Economists' forum
リンク: Economists' forum.
« Tear up the Bush doctrine and revisit America's real values | Main | Only fairness will assuage the anxious middle »
December 06, 2006
Falling dollar saga still has a long way to go
Richard Nixon's Treasury secretary, John Connally, famously remarked that "the dollar is our currency, but your problem". He would be right again now. The rest of the world normally wants a strong dollar. Yet the dollar is now in a bear market. How long might this go on? The plausible answer must be: a while yet.
Since early 2002 the dollar has been on a steep downward path: on JPMorgan's trade-weighted real exchange rate it has depreciated by 23 per cent since February 2002. This is the third such sustained decline since Mr Connally's remarks. The first was during the early 1970s. The second was from 1985 to 1988. On each of the two previous occasions, the depreciating real exchange rate also helped generate a big adjustment in the balance of payments. This was strikingly true in the 1980s. The same thing is happening again.
Between 1996 and 2004, real US domestic demand grew faster than real gross domestic product every year. This was necessary, I have previously argued, if GDP was to rise in line with potential, given the prevailing real exchange rates and the weak rate of growth of demand in much of the rest of the world. Over these years, cumulative growth in US real demand was 39 per cent, while GDP grew by 33 per cent. The difference was the real increase in the deficit in trade in goods and non-factor services.
The remainder of Martin Wolf's column can be read here (FT.com subscribers only). Discussion from our guest economists is free - click 'Comments' below
TrackBack
TrackBack URL for this entry:
http://www.typepad.com/t/trackback/7109088
Listed below are links to weblogs that reference Falling dollar saga still has a long way to go:
Comments
Jeff Frankel: Martin is probably right that we have entered a new phase of adjustment, reminiscent of the late 1980s, during which the dollar will continue to depreciate in order to limit the widening of the US current account deficit and the rise in net US indebtedness. I also agree that currencies in Asia and among oil-producers will have to bear a larger share of the adjustment vis--vis the dollar than they have so far.
I think the end of the Bretton Woods regime in the 1970s may be even a better precedent than the 1980s. Three economists at Deutschebank (Michael Dooley, David Folkerts-Landau and Peter Garber) have deservedly received a lot of attention for their claim that the current period resembles the Bretton Woods period, with Asian central banks now playing the role that European central banks played in the 1960s, that is, accumulating dollar reserves because they did not want to see their own currencies appreciate and their export industries lose competitiveness.
But I think we are closer to the end of the Bretton Woods system than the beginning. The Johnson-Nixon economic policy of fiscal and monetary expansion (driven by both the Vietnam War and increasing domestic spending, without a willingness to raise taxes to pay for it) led to declining trade balance and balance of payments. It thereby accelerated the end of the Bretton Woods system in 1971 and the depreciation of the dollar during the remainder of the decade. For the first time, the mark and the yen took on roles as international currencies, reflected in the foreign exchange reserve holdings of central banks, and steadily gained share during the 1970s and 1980s at the expense of the dollar.
The same is happening in the current decade. A combination of fiscal and (until recently) monetary expansion, driven by both the Iraq War and increasing domestic spending without a willingness to raise taxes to pay for it is accelerating the deterioration in the trade balance. The gradual trend decline in the importance of the dollar in the reserve holdings of central banks has resumed, after a reversal in the 1990s. For the first time in 50 years, there is a credible rival for the dollar: the euro.
As Martin says, the story is not yet over. Until now, the US has continued to enjoy the "exorbitant privilege" of being able to borrow unlimited amounts in its own currency. Most of the lively academic research on the topic takes such a privilege as a structurally given eternal characteristic of the universe (1). But the