By Neil Irwin
Washington Post Staff Writer
Saturday, October 10, 2009
Friday's news that the trade deficit narrowed in August shows the silver lining from the steep decline in the value of the dollar.
The dollar has been declining relative to other major currencies for months, and this week there has been a wave of worry that foreign investors might curtail their investments in dollar assets. But so long as the slide remains gradual and orderly, as it has so far, economists generally view it as a plus for the U.S. economy. While it makes imported goods such as oil more expensive, it makes U.S. exporters more competitive, helping rebalance an economy that has been skewed away from exports for years.
In August, the gap between what the United States exports versus its imports narrowed to $30.7 billion, from $31.9 billion, as exports rose and imports fell, the Commerce Department said Friday. The dollar rose 0.5 percent versus other major currencies Friday, as investors interpreted a Thursday night speech by Federal Reserve Chairman Ben Bernanke to suggest that the central bank could raise interest rates in the not-too-distant future.
But even as the dollar ended the week on an uptick, it is still down 14 percent against other major currencies since March. Earlier this week, fears deepened in the world's political and financial capitals over the future of the currency, starting with reports that foreign governments are looking for alternatives to the dollar as a "reserve currency." On Thursday, central banks of South Korea, Indonesia, Thailand, and other east Asian nations intervened in currency markets to keep their currencies from rising too far, too fast.
Part of the recent decline in the dollar simply reverses the artificial boost it received during the depths of the financial crisis, when investors put their money into investments seen as safe. But there is a broader fear in markets: that the steep-but-gradual decline of the dollar of recent months could give way to a rout, the kind of self-reinforcing run on the currency that occurs semi-regularly in developing nations with shaky finances.
"There seems to be a paradigm shift underway where more and more foreign investors are becoming concerned that the long-term path of the dollar is downward," said Bernard Baumohl, chief global economist at the Economic Outlook Group. "We're seeing many investors begin to take steps to make sure that their portfolios do not suffer as a result."
In a run on the dollar, that thinking would create a cascade -- fearful global investors would shy away from dollars, expecting further steep declines, creating a self-fulfilling prophesy. Analysts generally think that if such a pattern were to develop, as has happened in East Asian nations in the late 1990s and in Argentina early in this decade, world governments would likely take aggressive actions to combat it.
That's because everyone has something to lose. In the United States, such an event would drive up the price of imports dramatically, making it much more expensive to finance the government's debt, and potentially lead the Federal Reserve to raise interest rates so soon as to drive the economy back into recession. Exporters in Europe and Japan would be much less competitive, damaging those economies. And China has based its entire economic policy around keeping its currency low against the dollar to encourage exports, a strategy that would be undermined by a disorderly decline in the dollar.
But while government officials have closely monitored the jitters in the foreign exchange markets this week, there were no new public pronouncements from the Treasury Department on the dollar, nor any signs the U.S. government was considering intervening in currency markets to prop up the dollar.
"I'm sure that risk looms very much on the minds of top Treasury and Fed officials," said C. Fred Bergsten, director of the Peterson Institute for International Economics and a onetime Treasury official. "But if there were a sharp dollar fall, you can be sure that other nations would be happy to join in with the U.S. to try to address it."
The concerns about the dollar reflect angst in financial markets over U.S. economic policy. With the budget deficit exceeding 10 percent of gross domestic product this year and the path to lowering deficits unclear, some investors have doubts about the government's commitment to fiscal sustainability -- though bond investors have had little reluctance to lend the government money, as reflected in Treasury bond prices.
The U.S. government has been reluctant historically to intervene directly in the currency markets.
"Given the Treasury's historic aversion to intervening in foreign exchange markets," said Alan D. Levenson, chief economist at T. Rowe Price, measures that the department might take "would more likely relate to restoring growth and charting a course for intermediate-term fiscal sustainability than to short-term exchange rate stabilization."
Thus far, investors continue plowing money into dollar-based assets such as Treasury bonds, so interest rates remain low for American households and businesses, despite the worries. The U.S. government can borrow money for 10 years at 3.4 percent, very low by historical levels.