Commentary: The Dollar Is Falling--but the Sky Isn't

By Peter Coy

The U.S. dollar suddenly looks like a 98-pound weakling. The accounting scandal at WorldCom Inc. (WCOM ) has added to foreign investors' fears that U.S. profit figures aren't to be trusted. On June 26, the dollar hit 98.3 cents per euro, the weakest level against that currency since February, 2000. The dollar bought only 120 yen, the fewest since last September. Since Apr. 1, when the dollar's slide began, it has lost more than 11% of its value against each major currency.

Some respected economists and market analysts worry that the dollar's slide could turn into a tailspin. Two of the preconditions for a dollar crash are in place: a giant trade deficit and a crisis of investor confidence. Such a downward spiral could mean big problems for the economy: Inflation would surge, export-led foreign economies would suffer, and there wouldn't be much the Federal Reserve could do. Any Fed attempt to stop a dollar crash by raising rates would kill the healthy housing market, stall the economy--and probably fail to bring back foreign investors anyway. "I'm concerned," says Edward E. Leamer, an economist at the University of California at Los Angeles' Anderson School of Management. "The speed of the adjustment is the critical issue."

But things don't have to turn out for the worst. And most likely, they won't. The dollar loses altitude every few years, but it hardly ever takes a nosedive. Because the dollar floats freely, there isn't the kind of pent-up selling pressure that afflicts currencies pegged to the dollar. Moreover, even if global investors are skeptical about the U.S., they have few better options: Europe is soft and Japan nearly comatose.

Indeed, despite the current market jitters, the dollar has some strong props under it. The productivity of the U.S. economy continues to improve, rising at a 4.3% annual rate in the first quarter. Eventually, the economic recovery should revive profits and stocks. "A return to profits is imminent," predicts Carl B. Weinberg, chief economist of High Frequency Economics Ltd. in Valhalla, N.Y.

You wouldn't guess it from the headlines, but the dollar's decline to date has been modest. It has dropped about 8% since February against a basket of rich-country currencies. Measured against a trade-weighted index of the 26 most important currencies, it's off less than 2% this year, after adjusting for inflation. Harriett M. Richmond, head of currency management for London-based J.P. Morgan Fleming Asset Management, says that she believes the dollar's recent tumble has left it fairly valued, and that its long-term trend is up, not down: "The longer-term relative-productivity trends for the dollar are still favorable," says Richmond.

Suppose the dollar does go down some more. What's the problem? As long as the decline is orderly and doesn't continue to spook foreign investors, it will be a good thing for the U.S. economy, as the Bush Administration quietly recognizes. A cheaper dollar would give a fighting chance to U.S. manufacturers and farmers who have been priced out of global markets. And it would push other nations to do what they should have done long ago: Lower interest rates and reform hidebound financial systems to stimulate domestic demand instead of counting on American consumers to keep their economies afloat. Sure, a weaker dollar will raise import prices in the U.S., but that's a small problem, with inflation so low.

To close the trade gap, the dollar needs to keep falling. Exports are so much lower than imports that they must climb 40% faster than imports just to keep the deficit from growing. Economists at Goldman, Sachs & Co. predict that even if the dollar falls another 5% to 10%, the trade deficit will climb to a record 5% of U.S. output by late 2003. Far from fretting about dollar weakness, people ought to worry that the dollar still isn't weak enough.

Coy is economics editor.

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