Defining The Dollar Down

It is, of course, true that Americans with non-refundable tickets to Europe’s vacation spots are in for a shock at just how little their dollars buy, but this is not high season for international tourists, so few are affected. Even fewer have sympathy for the London-based American investment bankers who are finding their dollar-denominated salaries don’t go quite so far in Britain’s fine restaurants and shops. As economist John Makin put it in his latest advisory, “The dollar’s recently accelerating move downward has evoked more concern abroad in Europe and Asia than it has inside the United States where a beatific calm has prevailed.” That doesn’t mean, however, that the dollar’s descent doesn’t matter. It does. Or, to be precise, it might.

When all is said and done, the dollar will remain weak until Americans stop buying billions more from overseas than we sell to foreigners. That will happen when Americans save more, Europe reforms its economies so that they are capable of import-inducing growth, and Asian countries allow their currencies to appreciate against the dollar–another way of saying, when these Asian countries stop subsidizing their exports to America.

Meanwhile, the prospects for an improvement in America’s trade position seem dim. Consider the five “A”s that paradoxically combine to mean failure: autos, agriculture, aircraft, apparel, and audio-visual products. All have been the backbone of U.S. exports; all are in trouble.

Start with autos. We are importing almost $130 billion more in cars, trucks, and parts than we are selling abroad. That makes the deficit in the auto trade almost as large as the deficit in the oil trade. The cheaper dollar should improve the competitive position of American automakers, enabling them to snare market share from Japanese and other manufacturers, who will have to raise prices here as they need more and more dollars with which to buy yen to pay their workers in Japan. But Detroit, which has accustomed consumers to huge discounts and interest-free financing in order to keep factories operating (union contracts require paying auto workers whether or not they are on the assembly lines), is desperate for profits, and will probably match the foreigners’ price increases. Consumers will pay more for both made-in-the-USA cars and imports, leaving the auto trade deficit about where it is now.

Things in Des Moines are not much better than those in Detroit. Since the 1950s the value of America’s agricultural exports has exceeded the value of its imports. Those days are over. Lower prices for grains and cotton are pushing down the value of U.S. exports, while imports of wine, beer, snack foods, fresh vegetables, and other high-value products continue to increase. In 1996 America ran a record agricultural trade surplus of over $27 billion; this summer, imports exceeded exports.

The situation is no cheerier when it comes to aircraft. Boeing’s long dominance of the market for planes is over. Airbus took firm orders for more jets than Boeing last year (217 vs. 197) and will repeat that victory this year. Boeing, which still holds an edge in revenue booked ($19.8 billion vs. $17.5 billion), has complained to the World Trade Organization that Airbus received $15 billion in unlawful subsidies from European governments over the past 30 years. That hasn’t stopped Airbus from asking Europe’s governments for loans to fund development of its proposed A350 aircraft, which is aimed at the same market as Boeing’s planned 7E7, a 200-300 passenger long-distance jet. The E.U.’s new trade supremo, Peter Mandelson, says he prefers negotiation to litigation, but he has not yet built up any credibility as a negotiating partner. Mandelson, whose understanding of economics is, er, minimal, has a reputation for leaking private negotiations and for possessing so many hidden political and personal agendas, including helping Tony Blair win next year’s referendum on the E.U. constitution, that Boeing might reasonably prefer the WTO’s straightforward forum to talks with Mandelson. Certainly, U.S. Trade Representative Bob Zoellick, who had a sound working relationship with Pascal Lamy, Mandelson’s predecessor, will be well advised to sup with a long spoon when he dines with a man better known for divisiveness and political intrigue than conciliation.

Next on the “A” list is apparel. On January 1 the Multifibre Agreement–WTO rules governing the $400 billion per year textile trade–expires. Quotas that limited how many pairs of jeans and how much fabric each country is allowed to export will be gone, leaving low-cost China and India free to take business from competitors in Asia, Africa, Latin America, and the United States. American consumers, who snap up $90 billion of textile imports every year, will benefit from cheaper goods. But the jobs of some 695,000 American workers will be threatened, making it likely that the Bush administration will take what one Commerce Department official calls “safeguard actions.” American manufacturers are calling for the maintenance of 15 of the 91 quotas, including those on trousers, underwear, shirts, and sheets (bras and dressing gowns are already subject to import-limiting “safeguards”). Before yelling “protectionism,” keep in mind that one reason the made-in-Asia goods are so competitive in American markets is that the Chinese regime artificially keeps its currency undervalued by pegging it to the dollar, that South Korea’s monetary authorities have bought $4 billion in foreign currencies to keep the won from rising even more than it has (10 percent since early October), and that the Bank of Japan, after abstaining from intervention since March despite an 8 percent rise of the yen against the dollar in the same period, appears poised to reenter the markets in concert with the E.U. to prevent the yen from rising further. An Adam Smith-style free market, currency markets just ain’t, and that distorts the trade in goods and services.

Finally, we have audio-visual (AV) products, a segment of what are called “core copyright industries.” This core group turns out some $630 billion of films, television, prerecorded music, computer software, and print products every year, and accounts for about $90 billion annually in exports (more than either autos or aircraft). The U.S. Trade Representative estimates that intellectual property theft costs the core industries $250 billion every year; BusinessWeek reports that 92 percent of Chinese computers run on software that is pirated or unlicensed.

