "If the dollar has a significant but gradual decline over the next four years-like 10 percent per year-that would be good and give us time to ramp up our exports...without throwing the economy into dislocation. It all depends on the pace and the orderliness of the decline."
Even if interest rates climb and both deficits narrow, Bivens sees no quick fix for the U.S. economy, since the effects of currency changes don't show up for 18 to 24 months. Indeed, say economists, America and its families, companies and government have to save more so the U.S. can reduce its dependence on the funds of foreigners, who now hold about 40 percent of all U.S. Treasurys.
Bivens is cynical about Bush's promise of spending relief. "I don't believe it's going to happen," he says. "Even if he managed to cut the deficit in half in five years, that won't be enough." He urges a tough stand against China, frosted by diplomatic finesse.
Cassidy suggests the U.S. take the lead. "It's sort of like a see-saw," he notes. "As [the dollar] goes down, something has to go up. That tends to be the euro, the pound, the Canadian dollar. The [U.S.] dollar is the fulcrum. The kids are in the playground, but we need an adult to come in and take charge. ...Do you believe the Congress would fund a bailout of China? I don't think so."
