May 04, 2003

The Coming Decline in the Dollar

Morgan Stanley's Stephen Roach hopes and thinks that the dollar will fall far, will fall soon, and that in fact the return to equilibrium valuations is already underway. I'm not sure that it is underway and I'm not at all confident that it will be soon: I recall the late Rudi Dornbusch, who always said that currency value imbalances last much longer than anyone sane would believe possible, and then turn themselves around much more quickly than anyone lulled by the previous period had imagined possible. Fundamentals are on Roach's side. But fundamentals plus $2.80 will get you a BART ticket from Lafayette to Berkeley.

Stephen Roach: ...But there?s even a deeper significance to dollar depreciation. Largely for political or other institutional reasons, both Europe and Japan have been unwilling or unable to adopt pro-growth policy measures. Japan is fearful of ending the ?convoy system? of zombie-like companies; the resulting rise in unemployment is an anathema to a system where social contracts still involve some form of lifetime employment. Europe is constricted by a misguided rules-based system of macro policy determination. Monetary policy is still aimed at fighting inflation in an increasingly deflationary world. And fiscal policy is set by the arbitrary constraints of the Growth and Stability Pact, which did not take cyclical distress into serious consideration. Europe and Japan show little or no inclination to voluntarily alter these deeply entrenched approaches. So, in my view, it seems entirely appropriate to put pressure on both economies to change. The currency lever is the most effective means to accomplish this objective. If the dollar stayed strong and the world held to its course of US-centric growth, Europe and Japan would have no incentive to change. A weaker dollar would leave them with no other choice.

Plagued by unprecedented external imbalances, the world simply cannot afford to stay the course of US-centric growth. A lopsided global economy needs a shift in relative prices to find a new and more stable equilibrium. The dollar -- the world?s most important relative price -- has to fall. Such a decline may now be under way. And the world will have no choice other than to figure out how to cope with the imperatives of global rebalancing.

Posted by DeLong at May 4, 2003 11:13 AM | TrackBack


All we need to do is watch the dollar decline in value and Japan and Germany will be forced to become America in economic policies. Give me a break. Germany and Japan are democracies, and there is such a thing as politics that will not simply allow a wholesale economic restructuring if the Yen and Euro were to appreciate. Currency values may change, but economic restructuring in Japan and Germany will be gradual and different than they would be in America. Likely, the dollar will not lose enough value to solve our problems, let alone the problems abroad.

Posted by: anne on May 4, 2003 11:34 AM

Notice that the tax cut bill now slated to pass out of the House of Representatives is even more skewed to the rich than the President's original plan. Forget about slow growth, forget about jobs, reward the rich. Radical conservatives are bent on undoing middle class America. A decline in the value of the dollar is not the answer to our economic needs.

Posted by: lise on May 4, 2003 11:58 AM

The COMING decline in the dollar? A year ago, the Euro was at 90 cents, it's now above $1.10. A year ago, the Pound was $1.40, it's now $1.60. These are mammoth shifts. What a difference a war makes.

Posted by: jam on May 4, 2003 01:43 PM

I do not think that the war had anything to do on this outcome, in some aspects it seems that there was a trend to revaluation of the Euro versus the Dollar, what the war seems to have done is to put a brake on it at some moments.


Posted by: Antoni Jaume on May 4, 2003 02:03 PM

Suggest taking a look at currency moves over the years. The move of the dollar in the last year is really quite moderate especially against a basket of trade weighed currencies. Moderate indeed.

Posted by: jd on May 4, 2003 02:07 PM

"Mammoth shifts" these dollar values are not.

Posted by: bill on May 4, 2003 02:09 PM

The "Stephen Roach" link is broken.

Posted by: Europundit on May 4, 2003 03:28 PM

OK. Maybe "mammoth" is overstated. But a 90 cent Euro going to a $1.10 Euro is a 22% change, which ain't chopped liver, either. Back in the old days, it took anguished argument before a country formally devalued to that extent.

I accept that things aren't so drastic on a trade-weighted basis, but Roach is taking about effects outside the US and specifically instanced Europe, so the Euro movement seems relevant in a way that a US-centric trade-weighted basket isn't.

Posted by: jam on May 4, 2003 03:30 PM

Anne, Europe is more than Germany (insert raised eyebrow smilie or something.)

