Greenspan Hits the Trifecta: Dollar's Decline Inevitable
Philadelphia Inquirer, November 28, 2004
Knight-Ridder/Tribune Information Services, November 22, 2004
Saskatchewan News (Canada), November 24,2004
Wichita Eagle, November 26, 2004
Myrtle Beach Sun-News (NC), November 28, 2004
Economy.com, November 28, 2004
Connecticut Post, November 28, 2004
Benson County Farmer's Press (North Dakota), November 28, 2004
Is anyone wondering why Alan Greenspan waited until after the election to announce what most economists have known for years: that foreign central banks are not going to keep up their current lending to us indefinitely? The statement last week, expressed in typically round-about "Greenspan-speak," was just clear enough to send the stock market, the bond market, and the dollar all reeling. In horse-racing parlance, he hit the trifecta.
Here is the problem: the United States has been importing a lot more than we are exporting, to the point where we are now borrowing nearly 6 percent of our national income from the rest of the world. This is not sustainable: if you project this rate of borrowing out a few years, you end up with levels of foreign debt that almost no developed country has ever had.
The only feasible way to reduce this foreign borrowing to a sustainable level -- we don't have to have balanced trade -- is for the U.S. dollar to fall against other currencies. This would increase the price of our imports, and reduce the price of our exports to other countries. This is not a bad thing -- in fact it is not only inevitable but necessary in order to save what is left of our manufacturing sector and yes, even recover some of the jobs in that sector that have been lost.
Since 2000 we have lost almost 3 million manufacturing jobs, and the number one cause of this hemorrhaging is actually the overvaluation of the U.S. dollar. If the dollar is overvalued by 30 percent, this is equivalent to giving a 30 percent subsidy to imports entering our markets. At the same time, it is also the same as having U.S. companies face a 30 percent tariff on everything that they export abroad.
It is an understatement to call this a huge disadvantage for U.S. manufacturers. And since wages in the manufacturing sector have historically been higher and have often driven wages in other sectors, the loss of these jobs is one of the causes of increasing income inequality in the United States.
Unfortunately most of our policy makers do not care much about any of these things. Wall Street prefers an overvalued dollar because it keeps inflation low by making imports cheap, and it also makes it cheaper to acquire assets (and hire labor) overseas.
So both the Clinton and Bush administrations have officially embraced a policy of maintaining a "strong dollar." This sounds very nice but is comparable to a doctor pursuing a "strong influenza virus" policy for his patients.
In any case we have now reached the point where private foreign investors are no longer financing our foreign borrowing -- it is foreign governments, primarily China and Japan, that are doing this for political reasons of their own. But as Mr. Greenspan noted, this cannot go on indefinitely. By choosing to hold their reserves in dollars instead of Euros, for example, they have already lost hundreds of billions of dollars over the past two years. Many developing countries who can afford it even less are also facing significant losses by continuing to hold dollars.
The overvalued dollar is a bubble, like our stock market bubble prior to 2000. In fact the stock market bubble contributed to the dollar's overvaluation by attracting large amounts of foreign capital to the U.S. stock market. Greenspan is right to call attention to the dollar bubble. He was also right when he briefly pointed to the possibility of "irrational exuberance" of the stock market at the end of 1996. Unfortunately he subsequently backed off from those remarks and allowed the stock market bubble to grow to dangerous proportions.
Our stock market bubble burst in 2000-2002, but it could conceivably have gone on much longer. If so, the consequences when it burst would have been even worse. This is even more true of the dollar bubble, since every year that the dollar remains overvalued costs us hundreds of thousands of manufacturing jobs.
The adjustment to a lower dollar will not be painless, since higher import prices will add to inflation, and long-term interest rates will almost certainly rise from their extraordinarily low levels of today. But there is no sense in remaining in denial.