Timing is everything, in life and financial markets. And the new Treasury secretary, Lawrence Summers, must wonder occasionally whether his predecessor, the wily ex-bond trader Robert Rubin, got out while the getting was good.
Summers got some good news Friday as Wall Street celebrated a report that new jobs are being created more slowly than expected. In the sometimes perverse logic of the markets, that eased investors' fears that the economy is overheating and that the Federal Reserve will have to raise interest rates again soon. The stock market roared upward, with the Dow gaining more than 235 points.
But Summers faces an important test soon in how he deals with the weakness of the dollar in foreign currency markets. Because it reflects deeper structural problems in the U.S. economy, some analysts view the dollar's recent dip as a sign that storm clouds may be ahead for Pleasantville.
A quiet sell-off of dollars has been going on for weeks. The U.S. currency has fallen from about 122 yen to the dollar in mid-July to about 110 Friday. Meanwhile, the dollar also has been falling against the new European currency, the euro, which only a few months ago seemed laughably weak. After falling almost to one-to-one parity in midsummer, the euro has bounced back to about 1.06 dollars Friday.
Friday's stock market surge temporarily could ease pressure on the dollar, analysts say. But the dollar sell-off could accelerate again, if traders see more signs of robust economic growth in Japan and Europe and decide to shift investments into those currencies.
The odd thing is that the dollar has been slumping at the same time U.S. interest rates are going up. That isn't supposed to happen -- higher U.S. interest rates, in theory, should make investors more willing to hold dollars.
"Signs are building up that a dollar crisis is ahead," says C. Fred Bergsten, head of the Institute for International Economics. He's something of a dollar-pessimist and has been warning since January that a "sharp decline" is looming.
Bergsten reckons that the dollar is still about 20 percent overvalued in terms of economic fundamentals, even after its recent decline. By his calculations, an equilibrium level would be about 90 yen to the dollar and 1.25 dollars to the euro -- both roughly 20 percent below current levels.
Bergsten fears that a sharply declining dollar could produce a "triple whammy" for the U.S. economy. First, it would make inflation worse -- by his estimate, every 10 percent fall in the dollar would add one percent to the inflation rate. Higher inflation, in turn, would push up interest rates, and higher rates would put the brakes on the stock market. Adding to the carnage would be a likely flight from U.S. stocks and bonds by panicky foreign investors.
The dollar's problems are a reminder that in economics, you can't escape the fundamentals forever. What's inescapable in this case is the large and persistent U.S. trade deficit. The U.S. deficit, which measures services as well as merchandise, is likely to total more than $300 billion this year, or about 3.3 percent of GDP. That's a new record, and the largest deficit in percentage terms since 1987.
These dry trade statistics are important, because they describe a basic structural imbalance in our economy. Simply put, we consume hundreds of billions of dollars more in goods and services than we produce -- with the rest of the world financing our free ride. In one sense, this surging U.S. demand -- and the rest of the world's willingness to finance it by buying our stocks and bonds -- demonstrates the robustness of our economy. But such huge trade deficits can't last forever, and the most likely form of adjustment will be a declining dollar.
Like the budget deficits of the '80s, the trade imbalance is a warning that we should put our financial house in order. That's the theme of a powerful new analysis that will be published this month by Catherine L. Mann, entitled "Is the U.S. Trade Deficit Sustainable?" Her answer is no.
Mann explains that U.S. deficits are in "unsustainable territory." They may persist for another two or three years, she says. "But the United States cannot forever consume beyond its long-term means; nor will its financial investments always be so favored." What policymakers must do, she says, is improve the underlying health of the economy -- especially by raising our household savings rate.
Summers's challenge, now that he has his hand on the tiller, is to continue the dollar voodoo-magic of his predecessor. When foreign markets were jittery, Rubin typically would issue an incomprehensible statement -- leaving the markets uncertain whether he would or wouldn't intervene to support the dollar.
Though Rubin got the credit, Summers was one of the architects of Rubin's "minimalist" theory of intervention. His view was that the Treasury shouldn't talk the dollar up or down for short-term reasons. Instead, it should try to get the fundamentals right and leave the traders guessing.
Summers regularly repeats Rubin's mantra that "a strong dollar is good for America." What will he do now as the dollar shows signs of weakening? For better or worse, the new guy can be sure that the whole financial world will be watching.