AmerCon : Econ : Currency Markets : Tensions abroad

New York Times
2005.01.25

Dollar's Steep Slide Adding to Tensions U.S. Faces Abroad

This article was reported by David E. Sanger, Mark Landler and Keith Bradsher and written
by Mr. Sanger.

Author: David E. Sanger

WASHINGTON, Jan. 24 - After a first term in which terrorism and war dominated President
Bush's foreign policy agenda, his allies in Europe and Asia suspect that his next
confrontation with the world could take on a very different cast: a potential currency crisis,
in which a steep plunge in the value of the dollar touches off economic waves around the
world.

Already, the tensions over the dollar are becoming a recurring source of friction, a conflict
that does not reverberate as loudly as the differences over Iraq but may be as deeply felt.
At a meeting in Paris on Monday, the finance ministers of Germany and France
complained that Europe had unjustly borne the brunt of the dollar's decline, and called for
coordinated action to stop it.

"Europe has until now paid too big a share in this readjustment," Hervé Gaymard,
the French finance minister, said. His German counterpart, Hans Eichel, said the United
States needed to reduce its deficits, adding "each one has to play its role."

Two months ago, similar sentiments came from China's prime minister, Wen Jiabao, whose
nation is at the center of a struggle with Washington over currency policy. He complained
about the fall of the dollar, asking, "Shouldn't the relevant authorities be doing something
about this?"

In an interview just before President Bush's inauguration, Treasury Secretary John W.
Snow played down the tensions. "We understand that deficits matter," he said, insisting
that the tight budget Mr. Bush is expected to send to Congress next month should give
foreigners and the financial markets the solace they seek.

But should the dollar continue to fall - if, for example, global investors determined that Mr.
Bush did not have the will to hold spending down - it would not only add to tensions,
analysts said. It might also force up interest rates at home to keep foreigners
interested in financing America's need to borrow more than $600 billion a year to
cover its gap in the current account. The current account is the broadest
measure of the trade and financial flows into and out of the country.

To be sure, the dollar's fall may never reach crisis levels, and in the last few weeks, after a
more or less steady fall of almost 35 percent against the euro and 24 percent against the
Japanese yen over the last three years, the dollar has stabilized a bit. Many experts argue
that a further decline, if relatively modest and gradual, is entirely manageable.

Administration officials, along with a number of like-minded economists, contend that the
nation's record trade and current account deficits are not particularly worrisome, a
reflection more of strong foreign interest in investing in the American economy than any
sign of global weakness.

But across Asia and Europe, a wide range of officials and analysts worry that Mr.
Bush's economic team may not be up to the challenge of grappling with the issue.
They contend that Washington has retreated from efforts to marshal the biggest
economies of the world into a mutual effort at more robust and balanced growth.

Many European politicians and exporters cannot shake the suspicion that the Bush
administration, despite its statements supporting a strong currency, has been perfectly
happy to watch from the sidelines while the dollar heads down.

At a moment of surging American trade deficits that have reached a record share of
economic output, a falling dollar makes American exports more competitive and puts
imports from Europe at a particular disadvantage.

"It's hard to tell an entrepreneur to wait two years for a policy to change when he says, 'I've
got to deliver my goods tomorrow,' " said Anton Boerner, the president of BGA, the
Berlin-based association of wholesalers and exporters.

Mr. Snow, for his part, paints a vastly different picture of the international economic
landscape. He described the current situation as one of America's remaining the economic
envy of the world, where yawning deficits are being addressed and where there is little risk
that foreigners will rethink the wisdom of lending the United States hundreds of billions of
dollars a year to finance the trade gap and to cover the vast borrowing needs of the
federal government.

Mr. Snow suggested some in Europe are seeking a convenient scapegoat, particularly
after the tensions over Iraq, to blame for the Continent's own inability to generate stronger
growth.

"The current deficit levels are too large," Mr. Snow said, describing himself as a deficit
hawk who sees a chance to cut spending because the American economy is growing
again. "They have to come down, and they will come down."

But deficits aside, he argued, "overwhelmingly the United States is looked at as the model
for success." After years of stagnation in money flowing into the government, "revenues
look good," and the turning point will come in a couple of weeks, he said, when Mr. Bush
sends a budget to Congress in which "you will see a number of programs that not only
don't grow at the rate of inflation, but that decline."

While the budget is a domestic document, assessments of whether it will realistically
grapple with the underlying problems and whether Mr. Bush has the political will to push
tough measures through Congress may determine whether investors around the world
stick with the American economy or head for the exits.

'At a Critical Juncture'

No one knows for sure if the doubts that have already contributed to the dollar's decline will
intensify. Some worry that the markets may conclude that Mr. Bush will put the financing of
the Iraq war, military transformation and the costs of revamping Social Security ahead of
deficit reduction.

Others fret about the risk that a large, highly leveraged hedge fund or a big bank could be
caught betting the wrong way in the markets, touching off a sudden currency sell-off that
could have implications for the rest of Mr. Bush's term.

"We're at a critical juncture," said C. Fred Bergsten, director of the Institute for
International Economics, and a persistent critic of how Mr. Bush's team has handled its
global economic role. "The imbalances get worse and worse," he said, rivaling Japan's in
the mid-1990's.

