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FINANCE: Deficits Tarnish U.S. Dollar

Emad Mekay

WASHINGTON, Dec 17 2004 (IPS) - The weak dollar has rattled foreign owners of U.S. greenbacks, but economists say that by taking a few measures Washington could trim its trade deficit and restore global confidence in the currency.

Current account figures – which measure trade in goods and services, investment returns and one-way financial transfers – released Thursday by the Bureau of Economic Analysis showed that the U.S. trade deficit continues to grow even as the dollar falls against the Euro and other major currencies.

The current account deficit, the broadest measure of the nation’s transactions with the rest of the world, inched up in the July-September period to a record high.

According to the U.S. Department of Commerce, imports of goods and services were 54 percent larger than exports in the third quarter of 2004, sending the deficit to a historic high equal to 5.6 percent of the size of total U.S. output or gross domestic product (GDP).

Up 14 billion dollars to 532.6 billion dollars, imports continued to increase faster than U.S. exports, which grew by only 10 billion dollars, to 382.5 billion dollars

Economists were quick to point to the news as evidence that the dollar’s drop has failed to curb the ballooning current account deficit; many experts also urged the administration of President George W Bush to intervene to restore confidence in the U.S. economy.

"The real cause for the decline of the dollar is that we have a current account deficit, and we cannot keep borrowing at this rate from the rest of the world," said Mark Weisbrot of the Centre for Economic and Policy Research (CEPR) in Washington.

A lower dollar means that Americans planning overseas travel, for example, will have to come up with more cash for the same trip. Imports from Europe and Asia will also be more costly for U.S. consumers.

At his "economic summit" Wednesday, Bush tried to soothe the concerns of investors in the U.S. dollar and Europeans worried about their sales to the United States, promising to "work on" his administration’s budget deficit in the next Congress.

"We’ll do everything we can in the upcoming legislative session to send a signal to the markets that we’ll deal with our deficit, which, hopefully, will cause people to want to buy dollars," said the president.

"It’s about time he paid attention to the issue, at least rhetorically," said the New Democrats, a Washington, DC-based think tank that leans to the opposition Democratic Party, in a statement Thursday.

Since early November, the dollar has hit new record lows against the euro almost every week.

The greenback is now at 10-year lows against almost all other major traded currencies – the British pound, Japanese yen, Swiss franc, Australian dollar, Swedish kroner, Danish krona and Canadian dollar.

A euro that cost only 84 cents in June 2002, and 1.21 dollars in September, now requires about 1.32 dollars.

Analysts also say the currency’s plunge is a sign of how negatively the world has come to view the debt-ridden fiscal policies of the Bush administration, which drained the surplus it inherited from former president Bill Clinton.

It has turned a 236.4-billion-dollar surplus into a 413-billion-dollar deficit.

But despite Bush’s "verbal intervention," there are fears the administration is bent on taking further measures that could expand both the budget deficit and the current account deficit.

For instance, the White House is planning more tax cuts and greater defence expenditures, which are unlikely to be blocked in a Congress dominated by big spenders from Bush’s Republican Party.

The administration argues that the news is not all bad. With a weaker dollar, U.S. exports become less expensive, and when the world embarks on its buying spree for those cheaper goods, the current accounts deficit will shrink.

But to date, while exports have grown imports have risen at an even faster pace.

Low interest rates have kept U.S. consumers buying imported goods despite the currency’s fall, analysts say.

The trade imbalance with the 12-nation Euro bloc, for example, has risen from 73 billion dollars in 2002 to around 95 billion dollars this year.

But the biggest fear among economists is that the dollar could tumble at an even more rapid and uncontrollable pace, sparking consequences that go well beyond trade.

"Rapid and unmanageable drops can cause financial panic and recession. Over longer terms, a weaker dollar can be inflationary and force interest rates up," said the New Democrats in their statement.

Last week’s ‘Economist’ magazine illustrated those fears on its cover page, where a white caterpillar nibbled away at the greenback.

The oft-heard suggestion, which many economists appear to support, is that the drop could erode the dollar’s 60-year role as the world’s reserve currency.

While China, with huge oil reserves, has denied it is selling off dollars, oil-rich countries in the Arab Gulf have said they plan to diversify their reserves to include other currencies.

"This could start a stampede," predicted Weisbrot.

"By choosing to hold their reserves in dollars instead of Euros, for example, (countries like Japan and China) have already lost hundreds of billions of dollars over the past two years," he said. "Many developing countries who can afford it even less are also facing significant losses by continuing to hold dollars."

Some economists argue the dollar needs to decline by another 15-20 percent in order to cut the current account deficit to a reasonable level.

Most of this further correction should take place against Asian currencies, which will require China to revalue its exchange rate against the dollar by about 20 percent, according to C Fred Bergsten, director of the Institute of International Economics (IIE) in Washington.

Weisbrot agrees. "This is not a bad thing – in fact it is not only inevitable but necessary in order to save what is left of our manufacturing sector and, yes, even recover some of the jobs in that sector that have been lost," he said.

According to an IIE analysis published earlier this month, "the decline of the dollar has been quite orderly to date and world economic growth has remained brisk. Another six months or so of realignment at the recent pace could complete the process satisfactorily."