Treasury secretary blasted for dollar's malaise and his apparently cavalier attitude to the growing US current account deficit which now stands at 4% of gross domestic product
In search of a scapegoat for the dollar's latest bout of dyspepsia, the foreign-exchange market settled on US Treasury secretary Paul O'Neill.
O'Neill is something of an original in a town where ideas are cut to fit this year's fashions. He speaks the truth. His audience might prefer that he recite on command his predecessor Bob Rubin's mantra, 'a strong dollar is in the best interest of the US'', but O'Neill refuses to play the game.
You've got to admire a guy who is honest enough to admit that the foreign-exchange value of the dollar is a reflection of policy, not a policy in and of itself. Run a good country, create an environment for the private sector to thrive and prosper, and a strong dollar will be the result, not the other way around.
'It's a candid admission of the view that a strong dollar is a good thing, but that we don't set it,'' said Neal Soss, chief economist at Credit Suisse First Boston. O'Neill went up to Capitol Hill earlier this month to testify on international economic policy. His prepared text had nary a mention of the dollar. He went out of his way to disabuse his audience, the Senate Banking Committee, the American people and currency traders, of the notion that US manufacturers had prevailed on the administration to weaken the dollar.
'There's apparently some breathless anticipation that I'm going to say something to intentionally indicate a change in policy, position or direction,'' O'Neill said. 'That is not the intent.''
It was, however, the outcome. The fall in the dollar versus major world currencies in early May was just the continuation of a slide that began in earnest in April.
Senate Banking Committee chairman Paul Sarbanes, a Maryland Democrat, hammered away at what he saw as O'Neill's cavalier attitude toward the large and growing current account deficit, which is close to 4% of gross domestic product. Given the strong growth in the US relative to our trading partners, and given the US's strong propensity to consume, the current account deficit is projected to balloon to some 6% of GDP by the end of next year, according to some analysts. That would be, in economists' parlance, 'unsustainable.''
Clearly Sarbanes doesn't want to wait to see if it can be sustained. After many attempts to rattle the Treasury secretary, the senator resorted to that favourite argument children use with their parents: everybody else does it.
'I am really taken aback that we have a secretary of the Treasury who doesn't perceive any problems associated with this large current account deficit,'' Sarbanes said. 'Now, that flies directly contrary to what virtually every other economic observer is telling us.''
Those observers include the International Monetary Fund, the Economist magazine, Business Week, previous Treasury secretaries, Secretary O'Neill in his former life as a corporate chieftain, US manufacturers and a host of others. It was a delicious moment when O'Neill took Sarbanes's opening to point out that the IMF's forecasts have been somewhat wide of the mark. O'Neill's retort was to ask Sarbanes about his solution to the problem. 'If you don't like the current account deficit, we could say bugger them, the US citizens, we here in Washington know better,'' O'Neill said. 'They shouldn't be buying so much stuff from outside the country. That would fix the current account deficit. It doesn't seem like a brilliant thing to me to do.''
During the latter part of the 1990s, the flow of capital into the United States 'was greater than the appetite for foreign goods that underwrite it,'' said Bob DiClemente, an economist at Salomon Smith Barney. 'The value of the dollar was pushed higher to regulate the flow of traffic.'' The fact that the dollar was appreciating as the current account deficit was widening was proof positive that capital flows were dominant, DiClemente said.
Capital flowed into the US because the US delivered the best return to capital. 'Economic growth was strong, productivity growth was the envy of the world, real short-term rates were high, and the government's fiscal house was in order,' said Bob Barbera, chief economist at Hoenig & Co. in Rye Brook, New York.
'The productivity piece, so far, remains in place,'' Barbera said. 'But much of the rest of the story is gone.''
Many overseas stock markets have outperformed those in the US this year. Budget surpluses are gone for now and doubtful for the future. Money market funds pay a pittance, and 'the case for an extended period of easy money suggests they will continue to yield little for some time to come,'' Barbera said.
Add to that some bad policy decisions, such as trade protectionism (steel and lumber) and farm subsidies, and a surfeit of dollars sloshing around, courtesy of the Fed's extended period of easy monetary policy, and the elements are in place for the dollar to come down from its lofty heights. Academics would have you believe that the US's huge unsustainable current account deficit leaves the dollar vulnerable to a destabilising plunge. (They've had this view for about three years.)
'Unsustainable is not a sufficient condition for anything,'' DiClemente said. 'In academia, they don't have to mark-to-market their views.''
The fact of the dollar's vulnerability 'is not a condition that creates a crisis or an abrupt downturn,'' DiClemente said. 'The same market forces that brought about the dollar's rise will bring about the dollar's fall over time. It may happen while we sleep.''
Arguing against a precipitous decline in the dollar is 'the amazing mediocrity of Europe and fumbling in Japan,'' DiClemente said.
If senator Sarbanes is really interested in helping US manufacturers compete, he would be well advised to let market forces do the job for him. And as for Paul O'Neill, here's an audience of one for the truth any day, any time, even if the foreign-exchange market can't handle it.
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