Goldman Sachs: scrap the strong dollar policy

Michael Pollak mpollak at panix.com
Mon Aug 6 01:09:12 PDT 2001


On Fri, 3 Aug 2001, Lawrence wrote:


> 2.) Why do you think they are doing this? Do you think this is their honest
> opinion, how they really feel, or do you feel this release is some kind of
> political play?

I think it's their honest opinion: that the US finally doesn't have to worry about inflation because the economy is weak for the first time in a decade; and that there is presently no other engine of demand on the world stage, which looks scary.

Paul Krugman made a similar argument last week:

NEW YORK TIMES

AUG 01, 2001

Blessed Are the Weak

By PAUL KRUGMAN

T reasury Secretary Paul O'Neill recently gave an interview in which

he dismissed claims that the dollar was overvalued, arguing that

concerns about our trade deficit are based on "trivial and wrong

notions." He also thinks that concepts like gross domestic product are

obsolete. I took his remarks as an indication that the dollar's

inevitable decline will probably come sooner rather than later. And

while that will be embarrassing for Mr. O'Neill, it will be a good

thing for our economy.

Why does Mr. O'Neill's nonchalance suggest that the strong dollar's

days are numbered? Because there is a clear analogy between the

soaring dollar and the recent tech bubble. As Robert Shiller pointed

out in his book "Irrational Exuberance," a gradually rising asset

price acts like a natural Ponzi scheme, in which each new wave of

investors creates capital gains for the previous wave. If this goes on

long enough, it can silence the doubters.

But eventually the process ends -- and you know that the end is nigh

when white-haired executives reject old-fashioned accounting. That

means that the mania has spread to the suits, and that the Ponzi

scheme is about to run out of suckers.

The dollar has been rising against the currencies of other industrial

countries since the middle of the 1990's. This sustained rise has made

dollar bears look foolish, but it has also priced U.S. products out of

world markets. Since 1995 the U.S. current account deficit, the

difference between what we buy from foreigners and what we sell to

them, has quadrupled to an astonishing $450 billion. It goes without

saying that this is the biggest such deficit in world history. More

startling is the fact that at 4.5 percent of G.D.P., the U.S. current

account deficit is a bigger share of our economy than the deficits of

Indonesia or South Korea on the eve of the 1997 Asian financial

crisis.

In the past, deficits this large have always led to a currency plunge.

True, one hears arguments to the effect that the rules have changed,

that this time is different. Those arguments were presumably what Mr.

O'Neill had in mind when he dismissed concerns about the payments

deficit. Alas, it would be easier to take those arguments seriously if

they weren't so similar to the arguments people used to justify the

high dollar of the mid-1980's, just before it started dropping.

More ominously, I heard exactly the same arguments -- especially the

claim that rising productivity justifies a strong currency -- used to

dismiss concerns about Mexico's current account deficit just before

the 1995 peso crisis, and again in Asia two years later.

But would a sharp drop in the dollar be a catastrophe? Probably not.

In fact, if the dollar is going to plunge one of these days, now would

be a pretty good time. I wouldn't have said that a year and a half

ago; but times have changed.

Not long ago a drop in the dollar would have been a clear negative for

the global economy. A weaker dollar, which makes U.S. goods cheaper

compared with the products of other countries, redistributes world

demand toward the U.S. and away from the rest of the world. Back when

the U.S. economy was booming, this would have been shipping coals to

Newcastle; we already had plenty of demand, while other economies were

depressed.

Now, however, the U.S. economy has stumbled, and the strong dollar is

one of the reasons the Fed is having trouble pulling us back from the

brink. So right now a weaker dollar is in America's interests. It

still might create some problems elsewhere -- but on the other hand it

might be just the shock needed to wake the European Central Bank and

the Bank of Japan from their policy slumbers.

Is that a call to action? Should we actively seek to drive the dollar

down? There's a precedent: In 1985 James Baker, who was then secretary

of the Treasury, organized an international effort to tame the

too-strong dollar. It's still debatable whether his efforts made any

difference; possibly the dollar would have fallen in any case. But it

was a political triumph: Mr. Baker managed to take credit for the

dollar's decline. Alas, Mr. O'Neill's ramblings have probably

prevented him from achieving any comparable feat.

But never mind Mr. O'Neill; the great dollar decline is coming, and we

should welcome its arrival.

Copyright 2001 The New York Times Company | Privacy Information __________________________________________________________________________ Michael Pollak................New York City..............mpollak at panix.com



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