- The Washington Times - Friday, July 26, 2002

Last Friday, the Dow lost 390.23 points and closed at 8019.26. It continued dropping early this week to 7,702 on Tuesday, the lowest close for the blue-chip index since October 1998, when financial markets plunged after the Russian debt default. And again, there is an international component to the crisis. A week ago, the Commerce Department reported a record $37.6 billion trade deficit for May.

It was the second straight monthly record and surprised most analysts, who thought the deficit would shrink some given the huge jump in April. The deficit is being driven upward by imports, which have soared at an annual rate of about 16 percent, in the past three months.

The dollar dropped on the report of the spiraling trade deficit. Foreign investors understood the ramifications, even if it is unpopular to talk about them in Washington. The influential Goldman Sachs Group in New York reduced its estimate for U.S. economic growth in the second quarter to a 1.5 percent annual rate from an earlier forecast of 2.0 percent. Even the higher figure would have been a major falloff from the first quarter's performance.

The scandals rocking several major corporations could not cause this level of concern unless the foundation of America's international position had not already been weakened. Earnings are off in corporate America, and productive investment is lagging. Much of the spending that should have gone toward American-made goods in the spring to boost economic recovery, went to buy goods made overseas instead. And capital is being used to build and expand overseas factories rather than support U.S. industry.

While the debate over trade policy has focused on lost jobs and plant closings, another important fact at the moment is that the massive trade deficit has to be financed. It is because the U.S. must cover such a large amount with foreign capital that economists worry about sudden, destabilizing events that could shift the financial flows away from the America market and send the dollar plummeting as happened in many other countries in the late 1990s.

In the past year, foreign purchases of stocks and bonds are down 24 percent and foreign direct investment is off 63 percent. The weaker dollar could be part of a vicious cycle of disinvestments in the United States. If foreigners believe the dollar is sinking, they will hold fewer dollar-denominated assets. But, as they scale back investment, they weaken the American economy, depress the greenback further and turn their fears into self-fulfilling prophecies.

Besides the economic impact, a currency collapse would have a profound impact on U.S. national security and world leadership.

A strong and stable dollar is a strategic national asset. It supports American influence by making it easier for American business firms to acquire foreign assets and less expensive for U.S. military forces to operate overseas. It also makes U.S. foreign aid more valuable.

The fact that the dollar is the world's reserve currency allows Washington to draw on additional resources in a crisis, and to run financial risks that would sink lesser countries. Unfortunately, by using "emergency" financial measures during normal times, there is nothing left to draw on in a crisis.

Some business groups, like the National Association of Manufacturers, have been calling for devaluation to make American exports more competitive (and imports more expensive) in order to reduce the trade deficit. The superpower position of the United States does not allow this. NAM has the matter backward. Rather than gut the dollar to reduce the trade deficit, the trade deficit should be reduced to shore up the dollar.

President George W. Bush's action to slow the flood of steel imports was a needed corrective. This break from past failed policies must be broadened, not on an ad hoc basis of individual industries, but with an eye to righting the nation's overall trade balance. The United States should not allow itself to be so vulnerable that a few mouse clicks by foreign investors could send the country into an economic crisis.

There are, however, foreign governments who like to see America taken down a notch or two. China's central bank has started to raise the euro portion of its reserves portfolio in order to diversify its $242.8 billion foreign-exchange holdings away from the dollar. It should make Washington nervous to have a strategic rival with this kind of leverage, the result of running America's largest bilateral trade deficit with Beijing.

In 1971, when the Nixon administration was forced to devalue the dollar and drop its link to gold, it was the French government that applied the pressure. The resulting turmoil destroyed the post-World War II Bretton Woods system.

Today, the European Union, whose trade policies are heavily influenced by France, are anxious to see the dollar falter so it can be replaced by the new euro as the international standard. The dollar has now dropped below the value of the euro. No wonder the EU is so aggressive in trying to cripple America's trade laws and block any attempt to stem the U.S. trade deficit with complaints to the World Trade Organization. The EU sees a chance to end the post-Cold War American hegemony that has so vexed European sensibilities.

The Bush administration must not let this happen.

William R. Hawkins is senior fellow at the U.S. Business and Industry Council.

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