> Barron's - April 24, 2000
>
> Worries About the U.S. Current-Account Deficit Are Hitting Closer To
> Home, Including at the Fed
>
> By William Pesek Jr.
>
> It seems the newest thing about the New Economy is the U.S. dollar.
> The greenback's remarkable resilience during Wall Street's
> near-collapse two weeks ago has analysts grasping at a new currency
> paradigm to explain why it, too, didn't plunge. In reality, though,
> the old rules still apply to the dollar, which is why concern is
> growing about a plunge in the world's reserve currency.
>
> The last years of the 20th century have given global policy makers
> plenty to worry about. Southeast Asia fell off a financial cliff.
> Russia's economy imploded, sending shock waves through world markets.
> Latin America nearly returned to the crisis days of the 'Eighties.
> And Japan, already 10 years into its malaise, continued to generate
> headwinds for the rest of the international economy. But the U.S.
> economy and dollar were safe harbors amid these stormy seas.
>
> But attention is turning to the ultimate potential systemic problem
> of the century: The U.S. economy's external imbalance. While
> policy-makers in Frankfurt, Hong Kong and Buenos Aires have been
> worried about it for some time, the gaping U.S. current-account
> deficit is getting more consideration, especially in Washington and
> New York. Currency and bond investors, fearing that the old paradigm
> that says currencies with massive current-account deficits are
> vulnerable still applies to the dollar, are getting jittery.
>
> "Where the dollar's concerned, the old rules are still relevant,"
> says Anne Parker Mills, economist at Brown Brothers Harriman. "They
> haven't so far because markets don't believe the recent slump in
> stocks is for real and they see it as a buying opportunity." Indeed,
> a side effect of Wall Street's irrational exuberance is that it may
> be keeping the dollar artificially high given the breadth of the
> U.S.' current-account imbalance.
>
> Group of Seven officials, meeting in Washington recently, were quite
> candid in their concerns about what a sudden shift in market
> psychology would mean for economies near and far. They would prefer a
> slow, orderly reversal. The International Monetary Fund listed the
> U.S. current account as a growing risk to the global outlook.
>
> The bond market lost ground last week, in part because of concerns
> about the dollar's outlook, and it remains vulnerable to any shifts
> in sentiment on the greenback. Some bond selling reflected concerns
> about Federal Reserve rate hikes. The equity markets' ability to
> stabilize after recent volatility also played a role; investors who'd
> moved into bonds for safety stepped back into stocks. The yield on
> the 10-year note rose to 5.99%, compared with 5.85% a week earlier.
> Among shorter maturities, the two-year note yield hit 6.35%, up from
> 6.29% a week earlier. The 30-year issue lostless ground thanks to the
> Treasury Department's repurchase of another $2 billion of longer-term
> debt; the long bond yielded 5.83% by week's end, compared with 5.79%
> a week earlier.
>
> Publicly, Washington says the currentaccount imbalance -- which is
> running at a record $400 billion, or 4.3% of gross domestic product
> -- is really a sign of strength, not weakness. With much of the
> global economy doing poorly in recent years and the U.S. expanding
> briskly, investors naturally are favoring dollar assets. So the U.S.
> is getting plenty of financing from abroad.
>
> But privately, the sheer size of the imbalance -- and the fact that
> it's growing -- is bringing furrows to the brows of some normally
> unflappable policy makers. What if the rest of the world becomes more
> reluctant acquirers of U.S. assets? At the end of the day, the
> current-account is funded with capital inflows; that's why it's
> called a balance of payments. The question is: What set of exchange
> rates, interest rates and assets prices is needed to attract the
> capital? And interest rates and asset prices are where these
> seemingly foreign factors hit home. It may surprise Wall Street folks
> to learn that some high-ranking Fed officials are far less concerned
> about inflation than they are about the nation's external imbalance.
> "The current-account problem is a bigger one than inflation," one top
> Fed official told Barron's. "If prices heat up, we can work with
> that. But if tons of capital are pulled out of the U.S., capital we
> need to finance the deficit, then that's a systemic risk."
>
> Few phrases frighten policy makers more than "systemic risk." It was
> omnipresent at the height of the Asian crisis, during the Russian
> meltdown that toppled Long-Term Capital Management, and throughout
> the Orange County and Barings debacles of the mid-'Nineties. But now
> that other major economies are snapping back and American markets are
> showing signs of fatigue, officials in Washington and financial
> capitals around the world are doing some soul-searching about the
> U.S. outlook.
>
> The feeling is that something must be done to prevent volatile U.S.
> asset markets and a record current-account deficit from triggering a
> sudden and sharp reversal in global economic fortunes. Treasury
> Secretary Lawrence Summers favors a "balancing up" through faster
> global growth, rather than a balancing down through reduced U.S.
> growth. It's a strategy that underlines the precarious position in
> which Summers finds himself.
>
> The traditional methods of reversing a current-account problem --
> higher interest rates and a weaker currency -- are unappealing
> because they could slam the stock market, a major force supporting
> the economy. (That dynamic was evident in 1987, when the
> current-account last loomed this large. As the world lost faith in
> the dollar, interest rates soared and stocks crashed in October.)
> Particularly in an election year, it's not something Summers wants.
> Hence the allure of the balance-up-not-balance-down approach. If
> stronger growth in Europe, Asia and Latin America enables their
> consumers to buy more U.S. goods, then the current account could
> narrow, with fewer deleterious effects on the dollar and U.S.
> interest rates.
>
> Salomon Smith Barney economist Robert DiClemente thinks the pickup in
> global growth and moderation in oil prices, which have boosted the
> deficit of late, will trigger an orderly reversal. By early 2001,
> DiClemente thinks the current account will shrink to 3.7% of
> GDP-still a prodigious percentage.
>
> But many observers fear the worst. The U.S. has never before been so
> dependent on foreign money to finance its economy. It's bad enough to
> be running a large current-account deficit, but even worse when
> there's no end in sight to its growth. And if the adjustment is less
> benign than Summers hopes, the result would be rising inflation from
> a weak dollar and a weaker economy from higher interest rates -- the
> worst of all possible worlds.
>
> The dollar ended the week at 105.84 yen, compared with 104.78 a week
> earlier and 105.48 the week before that. The euro, meanwhile, ended
> the week at $0.9386, versus $0.9612 a week ago and $0.9547 two weeks
> ago.
>
> For the global marketplace, the repercussions of America's adjustment
> would not be positive. There would be spillover effects-volatility in
> world markets and the loss of the world's economic engine. Morgan
> Stanley Dean Witter economist Joseph Quinlan recently published a
> report on the degree to which Asia's stability relies on America's
> prosperity. It was entitled: "Fatal Attraction? Asia's Rising Export
> Dependence on the U.S."
>
> Neither would a plunging greenback be helpful to Europe. While it
> would bolster the flagging euro, the knock-on effects from a less
> vibrant U.S. economy would hardly be helpful just as Europe begins to
> get in growth mode.
>
> But as the events of October 1987 should serve to remind investors,
> the effects of a dollar crisis can come home to haunt Wall Street.