Why The Dollar Won't Tank

Foreign cash is fueling investment

If the financial crises that hit Asia and Latin America in recent years demonstrate anything, it's the fickleness of international investors and the ability of shifting hot-money flows to undermine seemingly sound economies. Now, some Cassandras are wondering whether it could happen in the U.S. The reason: a surging current-account deficit that's headed for uncharted waters.

With America's exports battered by sluggishness and recessions overseas and with imports swollen by higher oil prices and a growing influx of low-price foreign goods, the trade deficit in goods and services will soar some $86 billion during 1999, estimate economists at J.P. Morgan. And that's not counting a projected $14 billion increase in the bill the U.S. is paying to service its mounting international debt.

All told, this year's current-account deficit could hit $350 billion, or 3.9% of gross domestic product--above the record level it reached in the mid-1980s just before the dollar began its dramatic plunge. If investors decide they've had enough and the dollar tanks, U.S. interest rates could take off, ending the bull market and imperiling the expansion itself.

The good news is that most economists don't see this as a near-term threat. And the reason has to do with the intrinsic health of the U.S. economy.

While current-account deficits always reflect a gap between domestic savings and domestic investment, economist Michael Gregory of Lehman Brothers points out that, in the 1980s, investment was actually falling as a share of GDP. Driven by an exploding federal deficit, national savings were simply falling faster, and capital inflows were needed to fill the void.

By contrast, in the 1990s, he notes, the U.S. has enjoyed rising rates of both investment and national savings. With the federal budget moving into surplus, much of the money pouring into the U.S. has been helping to finance a high-tech investment boom. And since this enhances productivity and growth, it should make it easier for the nation to service its foreign debt.

Two other trends underscore the point: One is that capital goods have accounted for about 60% of the growth in imports over the past five years. Another is that a rising share of capital inflows have taken the form of foreign direct investment in U.S. business operations. Indeed, Joseph Quinlan of Morgan Stanley Dean Witter notes that such investment last year came to a record $193 billion--enough to cover 83% of the current-account shortfall.

The bottom line is that there's probably a lot more patient capital out there than some think. Foreigners know that, for the time being, a relatively strong dollar and large trade deficit are needed to help ailing economies overseas. And they also know that their capital is being put to good use in an essentially healthy U.S. economy.