- The Washington Times - Monday, January 27, 2003

John W. Snow, President Bush's pick to head the Treasury Department, faces an immediate challenge of how to handle a rapidly tumbling dollar.
For reasons ranging from fear about war with Iraq to low interest rates, a weakening economy and huge trade and budget deficits, the greenback since November has fallen quickly to three-year lows against the euro and is down by 17.5 percent against six other major currencies in the last year.
That raises the cost of imported goods from cars to French wine and makes it more expensive for Americans to travel overseas. The biggest concern for the Treasury is that a falling dollar also makes it more difficult for the country to finance its burgeoning debts, which require $1.4 billion in daily inflows from overseas.
The White House says it has not changed its "strong dollar" policy, but the currency's decline accelerated noticeably last month after the departure of former Treasury Secretary Paul H. O'Neill, who after a rough start two years ago became a strong defender of the dollar.
Mr. Snow, who as chief executive of CSX Corp. comes to Washington from industry rather than Wall Street, like Mr. O'Neill starts out handicapped in assuming the Treasury secretary's unique role as chief spokesman for the dollar. As CEO of the transportation company, he advocated a weaker dollar to help U.S. manufacturers deal with overseas competition.
Mr. O'Neill, a former chief executive of Alcoa Inc., never won any accolades from Wall Street, but he gained credibility as a dollar defender by steadfastly spurning pleas for a weaker currency from U.S. exporters in industries battered by the recession.
Mr. Snow is expected to adhere to the administration's earlier "strong dollar" policy, though he has refrained from commenting on the dollar or other economic matters ahead of his confirmation hearing tomorrow before the Senate Finance Committee.
All signs are that traders in the vast dollar market who are known to push a currency to the extreme once it has reversed course will put Mr. Snow to the test quickly. More than $1 trillion exchanges hands in trading each day.
"The U.S. dollar is in a full-fledged bear market, and the downtrend is still in the third inning out of nine," Merrill Lynch told clients last week. The Wall Street firm attributes the dollar's troubles mostly to the trade deficit, which in the last year bloated to $453 billion, or nearly 5 percent of the gross domestic product.
"The huge U.S. current account deficit is perhaps an old and tired story," Merrill Lynch said, "but breaking above 5 percent relative to GDP is a big deal the threshold that in the past got emerging markets into trouble."
To reduce the trade deficit to a more normal 2 percent of GDP, Merrill Lynch estimates that the dollar would have to decline another 20 percent. Ironically, it notes that the deficit has widened partly because the United States has been growing faster and absorbing more imports than major trading partners such as Japan and Europe.
Federal Reserve Chairman Alan Greenspan and former Fed Chairman Paul Volcker have been warning for years that the relentless growth of the trade deficit is unsustainable and someday will exact a price, causing the fall of the dollar.
Mr. Volcker has told the National Press Club that his biggest worry about the U.S. economy is that a precipitous drop in the dollar will touch off a full-fledged financial crisis, although he added that such a dire scenario can be avoided if the decline is gradual.
The United States was able to sustain large trade deficits when its economy and financial markets were booming during the 1990s, acting like natural magnets that lured foreign investors to put their dollars back into the United States. But after three years of big stock losses and economic weakness, investors have been casting about for more profitable alternatives.
Money has been flowing into everything from gold and bonds to Swiss francs, real estate and even the Norwegian krona and Canadian dollar currencies that have gained status as safe havens if the United States goes to war with Iraq. That is a reversal for the dollar, which for years has been the world's principal safe-haven currency.
Nick Parsons, head of currency strategy at Commerzbank, said the "daily ebb and flow" of jousting between the White House and Iraq has played a bigger role than economic factors recently in driving down the dollar.
"If we could construct an index of bellicosity, it would show a near-perfect correlation with the dollar," he said.
European leaders, who struggled to support the euro as it sank steadily against the dollar after its introduction in 1999, have been pleased about the reversal of fortunes. The euro is up by 26 percent against the dollar in the past year.
German Chancellor Gerhard Schroeder and French Prime Minister Jean-Pierre Raffarin issued a statement last week gloating over the euro's gains.
"It's not the euro that's strong, it's the dollar that's less attractive," said French Finance Minister Francis Mer, who is hosting a meeting of the Group of Seven finance ministers in Paris next month.
Investors who saw the United States as the best-performing economy during the 1990s now, after two years of recession and faltering recovery, "question if the U.S. method is still the best to create growth," he said.
Economists point out that the moderate decline of the dollar in the past year has had some beneficial effects. An important one was giving the European Central Bank leeway to stop defending the euro and cut interest rates to stimulate growth in the euro zone.
A softer dollar also helps hard-hit U.S. manufacturers, farmers and other exporters sell more goods overseas. The growth in exports, in turn, fuels growth in the economy and eventually helps to reduce the trade deficit.
A weaker dollar also improves the earnings of U.S. corporations that have offices overseas.
In the short term, however, a lower dollar raises the cost of imports and causes the trade deficit to bulge further, while raising prices and threatening to reignite inflation.
"The deficit is clearly draining tons of cash from the economy" and is a major culprit in the dollar's decline, said Joel Naroff of Naroff Economic Advisors. "As long as uncertainty over the U.S. economy and geopolitical risks continue, it will be difficult for the dollar to rally with this kind of deficit."
But Mr. Naroff predicted that the economy will reaccelerate once worries about the war are put to rest, and "the dollar will follow suit." He said the promise of returns on investments in the United States remains higher than it is in Europe or other regions.
Nariman Behravesh, economist with Global Insight, agreed that stronger growth in the United States in the end will support the dollar.
"The odds of a dollar crash are low," he said. Even if its decline accelerates into a free-fall, "the Fed and other central banks would likely intervene to prevent disruptive events."

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