By Robert J. Samuelson
Friday, December 8, 2006; A39
Let's face it. Foreign exchange markets are not mass entertainment. They're not the NFL, MTV or MySpace. So you might have missed the latest excitement of the sliding dollar. Who cares if the euro is now worth $1.33 instead of the $1.28 it was worth on Nov. 20 -- a 4 percent loss for the dollar? Well, we all should. The dollar's mysterious movements pose one of the thorniest economic questions of our time: Can the world economy thrive without the massive stimulus of ever-increasing U.S. trade deficits?
It's no secret that Asia, Europe and Latin America have feasted on the U.S. trade gap. In 2006 the deficit will reach about $800 billion -- bringing the cumulative total since 1996 to $4.4 trillion. But as the U.S. economy slows, so will Americans' ravenous appetite for imports. Likewise, the dropping dollar (down 11 percent against the euro this year) will make U.S. exports more competitive on global markets. Big exporting countries may suffer. They need stronger domestic economic growth -- or their economies may languish.
We refer awkwardly to "global imbalances": Some countries have big trade surpluses, others (mainly the United States) have big deficits. By and large the phenomenon has baffled economists, who didn't anticipate it. But the basic explanation is simple: The dollar's role as the main global currency.
It's the currency most used to set prices for raw materials: oil, wheat, copper. It's the currency most used to conduct trade. Japan invoices 52 percent of its exports in dollars, South Korea 85 percent and Australia 68 percent. Even France and Germany, which trade mainly in euros, use the dollar for about a third of their exports. Dollars also represent about two-thirds of the official foreign exchange reserves of governments worldwide. China and Japan have the largest reserves, at $1 trillion and nearly $900 billion.
The dollar's global role reflects America's political stability, its large and wealthy economy, its low inflation and its deep financial markets (there's plenty to buy, and it's easy to sell). Not surprisingly, the dollar dominates international bank loans and bonds. It's the favored way global investors hold their wealth in stocks and bonds or bank deposits outside their own countries. Likewise, many non-Americans use dollars as cash. The International Monetary Fund counts 13 countries that have adopted the dollar as their domestic currency; Ecuador is the largest. The Federal Reserve estimates that about $350 billion in cash -- roughly half of all circulating dollar notes -- is held abroad.
Global imbalances emerge because the U.S. trade deficits aren't automatically self-correcting. The surplus dollars that foreigners receive from their exports aren't necessarily dumped onto foreign exchange markets; that would normally lead to a cheaper dollar, more U.S. exports and fewer U.S. imports. Instead, foreigners keep many of the dollars. In recent years two trends have predominated: huge investments by foreigners in U.S. stocks, bonds, real estate and companies; and big additions to governments' foreign exchange reserves, usually by purchases of U.S. Treasury securities. Governments -- notably China -- often want to keep their own currencies artificially depressed, thereby aiding their exports.
In effect, the United States provides a service to the rest of the world -- a global currency -- and is repaid with imports. American consumers benefit; American producers don't. But the system may now be shaky. The U.S. economic advantages may be narrowing as other countries grow richer and develop better financial markets. Or, at some point, the big trade deficits may spill more dollars abroad than foreigners want to hold.
The tensions play out on the foreign exchange markets. The recent dollar sell-off, says Kathy Lien of FXCM, a brokerage service, was triggered by two events: speculation that the Federal Reserve might cut interest rates in early 2007 (that would make holding dollars less profitable) and signs that China might diversify its currency holdings. A gradual dollar drop would be desirable, especially if China relaxed its tight control over its own currency. Bloated U.S. trade deficits don't inspire confidence. They could provoke a panicky flight from the dollar, or protectionism.
But even this begs the harder questions. The dollar-based global economy has been kind to countries such as Japan, China and Germany, whose prosperity rests heavily on their export industries. Economists talk glibly about "rebalancing" the world economy. That means that export-dependent nations would rely more on domestic growth, and deficit countries -- mainly the United States -- would shift to more exports.
It sounds easy, but, especially for major exporters, the needed changes go well beyond twisting a few simple economic dials. They involve altering government policies, industrial structures and even popular attitudes. It's unclear whether these changes can be made. If not, a weak dollar might herald a weak global economy -- which would be bad for everyone.
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