San Francisco Chronicle
January 11, 2004

Why the U.S. dollar keeps falling, and why we should care

Sam Zuckerman

The almighty U.S. dollar hasn't been so mighty lately. For the past 18 months, the greenback has taken a one-way trip south, tumbling about 45 percent against the euro, the common currency of the European Union. Last week, the euro rose to an all-time high against its American rival, trading Friday at more than $1.28. What does the dollar's fall mean? Who gains and who loses as the buck sucks wind? Here are a few answers.

Q: Why is the dollar falling?

A: The usual explanation for the dollar's duress has to do with enormous twin deficits run by the United States. Every year we buy roughly $500 billion more in goods and services from foreigners than we sell overseas. At the same time, the federal government is running a budget deficit of more than $400 billion annually. Many economy watchers believe the United States is living above its means and will eventually have to cut back. "We are consuming more than we are producing," said Daniel Meckstroth, chief economist of the Manufacturers Alliance/MAPI, a trade group. That undermines confidence in the dollar.

Q: How much is the dollar's fall a matter of market psychology and how much is it a matter of economic fundamentals?

A: There's no question that sentiment is paramount in the day-to-day movements of the dollar. Traders and speculators sense the greenback's weakness and are betting it will continue, giving the trend added momentum. But ultimately fundamentals are driving the decline. To put it simply, the United States gives the rest of the world more than half a trillion dollars every year. In exchange, the rest of the world gives us products and services. That of course increases the supply of dollars held by foreigners. All else being equal, that increased supply will result in a lower price, i.e., a falling dollar.

Q: Has the dollar fallen harder against some currencies than against others?

A: Absolutely. The euro, the greenback's main competitor, has been the biggest gainer, along with the British pound sterling and such Triple A players as the Canadian and Australian dollars. To protect their domestic industries, major Asian exporting nations such as Japan, Korea and Taiwan have intervened in the markets to prevent their currencies from rising too strongly. As a result, the yen has appreciated less than half as much as the euro in the past 18 months. China is a story of its own. Its currency is fixed to the dollar and doesn't change. That's one of the reasons Chinese exports to the United States have risen unabated despite the dollar's fall in most of the rest of the world.

Q: Is a lower dollar good or bad for America?

A: It runs counter to intuition, but a gradual descent of the dollar is basically good for the country. Indeed, many experts argue that it is an essential part of the process of trimming America's trade deficit with the rest of the world. To be sure, the dollar loses bragging rights and the U.S. loses prestige. And consumers find Italian suits, French wines and German cars more expensive. But American goods and services become cheaper overseas. International sales of U.S. corporations rise, which boosts profits and preserves jobs here.

Q: Come on. It's not that simple, is it?

A: Truthfully, it isn't that simple. Different sectors are affected in different ways. Farmers, manufacturers and the U.S. tourist industry love a weak dollar because their products and services become more competitive in the global marketplace. But American banks and brokerage firms prefer a strong dollar because that attracts money from around the world. Retailers also like a strong dollar because it allows them to buy imported goods cheaply.

It gets even more complicated. Industries that import foreign-made components will find those parts more expensive. And companies with operations overseas may experience all kinds of contradictory effects. A U.S. company with a plant in Ireland exporting to the United States could find that facility less profitable in euro terms. But those smaller euro earnings might be worth more in dollars when repatriated to this country. It's the kind of thing to give a chief financial officer nightmares.

Q: So, who are the real winners?

A: The list of winners starts with American producers of goods and services. If they are exporters, their products become more affordable for foreign buyers. Even if they sell mainly to the domestic market, they benefit from the higher prices foreign competitors have to charge in the United States. The U.S. wine industry is a case in point. Imported wines have gone from about a 9 percent to a 25 percent share of the American market in the past few years. But, "after growing like crazy, imports almost came to a halt in October," according to Woodside consultant Jon Fredrikson. The falling dollar "is definitely on everybody's mind," he said.

Q: And the losers?

