HOW HE SEES IT Drop in value of dollar triggers concern

By DANIEL SNEIDER
KNIGHT RIDDER NEWSPAPERS
When President Bush met the leaders of 20 Asian and Pacific nations last week, he wanted to talk about North Korea and Iran. But those nations had another security crisis on their minds -- the fall of the dollar.
The dollar is now down to nine-year lows and there are jitters about a financial crisis. If foreign lenders lose confidence, they could trigger a freefall collapse of the dollar. As the cost of imports rise, inflation could jump. And interest rates for banks and home buyers would soar as investors demand a higher return for their greater risk.
That nightmarish scenario is probably overdrawn. But the dollar's drop reflects the belief that the American economy is not healthy.
The signs of illness are two huge and growing imbalances -- the federal budget deficit and the current account deficit, the shortfall between what America takes in from the world through trade and investment and what it spends. In 1990 the global balance stood at zero. Now the U.S. is $665 billion in the hole.
Reading the signals
President Bush made soothing noises at the Asian Pacific economic summit about the commitment to a "strong dollar." But investors correctly read the signals that the actual policy is to let markets drive the value of the dollar down in an orderly way.
The administration sees dollar devaluation as a way to correct a global imbalance. It will make American exports cheaper and more competitive and imports more expensive for American consumers. They are confident the U.S. remains an attractive place for the world to park its money.
Those currencies that trade freely -- the Euro, Canadian dollar, British pound and lately the Japanese yen -- have gone up rapidly in value against the dollar in the last few weeks.
The one major trading partner that has escaped so far is China, whose currency is fixed to the value of the dollar. The Chinese want to keep their exports cheap but American pressure may force a small revaluation of its currency.
Our trading partners are unhappy about the dollar's slide. But this is needed correction.
The danger is the fall will encourage countries to reduce their dollar holdings, shifting to Euros, gold or Japanese stocks whose value has been rising.
Huge budget deficit
The problem for the United States is that those dollars are now financing our huge budget deficit, which will hit $450 billion this year. The administration has been unwilling to ask Americans to pay for the war on terror and the war in Iraq.
The twin deficits are driven in part by the growing difference between what Americans spend and what they earn. American savings -- both household, corporate and, of course, government savings -- have deteriorated greatly in the last five years.
Instead we borrow money abroad. The dollar holdings of China, Japan, India and other Asian countries have lept up from about $1.1 trillion in 2001 to about $1.8 trillion in 2003. And much of that is invested in American Treasury bonds and stocks.
The Chinese, emboldened by the reality that we depend on their dollars, now happily lecture us on our profligate ways.
"The savings rate in China is more than 40 percent," the deputy head of the Chinese central bank recently told the Financial Times. "In the U.S. it is less than 2 percent. So the problem is that they spend too much and save too little."
It is true that Americans consume more than they produce. But we can keep doing it, up to a point, because the folks we import from -- mostly but not entirely in Asia -- are happy to produce more than they consume and to lend us money to buy their stuff.
"We are stuck with each other -- they are the lenders of last resort and we are the consumers of last resort," says Robert Madsen, senior fellow at MIT's Center for International Studies and an expert on Asian economies. "If they stopped lending we would have a lot of trouble. If we stopped consuming, they would go into recession."
A devaluation of the dollar should encourage Chinese, Japanese and others to spend more on American goods -- as well as creating an incentive for Americans to buy fewer imports. Hopefully the administration will succeed in managing an orderly devaluation and avoid a freefall.
X Daniel Sneider is foreign affairs columnist for the San Jose Mercury News. Distributed by Knight Ridder/Tribune Information Services./