EDITORIAL The dollar's dangerous path The Japan Times: Feb. 2, 2004 A stronger yen, or a weaker dollar, is a drag on Japan's export-led economic recovery. Trying to stem the tide, the government often steps into currency markets on a massive scale. Market players, however, worry that these dollar-buying, yen-selling interventions could be putting the Japanese and U.S. economies on a dangerous path: A falling dollar, should it continue, would open a Pandora's box on both sides, with dire implications for the world economy.
The theory goes something like this: America's "twin deficits" -- in the federal government budget and in the current-account international payments balance (mostly the trade deficit) -- continue to mushroom as President George W. Bush's administration pushes ahead with aggressive economic stimulus measures, such as huge tax cuts. As a result, investors and traders are coming around increasingly to the view that the greenback is in for a further fall. The twin deficits are already ballooning to an all-time record: roughly $500 billion a year each. Add to this the low savings rate, or the small reserve of surplus domestic funds, and there emerges a precarious picture of the world's largest economy growing on the back of borrowed foreign money. A large-scale flight of capital may choke off growth. For President Bush, who is seeking re-election in November, it is imperative to keep the U.S. economy moving forward. This makes it almost certain that the Bush administration will follow an expansionary fiscal and monetary policy. A weaker dollar seems to fit nicely into this policy because it helps expand U.S. exports while reducing the trade deficit. That explains why Washington, while talking of the "strong dollar," is winking at a weaker dollar. In Europe, meanwhile, investors concerned about a sinking dollar are cutting back on their dollar assets -- a clear indication that they are beginning to have second thoughts about the U.S. currency. A case in point: Natural gas utilities in Russia and the European Union are moving to use the euro, not the dollar, to settle their transactions. Japan's relations with the United States are complex. America's economic expansion is welcome, of course, because it creates more demand for Japanese products, thus adding to domestic growth. But a sharp rise in the value of the yen will deal a body blow to exporters and stunt economic expansion. Dollar-buying operations, which involve the purchase of U.S. government bonds and securities, increase capital flows to the U.S. These funds are helping the Bush administration continue its expansionary economic policy. At the same time, however, this is reinforcing the market perception that the dollar may be on the way down. For Japan, one result of the repeated dollar mop-up interventions is a sharp increase in the share of dollar assets in Tokyo's foreign-exchange reserves, which now exceed $600 billion. By contrast, China, an emerging economic power, has increased euro assets. These dollar holdings will depreciate further if the currency weakens. Yet the government keeps propping up the dollar to prevent its precipitous fall. But the dollar's slide will persist as long as the twin deficits continue to bulge. If it drops below 100 yen per dollar, the nation's export-fueled growth will suffer. Manufacturers, now on the recovery track, may be able to hold on, but nonmanufacturers like builders and retailers -- who have been stuck in minus growth over the past several years -- would be hit harder. The protracted slump in service sectors is largely responsible for stubbornly high unemployment. As for the U.S., a rapid fall of the dollar would drive up interest rates. Consumer spending and housing investment, both supported by tax cuts and low interest rates, are already showing symptoms of a bubble. Reality seems to call for a shifting of economic gears in favor of deficit reduction and currency stability. But the election-conscious Bush administration is set to pursue an expansionary course. The question for Japan is whether the economy, still not quite out of the woods, will be able to absorb the impact of a rising yen. If the ascent is measured, it probably can be managed. But the scenario of a slow but steady recovery will go awry if the dollar goes into a tailspin. The weakening dollar will be a major topic of discussion at February's Group of Seven meeting of finance ministers and central bankers. Japanese representatives should use the occasion to point out the dangers inherent in the twin U.S. deficits. Working in concert with European nations, Japan should also urge the U.S. to embrace an international effort to stabilize currency markets.