The losers are consumers, who have to pay more for imported goods. American tourists also are suffering sticker shock when they get their London hotel bill or the tab at that cozy Roman trattoria. "These are all examples of foreign goods and services that we have been consuming to excess," said UC Berkeley economist Barry Eichengreen. "That's what the decline in the dollar will eventually correct as we cut back on our consumption of these items."

Q: What about the technology sector?

A: The effects of a falling dollar on tech companies are particularly hard to sort out because technology is perhaps the most thoroughly globalized of all economic sectors. "The calculation varies company by company and product by product," said Tim Bennett, head of international policy at AeA, a technology trade group.

Many U.S. technology manufacturers now make most of their products overseas. The effects of a falling dollar will depend on where goods are produced, where they are sold and what the competition is. The biggest beneficiaries could be companies whose main rivals are European. For example, that might include business softwaremaker Oracle, which counts as one of its main competitors the German firm SAP. On the other hand, a U.S. company with factories in Europe might find its profits squeezed if that output is shipped back to America.

Q: How does the White House view the falling dollar?

A: The White House won't say so explicitly, but according to observers across the political spectrum, a lower dollar is the third leg of the Bush administration's economic policy, alongside tax cuts and low interest rates. "There seems to be a vested interest in the administration for a continued orderly decline of the dollar," said Bank of America currency strategist John Rothfield. A cheap dollar boosts American industry at the expense of foreign competitors and helps keep jobs in the United States.

Q: Is that different from the policy of the Clinton administration?

A: Yes. Clinton Treasury Secretary Robert Rubin supported a strong dollar as a way of drawing investment to the United States and supporting the nation's financial markets. By contrast, John Snow, the current Treasury secretary, redefined a strong dollar last year. The greenback's strength reflects its usefulness as a medium of exchange and the fact it is so hard to counterfeit, he told reporters in France.

Q: How is the administration's exchange rate policy viewed overseas?

A: In Europe, the administration's dollar policy is widely considered to be a form of economic nationalism benefiting the United States at the expense of other nations. "Many Europeans see this as an exercise in U.S. power," said UC Santa Barbara political scientist Benjamin Cohen.

Q: What about in Asia?

A: The Asians are spending a lot less time complaining about a weak dollar and a lot more time actively propping up the greenback in the currency markets. Central banks in Japan and other Asian nations have bought tens of billions of dollars to keep their currencies from rising too abruptly. Meanwhile, China has resisted arm-twisting by Snow and other American officials to allow its currency to rise.

Q: Does a falling dollar bring any dangers with it?

A: A lower dollar is only positive if it comes down gradually. "There is a real risk that an orderly retreat can turn into a rout," Cohen said. In such a scenario, panicked currency traders around the world would dump dollars, sending it into a tailspin. Overseas investors would withdraw money into U.S. stock and bond markets, and interest rates could shoot up. Similar currency collapses have occurred in such countries as varied as Mexico, Korea, Russia and Argentina over the last decade, although not in more developed economies.

Q: Is such a crash likely?

A: It's true that the United States is consuming far more than it produces, while going ever deeper into debt to pay for all that stuff. That can't continue indefinitely. Recent papers by former Treasury Secretary Rubin and the International Monetary Fund have raised the specter of a painful readjustment, with rising interest rates and slow economic growth. It's possible that such a situation could be touched off by a collapse of the dollar.

But other economists maintain that adjustment need not be abrupt. Interest rates have stayed low, and the stock market has boomed even as the dollar has fallen, they note. "There's no technical reason this can't last," said UC Santa Cruz economist Michael Dooley.

Q: What's the argument for a soft landing?

A: Collapsing currencies in Mexico, Russia and elsewhere were cases of hot money heading for the exits. Institutional investors sold their holdings en masse, touching off market crashes. But an increasing proportion of U.S. international debt is held by central banks, especially those of America's leading Asian trading partners. America is their most important market. The last thing a Japan or a South Korea wants is for the U.S. economy to fall into a slump. That puts enormous pressure on them to keep on using the dollars they earn from exports to buy U.S. Treasury debt. That in turn could give this nation breathing room to set its house in order.