In a nutshell, the dollar has supposedly been on a downtrend for the past three years because of what everyone calls an “unsustainable” current account deficit. If you pointed out that “sustainability” has never been defined and agreed upon — and a link between the dollar and the deficit has not been proven — you were drowned out by solemn voices quoting enormous numbers, such as “$600 billionplus,” the amount of the 2004 deficit when all the data finally comes in.
As a result of the deficit, the dollar was supposed to fall by 20 to 40 percent to boost exports and inhibit imports, which would bring the deficit back down to an acceptable level, say $300 billion, or 3 percent of GDP instead of 6 percent. Meanwhile, foreign capital inflows into the U.S. would be discouraged by the falling dollar, creating a shortfall, which would in turn trigger a crisis that would force the Fed to print money or raise interest rates at an accelerated pace, or both.
Raising rates to lure foreign capital would have the side effect of slowing domestic growth, possibly to near recession levels, which would be counter-productive — foreign exporters would get a higher rate of return on their money, but they would be turning off the spigot of U.S. demand for their exports. Therefore, foreigners should not kill the goose that lays the golden egg; they should continue to reinvest their export proceeds in U.S. markets.
Critics say the U.S. is vulnerable to foreigners, especially important central banks in Japan, China, South Korea, and Taiwan, which might lose their taste for U.S. paper as the dollar trends downward. Fed Chairman Alan Greenspan voiced doubt about the sustainability of the foreign appetite for U.S. portfolio assets. But in practice, the one with the power is the biggest debtor, not the creditor — just ask Donald Trump, who can all but name his terms to the big banks every time he goes bankrupt.
The U.S. government still wants the dollar to decline to promote its exports, not only in industrial products but in the one area the U.S. has a tremendous competitive advantage — agriculture. Last year will be the first in more than 60 years the U.S. did not run a surplus on agricultural products. Agriculture is like a touchstone for the trade balance. Autos, airplanes, high tech — they can wax and wane, but in agriculture the U.S. dollar has to be at a level to sustain a net export balance.
The foreign exchange market is starting to operate on this new understanding: If exporter nations don’t recycle their dollars back to the U.S. as equilibrating capital inflow, they will kill the goose that is laying the golden egg. And yet, the U.S. officially wants the dollar to stay in a downtrend so the underlying cause of the trade imbalance is rectified, at least somewhat.
Surplus countries that are recycling their dollars back into U.S. paper have to accept the currency downtrend; in return, the U.S. will give them a better real rate of return than they can get elsewhere, and a rising rate of return, to boot.
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