KONGThe strong dollar is the latest "irrational exuberance" produced by
the market. It is perverse and dangerous. It will prolong U.S. problems and hurt
the rest of the world just when it needs stimulus to offset the slowdown that
the United States must have to reduce private debt and the trade deficit to
Although a U.S. slowdown of uncertain
length is in prospect, the dollar is close to its high against the euro. Its
trade-weighted exchange rate has risen 10 percent in the past year even as the
Nasdaq and interest rates have collapsed. The trend is global and clearest when
measured against Asia's floating currencies. The yen has fallen 15 percent from
a year ago, the Korean won and Thai baht by 17 percent and the Australian dollar
by a stunning 23 percent. The story is the same whether or not economies are
technology dependent, have trade surpluses or are politically stable.
This is perverse. U.S. interest rates are
falling and will probably continue to fall at least as fast as those elsewhere,
even though U.S. inflation is almost the highest among member countries of the
Organization for Economic Cooperation and Development, and is well above that in
most of Asia. The U.S. current account deficit, at more than $300 billion, is
unlikely to decline significantly without a sustained U.S. slowdown.
Meanwhile U.S. money supply continues to
grow far faster than elsewhere. In the 1980s, markets used to respond to every
little blip in money growth. Now they prefer not to look at an acceleration in
money growth that suggests near panic at the Federal Reserve. Broad money has
increased an annual rate of 14 percent over the past three months, after an
already excessive 12-month increase of 10 percent. Yet Alan Greenspan, the Fed
chairman, has been accused of squeezing liquidity. Sooner or later money growth
rates far in excess of those in Europe or Japan will cause the currency to be
relatively and perhaps rapidly debased.
The yen may offer zero return but as a
store of value it is sound. Japan's government debt may be reaching
unsustainable levels but private debt has been declining at a similar pace, so
money growth has been negligible. Conservative monetary policies and a huge
external surplus do not suggest fundamental currency weakness.
The rest of Asia is showing moderate
economic growth with interest rates at historical lows. It has low inflation,
massive current account surpluses and foreign debt levels that in most cases are
easily serviceable. Most Asian currencies are significantly undervalued on
almost any trade- and inflation-adjusted basis. Yet the same investment houses
that gave us the Asian boom and bust then the Nasdaq absurdity now tell us to
beware of the yen and the rest of Asia, let alone the euro.
A strong dollar attracts the capital that
the United States needs to sustain its eventually unsustainable imbalances. It
may delay that day of reckoning but meanwhile is eroding the foreign profits of
U.S. multinationals just at a time when U.S. demand is itself weakening. Thus it
is contributing to the malaise on Wall Street. It is also shifting U.S. demand
to imports, which explains why manufacturing in the United States is hurting. It
will make the reduction in the U.S. current deficit more painful.
Far from being welcomed elsewhere as a
spur to exports, the strong dollar has begun to have negative impact. Japan is
the exception, but because it needs inflation, not more exports. Otherwise,
dangers abound. Europe's outlook is wilting with the euro. Argentina's current
crisis is the result of strong dollar combined with high government debt.
Brazil's new confidence has been eroded by its currency's decline.
In Asia a strong dollar is not the threat
it was in 1997. Now currencies mostly float, dollar debts are much lower and
external competitiveness is strong. Nonetheless, the headlong global flight into
dollars has undermined consumer confidence and investor sentiment. The sometimes
self-serving predictions from bank research departments about a new Asian debt
crisis have made governments more reluctant to provide stimulus to domestic
demand to offset weakness in exports to the United States.
So long as financial markets are driven
by inappropriate price signals, short-term thinking, herd mentality and
leveraged by derivatives whose lack of transparency is potentially catastrophic,
the world will have to live with destabilizing exuberances.
Governments and serious investors can
offset the excesses if they recognize that financial markets have become casinos
and that the leading players are croupiers, not gurus. The wise have no time to
lose if the world is to avoid the deadly combination of a weak U.S. economy,
credit excess and an overvalued dollar.