If foreign investors look elsewhere, interest rates could climb and living standards could fall.
By David Streitfeld
Times Staff Writer
November 14, 2004
During a routine sale of U.S. Treasury bonds in early September, one of
the essential pillars holding up the economy suddenly disappeared.
Foreigners have been regularly buying nearly half of all debt issued by
the U.S. government. On Sept. 9, for the first time that anyone could
remember, they stayed home.
"Thoughts of panic flickered out there," said Sadakichi Robbins, head of global fixed-income trading at Bank Julius Baer.
The foreigners returned in force at the next Treasury auction, and Sept. 9 was quickly dismissed as an aberration.
But the episode demonstrated how much the U.S. economy is dependent on
other countries to bankroll its free-spending ways. That fragility is
becoming even more precarious because of recent declines in the U.S.
dollar to multiyear lows, some economists say.
Amid worries
about bulging U.S. budget and trade deficits, the greenback dropped
last week to a record low against the 5-year-old euro, a 12-year low
against the Canadian dollar and a nine-year low against an index of
major currencies. Many analysts don't see anything that will stop the
decline.
A cheaper dollar reduces the value of American
securities, making them less attractive to foreign investors. That
could eventually precipitate what Robbins called "the doomsday
scenario" — Japan and China not only refusing to buy U.S. bonds, but
selling some of their $1.3 trillion in reserves.
The only way
Uncle Sam could then find new customers for its IOUs would be by
raising interest rates. And although higher rates are good for savers,
they would be disastrous for a country weaned on cheap credit.
"Sometime soon, the falling dollar is going to show up in rising
inflation, rising interest rates and a falling standard of living,"
said Harry Chernoff, an economist with Pathfinder Capital Advisors.
"The housing and mortgage markets, which benefited the most from
declining interest rates over the past few years, are likely to feel
the most pain."
Not everyone agrees that suffering is imminent.
The National Assn. of Manufacturers calls the dollar doomsayers "all
but hysterical." Manufacturers and produce growers like a cheap dollar
because it makes their products more affordable in foreign markets.
Even some foreigners like the low dollar. China has pegged its currency
to the dollar. A weak greenback means a weak yuan, making Chinese goods
cheaper in foreign markets and fueling the nation's economic boom.
To most American consumers, a falling dollar is more an annoyance than
cause for alarm. It raises the price of a cup of coffee to outlandish
levels during a Paris vacation, and may cause second thoughts about
buying a more expensive Volkswagen.
But a number of economists
and academics say there are real reasons for concern. If the dollar
falls too far too quickly, they say, those all-important foreign
investors will abandon the U.S. in favor of stabler places.
Indeed, there are signs that such an exodus might have already started.
In August, the most recent period for which there's data, foreign
private investors sold $2 billion more in U.S. stocks than they bought,
the Treasury said. Meanwhile, they dumped $4 billion more in government
bonds than they purchased.
"A run for the exits could happen
any day, that's for sure," said C. Fred Bergsten, author of "Dollar
Overvaluation and the World Economy" and director of the Institute for
International Economics, a Washington think tank.
Such a
prospect creates a tricky balancing act for policy makers. As long as
the dollar devalues in a slow and orderly way, and doesn't trigger
panic selling of American securities, Bush administration officials
appear to be comfortable with the fall. As they see it, the benefits of
boosting the economy through higher exports outweigh the drawbacks.
The administration approach could work out fine in the short run,
economists say. But eventually the slide must stop. Few countries can
maintain strong economies with a debased currency.
Indeed, if a
weak currency was the prescription for long-run economic health,
countries like Argentina and Mexico — which have suffered massive
currency devaluations in the last decade — would be financial titans.
Ultimately, these economists say, the solution is for the U.S.
government to reduce its massive budget deficit. That would curb the
need for Uncle Sam to issue so many Treasury notes. And the dollar
would rise on its own, because the deficit is the main reason it
continues to fall.
Having China decouple the yuan from the
dollar also could help, economists say. It's a step the Bush
administration has sought from Beijing, with little progress.
