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The dollar's value makes the US economy vulnerable to international forces

By Robert Hormats - posted Saturday, 1 September 2001


Let me try to make a few broad points and then try to go through a little bit of an analysis as to why I think the dollar has defied the law of gravity in some cases.

First, the strong dollar policy today is taking place in a very different context from the strong dollar policy of the Rubin and Summers years. Then, we had a policy of a strong dollar and we also had a strong economy. Now, we have a strong dollar policy, which is really a legacy of the last administration, which this administration has taken up, but we have a much weaker economy.

The only problem is that, as our economy has weakened, so have a lot of other economies. And while there are problems posed by a strong dollar there are a whole host of other problems. In many cases, those other problems are much more severe and, in many cases, localised in the sense that they’re not dependent on currency markets or currency misalignments. They took place, those problems emerged, from domestic economic problems, domestic economic weakness.

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Now, to some degree, certainly in the manufacturing sector in the United States, the strong dollar has exacerbated those problems. However, because of the investment boom and then the investment bust, because of an American economy which was overheated becoming a much slower economy, growing at a slower rate, the blame for those cannot be primarily laid at the foot of the dollar. So while the dollar poses problems, we need to look at it in the context of a whole series of other issues and, to a degree, it is making some of those other issues for some sectors considerably worse.

Second point is that there are two sort of competing issues that the United States government has to deal with. One, the United States has today a very large imbalance between domestic savings and domestic investment. And that money comes from the rest of the world. The United States has to attract net $425 billion, give or take, this year to fill the domestic savings-investment imbalance. And one of the things that has concerned the Treasury and concerned the Fed is to make sure that we have an attractive environment for that money to come in. If the environment becomes less attractive - for a whole host of reasons, any one of which could make it less attractive - then we run the risk of foreigners investing less money into this economy, and you have higher interest rates, you have a weakening dollar, and you have consequences for the inflationary outlook, and consequences for the growth outlook.

And this, I think, is a significant issue which the Treasury and the Fed have to deal with. The Fed in particular - Alan Greenspan had the opportunity in his Humphrey-Hawkins testimony on Tuesday to comment on the dollar. And he did not. And one of the reasons he did not is because he is concerned anything that could begin to push the dollar down could make his job considerably more difficult than it already is and it is already, as we know, quite difficult.

The other side of the coin, however, is that exports, as a portion of GDP, account for a larger portion of GDP than housing and autos combined. So weakening in the export sector is a very severe problem for the overall economy. And there, the strong dollar is unquestionably one of the elements that has led to a weakening of exports.

There are other elements, too, and that, of course, is that Japan’s been in a recession; that the East Asian economies, because of their dependence on the US, among other things, have begun to weaken. That’s not a dollar issue so much as a very weak growth outlook in some of our major economies that bought goods, particularly capital goods. And the area where exports have declined most dramatically is in the area of capital goods exports, and we can see that. The numbers are quite vivid and there are a lot of American jobs, as Steve has pointed out, tied up in that sector.

So you’ve got the financial issues and the inflation issues on one hand and very real sectoral issues on the other, and trade accounts for a large proportion of GDP, about 12 per cent – as I say, about the same as autos and housing combined.

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Now, when you look at where the dollar is overvalued, it’s not uniformly overvalued. I think where the overvaluation is most obvious is in the case of the euro. This is not to say it’s not overvalued against others, but there, I think, is where the BIS probably would argue that the levitation - the act of levitation was greatest.

So there are a couple of issues that are important in trying to understand that.

First of all, it was hoped, indeed expected by most Europeans, that Europe would outperform the US this year. In fact, it has outperformed the US in terms of growth, but by a much smaller margin than was anticipated. A much better performance by Europe than the United States would have been positive for the euro and probably strengthened the euro somewhat. That substantial outperformance has not occurred.

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This is an edited version of fourth of five speeches given to the Economic Strategy Institute Derivatives Study Center forum: "Is the value of the dollar harming the global economy?" at the National Press Club on Thursday, July 26, 2001. Click here for the full transcript.



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About the Author

Robert Hormats is Vice-Chairman of Goldman Sachs (Int'l).

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