The Hindu Business Line : Wisdom of the weak dollar

For the US, the best possible way to knock down internal wages is to embrace a weak dollar. Also, it heals the American economy and vitalises the developing economies, says G. Ramachandran

IT WOULD be both facile and naïve to regard the weakening of the US dollar as a threat to some of the major economies of Asia and Europe. The majority opinion is that the depreciation of the dollar is a matter of global concern. The concern is in two parts. First, the weak dollar hurts the competitiveness of the leading economies of the world whose currencies have risen vis-à-vis the dollar. Second, it leads to the building up of monetary pressure in many of the Asian economies. The accumulation of dollar-denominated reserves is seen to be the principal cause of the building up of monetary pressure.

Quite unsurprisingly, the informed view is that the European Central Bank should address these concerns. The ECB, it has been suggested, should work towards softening the impact of the strong euro. It should also cause the deceleration of the strengthening of the euro so as to restore the competitiveness of exports from the euro area. Europeans have been very eager to express their view that the `burden' of the dollar's realignment should be shared more evenly, especially by Asian economies.

A contrasting view is offered. This view discards the argument that the weak dollar is a burden to any economy. The weak dollar may well be the result of the large fiscal deficit built up by the Republican-dominated US Congress. But it has significant merits. It heals the American economy and vitalises the developing economies.

The weak dollar implicitly translates into a downward revision of wages, employee costs and household leverage in America. It contracts America's claim on global resources and makes these available for causing an upward jump in the growth path of several Asian and middle-income economies. The weak dollar may be regarded as Uncle Sam's gift to many of the developing and middle-income economies. This gift should be put to use most productively by these economies towards growing their per capita incomes.

Big and unique

The US economy is unlike any other economy in the world. It is worth reiterating the fact that it is the world's largest economy. It accounts for about $11 trillion of the nominal global economic output of about $33 trillion. That is, a third of the global economy is the US economy.

But the US economy is far less dependent than commonly assumed on the remaining economies than it is on itself. About 91 per cent of the US economy is wholly driven from within. Export competitiveness is not a major objective to this extraordinarily large part of the US economy. But its sustainability is important to the vitality of the global economy because it is its biggest customer.

The US economy is also far less dependent than assumed on the supply of globally traded commodities. If some of the niggling classification issues are ignored, close to 64 per cent of the US economy is wholly driven by services provided from within. The landed price of commodities such as crude oil, aluminium, copper and steel are irrelevant to the continued vitality and output of this large part of the US economy. It has no stake in a strong dollar.

Bubble without muscle

The US has always had its own formula to grow and sustain its internal economy. This capability shot up after the Reagan White House years (1980 through 1988) and began to show up strongly from 1992. Wage levels and employee costs rode up the escalator. In particular, the per capita incomes in many services job more than doubled. High household leverage followed. Asset price bubbles in the stock and housing markets followed too.

Even before the sustainability of these high per capita incomes and household leverage was analysed, the US stock market bubble ruptured in 2000, and much before the face off in November 2000 between Mr Al Gore, the White House vice presidential incumbent, and Mr George Bush Jr. The bubble had burst, all by itself. The US' magic formula to grow and sustain itself had come unstuck.

Muscle without bubble

What followed since January 2001 — technically the beginning of the George W. Bush White House years — is now part of folklore. The Federal Reserve Board knocked down the domestic interest rate, notch after notch. The US economy was carefully saved from skidding.

But when the interest rate falls, it is tough to squeeze off the ill effects of unsustainable consumption and high household leverage. Yet, there could be no compromise: The ill effects of unsustainable consumption and high household leverage had to be squeezed off. The answer: Wages had to be brought down.

The US has found its magic formula once more. It has understood the benefits of the weak dollar. Being the largest economy in the world and with the dollar as the global currency, the best possible way to knock down internal wages is to embrace a weak dollar. Iraq, from such a perspective, is a little extraneous to the economic logic. More important, the US did not have to tinker with the nominal wages and the interest rate.

The weak dollar has turned out be a strong unguent that has begun to heal the internal economy. But the purchasing power of US households in respect of goods and services wholly produced with internal resources has not declined. There have been no significant welfare losses because 91 per cent of the US economy is wholly driven from within and 64 per cent is wholly driven by services provided from within. The re-election of Mr Bush Jr. is not such a surprise.

But the purchasing power of households in respect of globally traded goods has been squeezed. This has in turn peeled off layers of leverage and borrowings hitherto added on by optimistic households. It has, of course, discouraged millions of potential borrowers.

What is remarkable is that the US has accomplished all of this without having to raise the interest rate all the way back to its December 2000 level. That — high interest rate — would have knocked the global economy off its axle. But the global economy has been carefully saved by the weak dollar.

Gift to the deserving

The decline in the purchasing power of US households in respect of globally traded goods has come at an opportune time. Many Asian economies — notably India — have begun to restructure their internal economies with the hope that their economies will grow at rates that exceed their historic rates.

These economies, China and India, for example, are material intensive economies. They depend on a range of globally traded commodities whose imports are vital necessities for keeping their economies chugging. The affordability of these commodities is among the primary determinants of their economic well-being.

Consider India. It is a big importer of fertilisers, non-ferrous metals with the exception of aluminium, crude oil and edible oil. Its growth could have been halted or hurt if the dollar had not been weak. First, higher crude prices could have crushed India. But the decline in the purchasing power of US households has taken the heat off global demand. Second, the weak dollar has made the rupee stronger. Internal affordability of imports has risen in very trying times.

Good, all round

The weak dollar's favourable impact has pervaded many economies. The global economy could not have grown at 5 per cent last year if the dollar's weakness had been a hurdle and a deterrent. Moreover, the global economy is expected to grow at 5 per cent this year and at over 4 per cent next year. These sanguine projections show that the weak dollar does not kill.

The weak dollar has pushed up internal productivity in the US. It has also pushed euro area economies and Japan to the extreme in their search for survival in tough times. They cannot complain that the weak dollar has made US exports more competitive and thus turning the US's trade balance into surplus. The US' trade balance continues to be in deficit: A whopping $664 billion over the last 12 months.

At the same time, the sheen has not worn off the trade balances of Japan (surplus $138 billion), the euro area economies (surplus $96 billion) and Canada (surplus $53 billion). And Germany has the least to complain (surplus $194).

The weak dollar may have hurt Australia (deficit $19 billion) and the UK (deficit $103 billion) the most. They are possibly the only two economies that may have borne the burden of the dollar's realignment. But they are not complaining. We should find out why, and turn a deaf ear to the others.

(The author is a financial analyst. Feedback may be sent to indiagrow@yahoo.com)

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