Such piracy is most obvious in the case of films. The worldwide popularity of American films and television shows makes them a major contributor to the nation’s exports. European films, made by subsidized producers for their own artistic satisfaction and the pleasure of the few Americans who prefer films-plus-espresso to plain old movies, pose no competitive threat. And British-made films, although popular in America because of their lush country-house settings and fine acting, are too few to make a dent in the favorable AV trade balance. The real threat comes from piracy by Chinese and other companies who put cheap, unauthorized videos of hit movies on the streets simultaneously with their commercial release. Investment bank Smith Barney estimates that losses due to piracy are running at over $5 billion annually–and that doesn’t include illegal downloading of films on the Internet.

THE PROBLEMS faced by these five leading U.S. industries, four of which only recently ran surpluses (not autos), suggest that it will be some time before the nation brings down its trade deficit–now running at around 5.7 percent of GDP and rising, well above the 1986 record of 3.5 percent–and that it will take a further fall in the dollar to begin to eat into the deficit.

After all, there is no reason to believe that any of the causes of the trade deficit will be addressed in a serious way by any of the world’s policymakers. President Bush might push his plans to reform both Social Security and the tax structure so as to increase savings and discourage consumption, but there is little appetite in Congress for such a radical change in tax and entitlement policy, and most of the changes proposed would result in at least a near-term increase, rather than a reduction, in the already swollen budget deficit. Those who do agree with the president that some reforms are needed can’t agree on which ones are both economically desirable and politically feasible. No consensus, no reform. This should be good news for the Europeans who are calling for a tighter U.S. fiscal policy: If they get what they say they are wishing for, they will find that deficit reduction slows the U.S. economy, reducing the demand for imports and turning Europe’s persistent no-growth into a recession.

Europe could accelerate–no, initiate–economic growth, but euroland is disinclined to reform its tax and regulatory regimes, or its inflexible labor markets. Have no doubt: Europe’s export-led recoveries, such as they were, have ground to a halt as the euro has soared relative to the dollar, making European goods increasingly expensive in America. And, with the yuan pegged to the sinking dollar, Chinese goods are now cheaper in Europe. Little wonder that Jean-Claude Trichet, head of the European Central Bank, calls the dollar’s fall “brutal.”

The Chinese could abandon the peg that has kept the dollar equal to 8.3 renminbi since 1994, and allow their currency to float, making their exports more expensive. But that would threaten the jobs of the tens of millions of urbanizing Chinese, cause the value of the over $500 billion of dollar reserves and Treasury bonds China is holding to plummet, and threaten the stability of the country’s shaky banking system–problems of which both Jin Renqing, China’s finance minister, and Zhou Xiaochuan, head of the central bank, are well aware. Both have hinted that they might, someday, maybe, and by a tiny bit, allow their currency to appreciate against the dollar, with Zhou telling a Group of 20 meeting in Berlin last month that Beijing is “reviewing its old foreign-exchange control systems.” But John Snow, who has been urging the Chinese to unpeg their currency from the dollar, will be back in the private sector long before the Chinese allow their currency to appreciate sufficiently–say, by 30 percent–to put a significant dent in our $160 billion trade deficit with that country.

Since none of the policymakers here, in Europe, or in Asia are prepared to make meaningful changes in the policies that have produced the U.S. trade deficit, it looks as if the dollar will have to bear the brunt of the adjustment needed to ameliorate global imbalances. Foreign investors have already begun to shy away from investing in America, reducing the demand for dollars, and therefore their price in other currencies. In the first quarter of this year, foreign investors bought a net $176 billion of long-term U.S. securities, and central banks loaded up on an additional $91 billion; in the third quarter those numbers fell to $158 billion and $42 billion, respectively. The old oil-industry adage, used to describe the lack of drilling during an oil glut, applies here: “People don’t plant ‘taters when they have a cellar full of ‘taters.” Foreign central banks, their vaults overflowing with dollars, are already diversifying their holdings. Bush’s bosom buddy, Vladimir Putin, is threatening to lead the march out of dollar assets, selling greenbacks and buying euros. India’s central bank has hinted at similar moves. China and Japan, with holdings of almost $1 trillion in U.S. Treasury securities between them, are riding a tiger: If they allow their currencies to appreciate by, say, 10 percent as the dollar falls, the value of their dollar holdings will drop by a nontrivial $100 billion, but if they continue to buy dollars, they will be adding to their already-ample stock of ‘taters.

The markets are guessing that holders of dollar assets will allow the dollar to fall further, but only gradually. Experience suggests that should result in a gradual whittling down of the trade deficit. After all, we’ve been there and done that: Not so long ago it was Japan that was going to cause the de-industrialization of America. But between early 1985 and late 1990 the dollar dropped by 40 percent against major currencies, and a trade deficit that was running at 3.5 percent of GDP became a small surplus early in 1991.

What does a cheaper dollar mean for American policymakers, businesses, and consumers? Policymakers will have to approach negotiations with China as any debtor approaches any creditor: fully aware that China can play havoc with the American economy if it is willing to suffer some pain itself. U.S. companies planning foreign acquisitions will find that they have to put up more (devalued) dollars to close deals. As for consumers–attention K-Mart (and now Sears) shoppers: If China lets its currency rise, everything from imported T-shirts to attractively priced electronic gear will cost more, as imports become more expensive, and domestic manufacturers find they have more room to raise prices without losing sales to imports. And Americans planning to imbibe some European culture this summer should start thinking instead about seeing the USA in their Chevrolets (and Toyotas and Hyundais). If the natural beauties of the Grand Canyon don’t beckon, consider taking advantage of the pegged and therefore cheap renminbi, and feasting your eyes on the wonder of the Great Wall of China.

Irwin M. Stelzer is a contributing editor to The Weekly Standard, director of economic policy studies at the Hudson Institute, and a columnist for the Sunday Times (London).