The ECB is hardly democratic, and the stability pact is also a voluntary of freedom of action, arguably an abdication too. They both represent sort of a suspension of ordinary electoral politics.

"If the dollar stayed strong and the world held to its course of US-centric growth, Europe and Japan would have no incentive to change. A weaker dollar would leave them with no other choice."

Sounds very much like overstatements toom me, I' no economist. ?

Posted by: Europundit on May 4, 2003 03:43 PM

Anne, Europe is more than Germany (insert raised eyebrow smilie or something.)

The ECB is hardly democratic, and the stability pact is also a voluntary of freedom of action, arguably an abdication too. They both represent sort of a suspension of ordinary electoral politics.

"If the dollar stayed strong and the world held to its course of US-centric growth, Europe and Japan would have no incentive to change. A weaker dollar would leave them with no other choice."

Sounds very much like overstatements to me, but I'm no economist. Hum?

Posted by: Europundit on May 4, 2003 03:44 PM

Anne, Europe is more than Germany (insert raised eyebrow smilie or something.)

The ECB is hardly democratic, and the stability pact is also a voluntary of freedom of action, arguably an abdication too. They both represent sort of a suspension of ordinary electoral politics.

"If the dollar stayed strong and the world held to its course of US-centric growth, Europe and Japan would have no incentive to change. A weaker dollar would leave them with no other choice."

Sounds very much like overstatements to me, but I'm no economist. Hm?

Posted by: Europundit on May 4, 2003 03:44 PM

Heh. Sorry everyone.

Posted by: Europundit on May 4, 2003 03:47 PM

On whether the war has anything to do with it:

I agree with Antoni Jaume that there were (still are) a bunch of other things pressuring for revaluation of the Euro against the dollar. One of them is (probably) capital burned in the dot com collapse seeking a safe harbour. That doesn't do the Yen any good because few would consider Japanese banks a safe harbour these days (not even Japanese housewives, perhaps), but it does help European currencies, particularly because European interest rates are higher than US rates.

My guess (purely a guess; if I actually knew what moved exchange rates, I'd be able to afford a computer with a better keyboard than this) is that the impending war, if anything, increased the nervousness of people wondering where to keep their capital and increased the flow out of the Dollar and into European currencies (not just the Euro: the Swiss Franc has also had a nice rise) over the last six months or so.

Posted by: jam on May 4, 2003 05:17 PM

TransNational Corporate Fundamentalism and the Strong Dollar

I. Leaving aside:

1.A. The dickweed administration's* sudden, overpowering desire to adopt Iraq

[Our New Baby, Thomas Friedman ]

1. B. and make life an earthly paradise
for those INEXPLICABLY poor, downtrodden heartlandish Iraqi people,

[A Tyrant 40 Years in the Making, Roger Morris ]

2.A. Exxon & etc.'s designs on the world's second largest proven reserves of one of the world's most important, finite

[THE END OF CHEAP OIL, Colin J. Campbell and Jean H. Laherrère (Scientific American, March 1998) ]

2.B. AND dangerous commodities,

[Melting of Earth's Ice Cover Reaches New High, Lisa Mastny ]

[As Trees Die, Some Cite the Climate, By Timothy Egan (New York Times) ]

[A Closer Look at Global Warming, National Research Council ]

3. Halliburton, Bechtel & etc.'s desire to make a few "inputs" off the business of putting back up every(non-living)thing the Pentagon's OTHER clients (Lockheed-Martin & etc.) made off of the business of selling the Pentagon what it needs for its "outputs": bomb craters & dead bodies,

[Weighing the Price of Rebuilding Iraq, Thomas R. Pickering and James R. Schlessinger ]

4. Ariel Sharon's intriguingly "well-connected" Washington advocates for HIS Likudnikish plan to "pacify" Islam,

[Can We Talk?, Eric Alterman ]

5. A. and the DEMONSTRABLE economic FACT that our hallowed "strong dollar" policy DOESN'T "work" for the VAST majority of us non-ultrarich, non-corporate fundamentalist, non-"transnational" Americans,

[Notes on the U.S. Trade and Balance of Payments Deficits, Wynne Godley ]

