Tuesday, February 10, 2004

Bush Administration's Policy: Tank the Dollar

Treasury Secretary John Snow has tacitly but unmistakably abandoned Washington's longstanding support for a strong dollar in favor of a weak dollar that is getting weaker, though he continues to insist there has been no change in policy.

Stripped of the code words and elliptical references to "excessive volatility" in exchange rates, the message that Snow delivered over the weekend to finance ministers from Europe and Japan was that the dollar's plunge against the euro is just fine and that the dollar should now decline more rapidly against Asian currencies as well.

What does this mean to the economy? Businessweek had this to say in May, 2003:

A falling dollar, at least for the first year or two, is like a deflationary tax. It takes time for consumers and businesses, both in the U.S. and abroad, to adjust their buying behavior. Until then, money is simply sucked out the door in the form of higher import prices, just as if oil prices had spiked and stayed high. The result: A weaker dollar depresses real wages and profits in the near term and makes a robust recovery even more unlikely anytime soon.

. . .

But for the immediate future, the effect of a declining currency will be negative. Consumers will pay more for imported shoes, VCRs, cars, and other goods, and have less money for other purchases. Similarly, rising costs will hurt earnings at many businesses that rely on imported raw materials and parts -- an increasingly large group in an era of global supply chains. Retailers, especially, will find themselves in a double bind since they'll have to pay higher prices to stock their shelves with imported goods even as their customers are increasingly cash-strapped.

Perhaps most distressingly, the weaker dollar could turn out to be a drag on business investment. With the exception of autos and trucks, imported capital goods account for about 40% of business spending on new equipment. That means a drop in the dollar could push up prices for capital goods, discouraging capital spending by companies. That isn't the outcome we want if we are looking to continue the productivity gains of the 1990s.

In a nutshell; International investers will flee the dropping dollar. Interest rates must be raised to attract buyers for ballooning U.S. debt. Higher interest kills the housing market. Import prices rise, which, with rising interest rates, jacks up inflation. High interest kneecaps business investment. The stock market drops, as international investors leave, and interest rates make bonds more attractive. Dropping investment capital causes insolvency for weaker businesses. A shakeout occurs, and the economy contracts.

This could add up to a serious economic crisis.


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