Pity the once-mighty greenback. Back during the Clinton years, treasury secretaries Robert Rubin and Lawrence Summers ceaselessly intoned the mantra “A strong dollar is in our national interest,” and the markets cooperated by driving its value against the major foreign currencies steadily higher. That momentum continued through the first year of the Bush Administration.
But for the past three years, the film has been running in reverse. Bush’s hapless treasury secretaries, Paul O’Neill and John Snow, have tried intoning the mantra, but with little conviction and no cooperation from the markets. Between the February 2002 peak and the December 2004 low in the value of the dollar, our currency lost 35 percent of its value against the euro, 22 percent against the Japanese yen and even 24 percent against the Canadian dollar. The greenback rallied weakly for the first several months of the year, but the gain amounted to no more than a few percentage points.
Why? And does it matter to those of us who aren’t invested in currency strength as some kind of phallic symbol?
The major reason for the dollar’s weakness is the profound imbalance in America’s dealings with the outside world: We import far more than we export. The trade accounts slipped into the red in 1976, and the deficit has been getting steadily larger. This is an unusual performance for a rich country, where rough balance or even large surpluses are the norm. Trade deficits are usually associated with countries undergoing impressive growth spurts, like South Korea in its glory days (though the country has since matured into surpluses)–or chronically troubled economies, like those of Africa or Latin America.
When imports greatly exceed exports, you must borrow vast gobs of money from abroad to make up the difference. During the late 1990s, most of our foreign money came from private investors, intoxicated by the New Economy miracle of the Clinton era. Lately, the task of financing American deficits has fallen to the central banks of Asia, whose dollar assets (mostly US government bonds) now collectively surpass $1 trillion. They acquire these dollars in two ways. First, when Americans import foreign-made goods, we pay in dollars, which then accumulate abroad. Since there is relatively little that we export to Asia, they don’t spend those dollars on our products; they acquire our securities instead.
And second, in an effort to keep the value of their currencies from rising against the dollar, which would raise the price of their exports, Asian central banks, especially China’s, have been selling their own currencies. When they sell their own currencies, they get dollars in return–dollars that are invested in obligations of the US government and related entities. As a result of these defensive operations, China has successfully kept the value of its currency, the yuan, unchanged against the dollar–and kept Chinese exports growing mightily.
This gusher of borrowed money–$2 billion-$3 billion of it every business day–has gone to finance Bush’s budget deficit and to cover US consumers’ penchant for buying stuff on credit. But instead of relying principally on their credit cards for the borrowed money, for the past several years consumers have been borrowing massively against the rising value of their houses (more than $2 trillion since 2000). The ultimate source of those borrowed funds: Asian central banks.