5.B. as well as the DEMONSTRABLE economic FACT that the "strong dollar" mantra HASN'T "worked" for the VAST MAJORITY OF AMERICANS for TWENTY PLUS YEARS NOW,

[Table 1. U.S. International Transactions: Balance on current account

(Millions of dollars)

1970 2,331
1971 -1,433
1972 -5,795
1973 7,140
1974 1,962
1975 18,116
1976 4,295
1977 -14,335
1978 -15,143
1979 -285
1980 2,317
1981 5,030
1982 -5,536
1983 -38,691
1984 -94,344
1985 -118,155
1986 -147,177
1987 -160,655
1988 -121,153
1989 -99,486
1990 -78,965
1991 3,747
1992 -48,515
1993 -82,523
1994 -118,244
1995 -105,823
1996 -117,821
1997 -128,372
1998 -203,827
1999 -292,856
2000 -410,341
2001 -393,371
2002 -503,427 ]

II. It should be noted that, in addition to:

1.A. Restocking the black market for antiquies,

[And Now: 'Operation Iraqi Looting', Frank Rich ]

1.B. and those much discussed but STILL undetected WMD's Saddam was SUPPOSED to be sitting on,

[Bush Convinced U.S. Will Find Iraqi Weapons ]

1.C.1. we ALSO sacked Iraq FOR the dollar...

"Muslims eye euro as new oil currency

April 22 2003

Since 1901, when drillers unleashed a Texas gusher and created the modern oil industry, barrels of oil have been sold for greenbacks. Whether they buy oil in Alaska, Norway or Bahrain, today's customers pay in US dollars...

...The US benefits from the global use of "petrodollars" because countries that import oil must have dollars on hand. This global demand for dollars helps keep the US currency strong.

Having a strong dollar lets US consumers buy imported goods for less, which helps hold down inflation.

At the same time, countries that export oil receive dollars, which they in turn invest directly in US securities to avoid currency fluctuation risks. Because these oil exporters are willing to purchase huge amounts of US Treasuries, interest rates also are kept low.

When Arabs first started looking for ways to harm the US economy in the 1970s, there was no real competitor to the US dollar. That changed on January 1, 2000, when about 300 million Europeans in 12 nations exchanged their national currencies for the euro.

This campaign against petrodollars was launched by Iraq's ousted leader Saddam Hussein himself. In September 2000, his regime announced it would no longer accept dollars for oil being sold under the United Nation's "oil for food" program. A government statement said that to confront the "daily American-Zionist aggression", oil would have to be paid for in euros. While that move had a negligible impact on the US economy, it gave Iraq a boost when the euro appreciated by 30 per cent against the US dollar in recent months.

Now that US military forces control Iraq, that nation is expected to once again accept greenbacks for its oil..."

1.C.2. the dollar according to Wall Street that is. Yes, THAT Wall Street:

[Notes From a Little Fish, R. Foster Winans ]

III. All of which is NOT to say that sacking Iraq actually did the dollar, ANYONE or ANYTHING (outside of Iraq) a DAMNED bit of NON-IMAGINARY good...

"Dollar Closes Slightly Higher, Down Sharply for Week

Fri May 2, 2003

The dollar took a pause in its downward trek Friday, finishing the day little changed against its major rivals but down sharply since Monday.

After a steep decline earlier in the week, the U.S. currency managed to halt its slide at least temporarily as traders booked profits and adjusted positions ahead of a long weekend for the London and Tokyo markets.

"It was largely technical trading in a thin market," said David Leaver, senior trader at Gain Capital.

The dollar garnered some support from the U.S. employment report for April and the subsequent rally for U.S. equities, while unimpressive economic data from Europe tarnished the euro and worries over Japanese intervention capped the yen, traders said.

However, the underlying trend remains bearish for the dollar, with the euro remaining at four-year highs versus its U.S. counterpart. The common European currency is still in demand, said Mr. Leaver, especially from accounts based outside the U.S...."

"Sold as economic cure, tax cuts hike deficit instead

Thu Apr 24,

Lost amid the good news of the April 9 fall of Saddam Hussein's regime was a troubling economic report: The Congressional Budget Office (CBO) said the deficit for just the first half of this fiscal year was a record $248 billion, nearly twice as big as a year ago.

