The dollar and the tyranny of the weak

Every administration has its economic low points. The Bush administration hit one last month in Dubai.

During the meetings of the International Monetary Fund and the World Bank that took place there, the US joined other members of the Group of Seven in calling for serious structural reform among the developed nations. So far, so good.

But the US also ensured that the same G7 communiqué called for "more flexibility in exchange rates". This triggered both a weakening of the dollar, presumably the desired result, and continued turbulence in bond and stock markets from Japan to Europe to the US - presumably not desired.

The phrase about currency flexibility did so much damage because it seemed to codify a shift away from the old strong dollar policy. And that shift does not come out of the Bush administration's typical culture of strength and growth. Rather, it represents a surrender to what we can call the tyranny of the weak.

Consider the logic inherent in the communiqué's "flexibility" section, and in the minds of many of its supporters. The US is growing faster than Europe. It is growing faster than Japan. It is growing intemperately. America's greed has generated a current account deficit with a single country, China, that is the largest such gap ever. What's more, the US is too productive. And that productivity is, at least right now, causing the US economy to generate too few jobs at home.

In short, the challenge is not to make the other countries grow faster. It is to slow the US to a pace that puts it in step with its weaker peers, Europe and Japan. You start by putting pressure on the dollar with a few remarks about the acceptability of flexible rates. You also press the Chinese to strengthen their currency. A weaker dollar then makes shopping abroad more expensive; the economy slows nicely. What else can the US do to stop its spending binge? It can help those classic weakling tyrants, its own smokestack industries and their unions. Help them - and hurt everyone else - by loading a few new tariffs on to Chinese products.

This argument fits in well with the zeitgeist, which tends to give the weak the throne in many spheres - the workplace, the dinner table. But it is based on some odd premises, as JP Morgan's John Lipsky pointed out the other day at a Council on Foreign Relations meeting in New York.

First, it overstates the importance of the current account deficit. While such a deficit can be a disaster, it is sometimes a simple symptom of fast growth. That may be the case for the US. Over the past eight years, the US has outperformed Europe by a total of 15 per cent and Japan by 20. America's growth potential has been recalibrated upwards; Europe's and Japan's have not. As Mr Lipsky and Columbia University's Charles Calomiris have noted, this means not only that the US will continue to buy a lot, but also that it will continue to attract the world's capital. So the current account deficit is a paper problem.

Another instance when a current account deficit matters less than many suppose is when the issue is trade among states with the same currency, or with linked currencies. That, Mr Lipsky suggests, is the case for the US deficit, at least to some degree. Some 80 per cent of it involves dollar-pegged Asian and North American Free Trade Agreement countries. The Chinese have told the US they won't unpeg for now. As for the Nafta economies, they are highly integrated with America's.

Another of the communiqué's oddities is the implication that it is acceptable to manipulate currencies for trade purposes. This is wrong, because of the resulting uncertainty. Regardless of where people think the dollar ought to be, nobody but a currency trader desires currency instability. Instability constrains growth. That is why Europe gave itself the euro.

Which brings us to the worst Dubai contradiction. It is the statement's acknowledgment, however unintended, that the growth gap is a US problem. This is the opposite of the administration's general message.

At this point, John Snow, the Treasury secretary, might interject that 99 per cent of the Dubai communiqué was about helping the rest of the world catch up. What is more, the administration managed to append to the communiqué a model supply-side document calling for cuts in marginal tax rates in various nations, pension reform in Italy and productivity increases in the laggard UK. There was even a suggestion for the US: reform of the tort system. Finally, Mr Snow might argue, dollar policy has not changed. The recent US reference to "flexibility" was nowhere near as strongly worded as a genuine devaluation démarche. In 1985 the then Group of Five leading industrial countries, gathered at the Plaza hotel in New York, demanded "further orderly appreciation of the main non-dollar currencies". Compared with this, Dubai's phrase is feeble.

Still, the reality of summitry is that statements about currencies trump statements about other economic policy. After all, Treasury secretaries, ministers of finance and central bankers have the power to move rates in seconds. But even a Republican Congress would not necessarily ever enable Mr Snow or President Bush to make tort reform law.

The best thing Mr Snow can do, therefore, is to uncodify the "flexibility" statement just as formally as he codified it. The Bush administration's economic record is too strong for it to succumb to the tyranny of the weak.

© Copyright 2003 Financial Times

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