Under the best scenario, economist Bergsten sees China acceding to
American pressure and easing or dropping the yuan-dollar peg by the end
of the year.
Allowing the yuan to float upward would raise the
price of Chinese goods in this country and reduce the U.S. trade
deficit with the new Asian powerhouse, estimated to be $150 billion
this year.
But if the Chinese resist, the euro will rise even
further. It could move up from last week's $1.30 to $2, Bergsten said.
Three years ago, it was worth 84 cents.
That ascent would upset
the Europeans, whose exports would suffer and whose economies are
already struggling. Central bankers usually speak in measured tones,
but European Central Bank President Jean-Claude Trichet was moved last
week to call the euro's rise "brutal" and "not welcome."
Neither the dollar nor the deficits became a hot-button issue during
the presidential campaign, for obvious reasons. No politician has ever
won an election by telling people their standard of living is going to
go down, particularly at a moment when it's so easy to get a loan.
"The insidious thing about deficits is that they go on as long as the
markets allow them to go on," said Maurice Obstfeld, an economics
professor at UC Berkeley and author of many works on global capital
markets.
"So people get lulled into the certainty they'll
always be able to borrow at low rates, and that this is right and
normal and an endorsement of their behavior," he said. "But it has to
stop at some point."
A slump in the dollar also has been
providing immediate benefits for some businesses, particularly
multinationals but also smaller firms.
"There's all this scare
stuff about the falling dollar, but it's allowing us to compete in the
marketplace more effectively," said Stephanie Harkness, chief executive
of Pacific Plastics & Engineering in Soquel, Calif.
Eighteen months ago, Pacific Plastics built a plant in Bangalore, India. It now employs 48 people there and 86 in Soquel.
"Our customers can save 50% when we produce molds for them in India
rather than here," Harkness said. "My ideal scenario is not to have a
plant in California at all."
If Pacific Plastics' bottom line
is improving, the government's is steadily getting worse. The gap
between what it spent and what it took in during the fiscal year that
ended Sept. 30 was $413 billion, a record.
This week, Congress
will have to raise the government's $7.4-trillion debt ceiling so it
can borrow more money. According to the nonpartisan Congressional
Budget Office, by 2008 nearly 10% of the budget will be devoted to
interest payments.
President Bush has pledged to halve the
deficit by 2008. Many economists say that will be difficult, if not
impossible, without raising taxes, something Bush has pledged not to do.
In his postelection news conference, the president said the economy could grow its way out of trouble.
"As the revenue streams increase, coupled with fiscal discipline, you'll see the deficit shrinking," he said.
The stock market soared on Bush's remarks, but the currency markets rendered a different verdict. The dollar continued to fall.
It's not only the government that is profligate. The U.S. current
account deficit — the broadest measure of international trade,
including exports, imports, services and investments — rose in the
second quarter to $166 billion, up 13% from the first quarter.
Much of the second-quarter shortfall was in goods: for every $20 in
products American manufacturers sent overseas, U.S. consumers bought
$36 in foreign electronics, cars and other items.
The current account deficit has risen from 1% of gross domestic product in 1990 to 5.4%.
That doesn't seem like much, and in the short term it isn't, said James
Gipson, chairman of the $7-billion equity mutual fund Clipper Fund, in
a letter to shareholders. But just like credit card debt, it compounds
over the long term.
"A slowly and likely growing share of our
output of goods and services will go to provide comfortable retirements
for the residents of Tokyo, not Topeka," Gipson wrote.
One trouble with owners in Tokyo is that they may decide they want to own something in India or China instead.
That's why the Sept. 9 auction prompted concern.
Usually indirect bidders, which include foreign governments, are heavy
buyers at Treasury auctions. This time, their purchases were less than
3%. Traders speculated that Japan was finally calling it quits.
What happened was never explained, but neither was it repeated.
"It turned out to be a fluke," said Kim Rupert, managing director for
global fixed-income analysis at Action Economics, a consulting firm.
"But at first blush, it was 'Oh my gosh.' "