At that pace, the federal government is on track to accumulate an unprecedented shortfall of $400 billion this year -- or $3,600 for every family -- after the bills for the Iraq war arrive. And it would saddle taxpayers with higher interest payments on a ballooning national debt, just as the government must finance the retirement of the huge baby-boom generation that starts in 2011.

Yet the dire forecast seems to have been lost on the Bush administration, too. Instead of responding responsibly to congressional fears about the exploding deficit, it is maneuvering to paint its outsized tax-cut plan as something it is not: an affordable tonic for an ailing economy.

The positive portrayal by an administration eager to show it is doing all it can to buoy the economy before the 2004 election makes sense politically. But the economic policy it masks doesn't..."

"EU Ponders Handling U.S. Hyperpower

(04 May 2003)

By Paul Taylor, European Affairs Editor

KASTELLORIZO, Greece (Reuters) - On the love boat that hosted Prince Charles and Princess Diana's honeymoon, European Union foreign ministers this weekend contemplated how to salvage their troubled marriage with the United States.

Cruising off an idyllic Greek island, ministers from the 25 present and future EU states tried to draw lessons from their rift over the U.S.-led war in Iraq and Washington's drive to reshape the world along its own lines with or without United Nations (news - web sites) authority.

"We all agree that, yes, there is a crisis or at least a problem in our transatlantic relationship," Greek Foreign Minister George Papandreou told reporters after chairing the discussion aboard the private luxury yacht Alexander.

Participants described two schools of thought around the table: those who believed the U.S. shift toward using pre-emptive force unilaterally if necessary was a temporary aberration, and those who detected a long-term shift under way even before President Bush's election and the September 11, 2001, attacks on the United States.

European External Relations Commissioner Chris Patten shocked some ministers by arguing that, but for a handful of disputed votes in Florida in the 2000 presidential election, there might never have been a war in Iraq, EU sources said...

Posted by: Mike on May 4, 2003 08:15 PM

Wouldn't relative exchange rates be most influenced by a combination of balance of payments and economic expansion? So, for example, for the period 1994-2000 or so, the US ran a large current accounts deficit, but a smaller capital surplus; although the gap between the two meant a negative balance of payments, the US GDP was also growing faster than the rest of the OECD and so it followed that holdings of dollar-denominated accounts was desirable. The operant word is "desirable": that desire can switch on a whim, but is less likely to do so (or less likely to remain switched) when other destinations for capital are very quickly maxed out.

Posted by: James R MacLean on May 4, 2003 08:19 PM

Why does Clinton get so much credit for balancing the fiscal deficit, while we have run such a bad trade deficit?

I would rather be paying ourselves in future for a fiscal deficit that bought infrastructure and investment in the working poor, rather than paying foreigners in future for oil we burned years before, and for third world manufacturing goods that are in a landfill. And be paying for the landfill too.

Posted by: nkirsch on May 4, 2003 11:07 PM

"At the same time, countries that export oil receive dollars, which they in turn invest directly in US securities to avoid currency fluctuation risks." This seems to be wrong. You need to invest in the currency or currencies of your expenses, not of your receipts, if you're worried about currency fluctuation risks. On the other hand, you would probably stay a little long on the US dollar, to cut down on currency *transaction* costs (since you can't know with perfect precision what currency future expenses will be in).

Posted by: Andrew Boucher on May 5, 2003 03:25 AM

Andrew Boucher,

since the dollar has been the currency of choice from the IIWW until now, the USA being the main trader for mosrt of this time, many sellers accepted direct payment in dollars, especially if their own money was not very circulated. Even between UE members till the EMU, like between Spain and Denmark, it was normal to work in dollars. Six years ago I worked on the informatics of a electronic import-export small enterprise, by the use of the dollar as almost only foreign currency it reduced the money management costs, since their provider could come from Hong-Kong, Corea, Taiwan, Finland, USA, etc.


Posted by: Antoni Jaume on May 5, 2003 04:37 AM

Just suppose (repeat: just suppose) we get a clear uptick in the business cycle in the United States within the next five-six months and an accompanying rally in equity markets, which anticipate that the recovery will be sustained. (Good news about employment comes later.)

Where does this leave the dollar?

I bet headed in the opposite direction as that forecast by Steve Roach, as Europeans and Japanese decide there is no better place than the US to put their capital, after all.

Anyway, and in all fairness, the dollar is always a very tough call.