"The projection is that they keep rising," he added, noting that the current account deficit is
running over 6 percent of the country's gross domestic product. "And it is a trajectory that
is bound to crack: people will stop buying dollars, and domestic politics will make the
soaring trade deficit with China just unsustainable."

For all those fears, foreign investors are still buying American. While much of that lending
last year came from central banks abroad, private investors have shown renewed
confidence lately. In November, the last month for which there are reliable numbers,
foreigners made net purchases of $81 billion, enough to easily pay for the amount by
which American imports exceeded exports.

"Our growth rates are still higher, over the long term, than Europe's and Japan's," said
Daniel J. Ikenson, a trade policy analyst at the Cato Institute. Given that, for foreign
investors, "there is no reason to think they will sell."

But the argument around the world is as much about leadership as about the
long-term strength of the economy. Unlike the debate over war in Iraq, in this
case the complaint is not about American unilateralism, but American retreat.

To America's allies, the era in which the world's largest economy also seeks to be the
world's economic leader has simply halted. Under both James A. Baker III, a Republican,
and Robert E. Rubin, a Democrat, the Treasury Department was viewed as one of
Washington's most powerful institutions. It flexed its muscles to trim the market's extremes
and stem crises, from an excessively strong dollar in the 1980's to the currency collapses
of the 1990's that stretched from Latin America to Asia to Russia.

There has not been an economic crisis of significant magnitude since Mr. Bush came to
office. John B. Taylor, the Treasury under secretary for international affairs, said that was
partly a result of preventive maintenance. "My first days on the job we had a crisis in
Turkey and one coming in Argentina and Brazil," he said. "Both were contained."

Today the Treasury is regarded as a vastly diminished institution, with comparatively little
influence in the White House. Mr. Bush is seen, rightly or wrongly, as far less comfortable
dealing with global economic management than he is sitting in the Situation Room, buried
in the details of the Iraqi insurgency or Iran's nuclear threat.

As a result, the weakening dollar, to the minds of many from Hong Kong to Berlin,
is a metaphor for a presidency so distracted by national security issues that
American economic influence has ebbed.

China Stands Its Ground

Washington's lack of success so far in pressuring China to finally allow its currency to float,
or at least appreciate significantly to reflect its vastly stronger economy, is cited as the
most striking evidence of Washington's diminished economic influence. Beijing has used
other issues, chiefly the Bush administration's dependence on China to help prevent North
Korea's development of nuclear weapons from touching off a wider conflagration, to keep
currency demands on the back burner.

That has contributed to a Chinese export surge that has soared to levels almost no one
predicted when the United States, Europe and China reached agreement on the accord
that brought Beijing into the World Trade Organization at the end of the Clinton
administration.

The Chinese, like the Japanese in their heyday, have begun to question American
economic policy. American officials say that the Chinese could solve a lot of problems by
not linking their currency to the dollar, a step toward solving a trade surplus that looks set
to hit a record of nearly $200 billion for 2004. It is a subject of enormous political sensitivity
in Beijing, because of its effect on the breakneck pace of China's economic growth.

But Mr. Taylor, the Treasury official, notes that teams of officials have visited China to offer
advice about how to manage a floating currency and the Chinese last year hired the
Chicago Mercantile Exchange to help it develop a market in currency futures.

"You don't do that," Mr. Snow said, "if you are planning to keep the currency pegged to the
dollar."

Seeking U.S. Leadership

China is only one piece of the global economic puzzle. The lack of interest by Mr. Bush and
Mr. Snow to put together a global accord on currency, akin to the Plaza Accord that Mr.
Baker organized in 1985, is viewed as evidence that Washington is content with a
downward drift of the dollar. And there is no one to replace the American role.

"It will be a world of chaos without a center," said Hideo Kumano, a senior economist at the
Dai-Ichi Life Research Institute in Tokyo. Japan itself, after a decade of downward spiral
that only now seems to be ending, has lost all pretense of assuming the mantle of
leadership. Bush administration officials have a deep skepticism bordering on an outright
ideological objection to intervening in the markets.

Certainly China, while growing in leaps and bounds, has neither the capacity nor the
interest. "China has a big population and big economic growth, but it is not a mature
economic system yet," Mr. Kumano noted. "I cannot imagine it replacing Europe or Japan
in terms of influence in the world economy. In such a condition, everyone must cope with a
world economy where you cannot rely on America."

For all the worries abroad, the Bush administration sees few signs of stress. "You don't
have any major economy now in recession, and volatility is low," Mr. Taylor said. "Even
inflation is contained in the emerging markets."

But the lesson of the 1990's is that currency crises, like the terror strikes of more recent
years, are nearly impossible to predict.

"Financing of the U.S. current account deficit has gone more smoothly than many
economists were predicting just a few years ago," wrote Roger M. Kubarych, a former chief
economist at the New York Stock Exchange who is now a scholar at the Council on Foreign
Relations, a nonpartisan research group.

"But that does not mean that market stability can be taken for granted forever."
_____

David E. Sanger reportedfrom Washington for this article, Mark Landler from Frankfurt and
Keith Bradsher from Hong Kong.

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