The dollar continued its decline in global currency markets yesterday, intensifying worries among some economists that mounting U.S. budget and trade deficits could send the U.S. currency into a tailspin.
But John B. Taylor, the Treasury undersecretary for international affairs, defended the Bush administration view that the deficits pose no danger of a dollar collapse. He issued a detailed rebuttal of what he called "scare stories."
The dollar fell yesterday to within a fraction of a cent of its all-time low against the euro of $1.2930, trading as low as $1.2898 before rallying slightly to close at $1.2867. It fell modestly against the Japanese yen and continued a sharp slide against the Canadian dollar, which rose to 83 U.S. cents yesterday for the first time in 12 years.
It was the second straight day that the dollar has fallen despite a surge in the stock market, continuing a trend that began in early October when it started slipping against the currencies of major U.S. trading partners. The decline rekindled the fears of some analysts that the dollar could be headed for a severe sell-off unless the White House and Congress make a major effort to shrink the budget gap.
"As the dust settles after the U.S. elections, the one theme that is developing is the growing recognition [in the markets] of the need for more dollar depreciation," economists at J.P. Morgan told clients yesterday, citing as one major reason the likelihood that "there will be no serious new policies to trim the U.S. budget deficit."
Behind such sentiments is the belief that the U.S. economy is too dependent on foreign investors and that they may balk at pouring money into U.S. securities if the country's debt continues to soar. Foreigners have provided much of the money the government borrows to cover its deficit, which was $413 billion in the fiscal year ended Sept. 30.
"One of the big drivers in the whole big picture the markets are looking at now is our being dependent on foreign sources of funds," said David Solin, managing partner at Foreign Exchange Analytics in Essex, Conn. "Obviously, if the foreigners step back [from investing in U.S. bonds and stocks], there are going to be serious problems, not only for the dollar, but for all financial markets."
The trade deficit also creates a dependence on money from abroad because many foreigners supplying goods to the United States take the dollars they receive and effectively lend them to the United States. The simplest example of such lending is their purchase of U.S. government bonds.
Because of concerns that the United States is too much in debt, the rise in the trade gap, which is running at an annual rate of about $600 billion, also raises the specter that foreigners might dump U.S. holdings.
Those scenarios were dismissed as fanciful by Taylor, who spoke yesterday at an American Enterprise Institute seminar on the current account deficit, the broadest measure of the trade gap.
The large influx of foreign money shows that "sound, growth-enhancing economic policies are continuing to make the U.S. an attractive place to invest," he said.
Taylor said administration policies already in place will help shrink the trade deficit. One is President Bush's pledge to cut the budget deficit in half, as a percentage of the U.S. gross domestic product, by 2009. That would decrease the trade deficit because lower government spending or higher taxes would reduce the amount of money consumers spend on imported goods.
Taylor pointed out that the Treasury is also prodding foreign governments to achieve faster economic growth, which should increase demand for U.S. exports, and that it is trying to persuade China to change its fixed-exchange rate policy by allowing its currency, the yuan, to rise. A higher yuan would be likely to slow the flood of Chinese goods into the U.S. market because those products would become more expensive for U.S. consumers.
"Even if those policies take some time" to reduce the trade deficit, Taylor said, "there is no reason to think there will be problems in the meantime" in continuing to obtain enough money to cover the gap.
Taking issue with analysts who have voiced concern about a recent drop in investment by foreigners in U.S. Treasury bonds, Taylor said, "It is important to put the current account in the perspective of the total amount of financial flows crossing U.S. borders in large, open and flexible markets."
He cited the fact that the current account deficit increased by $19 billion in the second quarter even though government data showed a decline of about $180 billion in purchases of U.S. assets by both foreign central banks and private investors. The U.S. economy experienced no turbulence because U.S. buyers in effect replaced the foreigners.
Taylor's views were seconded by some of the other speakers at the seminar, including Allan H. Meltzer, a professor at Carnegie-Mellon University. But others maintained that the current account gap is certain to drive the dollar down one way or another -- either gently and gradually, or suddenly and sharply. Although a gradual move downward would help the economy by boosting exports, it would erode U.S. living standards below what they would be by making imported goods more expensive.
Bush's news conference yesterday did little to lessen concerns over the deficits, Wall Street analysts and currency traders said. Bush simultaneously promised not to raise taxes under the guise of tax simplification, to pursue a costly restructuring of Social Security and to cut the budget deficit in half by 2009.
The currency markets aren't buying it, said William G. Gale, an economist at the Brookings Institution.
White House officials "have Alan Greenspan to help keep interest rates down, but they can't control the foreign exchange markets," Gale said. "I think investors are acting appropriately."