Posted by: Jim Harris on May 5, 2003 05:10 AM

How MUCH did you "bet", Jim ;?)

Posted by: Mike on May 5, 2003 05:39 AM

Here I go, where angels fear to tread. Cousin Jim is right (all references to blood relationhsip purely facetious), fx rates are among the peskiest of all economic and financial series. At least stock prices have a trend over the long run (outside Japan, anyway). The initial argument was that Germany and Japan will have to liberalize their economies if their currencies appreciate. On the stupid assumption that recent trends will hold, the Eurozone looks to be in for a whole lot more liberalization than Japan. The euro is the big "winner", chugging higher against Stg, yen and the dollar of late. For all the attention lavished on Usd/Jpy by Japan's finance ministry and the press, it has been headed sideways for some time. Meanwhile, Japan's trade surplus with the US is narrowing from roughly $6.8 bln each month in 2000 to $5.8 bln in 2002. Exchange rates are far from the whole story when it comes to trade.

The objections posted here to the notion that Germany of Japan will grow more efficient under pressure from a weak dollar seem to depend on all change coming from the government. The US regulator scheme is surely more flexible than that in either Germany or Japan, but some recognition must be given to private sector efforts. Japan once prided itself on its ability to adjust to any exchange rate, as long as that rate was arrived at gradually. That was back when Japan was the supposed model for the rest of the world. Private Japanese firms simply found ways to reduce costs and (most of the time) maintain margins. The response to a stronger yen (among other things) more recently seems to be to send productive capacity to China and elsewhere in Asia. (The "other things" include very low wages in China and elsewhere, probably more influential than exchange rates.) What Japan probably needs to do is find a new place in the world, one that does not depend on exports of manufactured goods. I don't know how they would go about that, but I'd bet it won't be driven by voters or bureaucrats.

As to what is driving fx rates, heck I don't know, but I can make a few observations. The ten-year bund/note spread is roughly 10 basis points, while the spread on overnight money is closer to 75 bp. Thus in periods when safehaven investments are popular (periods of falling stocks, rickety corporate ethics, war, terrorism), there would be a greater advantage to euro denominated accounts than during periods when equities and longer-dated corporate or sovereign debt is more favored. The euro's performance against the yen has been more persistent, just as the yield pick-up against Japanese assets is persistent across the yield curve (10-year JGB sometimes yield as little as 65 bp), so that even when safehaven instruments aren't more favored, the euro would have an advantage over the yen. Just a guess.

Posted by: K Harris on May 5, 2003 08:37 AM

I'm not sure what Stephen Roach uses for his model of exchange rates so I have no idea how he can say the dollar is overvalued and should devalue. Yes, we have a large current account deficit so one's model is simply that the exchange rate must adjust to have the current account move towards zero, then the model might give this prediction. But isn't the current account simply the reflection of the difference between national savings and investment. And with the U.S. fiscal stimulus dramatically reducing U.S. savings, isn't the strong dollar the result of the world's savings = investment equilibrium? OK, I have not put forth a full general equilibrium model but has Mr. Roach done so?

Posted by: Hal McClure on May 5, 2003 12:19 PM

Hal, The Economist claims, via their Big Mac Index, that it is the Euro which is now overvalued, in term of purchase power parity. The rate of change should be very near to parity, while it is at 1.12 and the same goes for the pound.


Posted by: Antoni Jaume on May 5, 2003 12:39 PM

As someone who trades currencies I would like to point out that The USD broke out of its trading range in the beginning of April of 2002 and was mainly due to concerns regarding the current account deficit. This was well before there was any likelihood that we would invade Iraq. And as far as being a drastic devaluation I would like to point out that at 1.1292 USD/EUR it is still within the 1999 trading range (BTW the low was 0.8230 on 10/26/00). I would argue that from 2000 to the beginning of 2002 the USD was overvalued vs. the EUR and is now closer to an appropriate value. From what I’ve seen the war seems to have little direct correlation with the USD exchange rate vs. the majors. I don’t know why people are so concern with the CA deficit. A negative CA means your GDP is growing more than the rest of the world and attracting investment. Would you rather the US have a trade surplus and negative GDP growth like Japan?

Posted by: Brian in NYC on May 5, 2003 02:37 PM
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