Let The Dollar Go Its Own Way

Here's a scenario for you. If the new euro drops 15% in value against the dollar and the yen rises 10%, all three currencies could easily reach parity. Currencies often move more than that in a single year. True, the yen will have to drop two zeros, but the success of the euro is putting pressure on Japan to do that anyway. So if euro=dollar=yen, what then?

"Link them!" a chorus of financial gurus will say. End the currency volatility that decimated Asia, gutted the Long-Term Capital Management hedge fund, and nearly brought the world's financial house down last autumn. Stop the foreign-exchange turmoil that washed through the markets recently with the yen careening around and the Brazilian real suddenly tanking. Sounds great, yet despite the wonderful symmetry, tying the euro, the dollar, and the yen (and their respective currency blocs) together would be a major mistake. Something has got to give in market economies, and if currencies are frozen in place, then interest-rate movements would have to take up the slack. That wouldn't be a problem if the U.S., Europe, and Japan were on the same economic and financial wavelength, but they're not.

Just for starters, the U.S. is running a budget surplus of 1% gross domestic product, while Europe and Japan are running deficits of 3% to 4%. Europe and Japan, however, have trade surpluses that amount to 1% of their respective GDPs, while the U.S. has a mounting trade deficit that will surpass 3% of GDP this year. Then there is the matter of growth. The U.S. is running a hot information economy, growing at nearly 4% annually, with unemployment down to 4.3%. But Japan is stuck in recession, and unemployment is rising. Europe, putting in an O.K. performance in 1998, is slowing down, and unemployment remains in the double digits. True, everyone lives in a deflationary world these days. But that's neither a necessary nor a sufficient reason for linkage.

There will be talk of linking the three currencies at the upcoming World Economic Forum meeting in Davos, Switzerland, as part of the effort to improve the international financial architecture. A single currency has clearly helped Europe to begin enforcing fiscal discipline, restructuring corporations, and creating deep, liquid capital markets. But the U.S. has achieved all that already, and its biggest problem--the trade deficit--can best be solved by letting the dollar float.

Before it's here, it's on the Bloomberg Terminal.