The Great Global IMBALANCE HOAX

From November 2003 to February 2004, and again going into year-end 2004, the dollar fell more than 10 percent against the Euro. In each case, the underlying cause of the dollar’s drop was universally reported to be the “structural global imbalance,” whereby the U.S. runs a huge current account deficit that is offset by foreigners, including central banks, who buy U.S. financial assets.

It’s not so much the U.S. current account deficit itself that propels the dollar downward, but the fear that foreign investors, especially central banks, will withhold demand for U.S. securities, especially Treasuries, until the dollar finishes dropping or the real return is compellingly greater than the return on equivalent assets.

We’ve been here before. In fall 1985, the countries that later came to be known as G7 (U.S., Great Britain, Germany, France, Canada, Japan, and Italy) met secretly at the Plaza Hotel in New York and decided to drive down the price of the dollar to correct a trade imbalance of about $120 billion annually. The dollar fell 21 percent against the Deutchemark the following year, and another 18 percent the year after that. In 2000, the trade imbalance again became a big topic in the foreign exchange market. That time, the dollar rose against the euro.

What’s different this time is the Federal Reserve is doing most of the talking. The fear of inadequate foreign funding of the current account deficit has been voiced by a whole slew of Fed officials, both regional Federal Reserve Board presidents such as Janet Yellen (San Francisco) and Robert McTeer (Dallas) as well as Fed Governor Ben Bernanke.

Ahead of the G20 meeting in Berlin, Fed Chairman Alan Greenspan laid down the rules for thinking about the global imbalance (www.federalreserve.gov/BoardDocs/speeches/2004):

“The question now confronting us is how large a current account deficit in the United States can be financed before resistance to acquiring new claims against U.S. residents leads to adjustment. Given the size of the U.S. current account deficit, a diminished appetite for adding to dollar balances must occur at some point.”

Once you get past the ornate language, you realize this is practically an invitation to sell dollars. It’s also a near-verbatim repeat of what Greenspan said in 2000, except then he was speaking in a considerably more relaxed, almost offhand way. This time, Greenspan was speaking at a major European conference and knew his words would flash around the world in seconds.

Treasury Secretary John Snow contributes to open acceptance of the dollar falling when he says, on principle, U.S. policy is for a stronger dollar, but if the market wants to take the dollar down, the U.S. believes in free markets.