The Hindu Business Line : Fall and fall of the dollar: US must buck up

The dollar money game is fascinating as it has been performing a unique circus act "without any net under it" for a longish period, providing thereby a fertile opportunity to international money managers to make quick money. In a recession-ridden global economy, the fall of the dollar signals the loss of faith in the very first currency itself. The US must quickly put its economic house in order, just like any other debt-ridden country.

"MONEY is a commodity such as potatoes — if only ten people want them, they are worth only so much. If thousands want them, well..." said a Zurich banker shrugging his shoulder, at the height of international monetary crisis in January 1973.

This was a time when the weak US dollar was heading towards its inevitable second devaluation against gold. The Swiss franc was a star performer then, outsmarting its nearest competitors, the sturdy German mark and the Japanese yen. More then three decades after that momentous dollar crisis which ripped apart the Post-War Bretton Woods System, the dollar has plunged more steeply against the euro and gold.

In terms of the scale and severity, the depth and duration of the currency crisis, the 2003-04 dollar plunge is also more savage than its previous collapse under the Jimmy Carter regime (1978-79).

But for the massive intervention of Asian central banks reluctant to permit the inevitable revaluation of their currencies, the fall of the "Lord of the Bretton Woods currency ring," and ``the return of the king" under floating — the US dollar — would have been worse. Indeed, the worst is yet to come. But neither Europe nor Japan wants its currencies to rise against the dollar any further.

In a recession-ridden global economy, particularly in the context of the inflation-free developed economies, the fall of the dollar by a huge percentage clearly signals the loss of faith in the very first currency itself. The recent issue of The Economist of London also draws attention to this and laments over it.

To quote the journal: "Of late, it (dollar) has been wobbling around unconvincingly: The US needs a weaker dollar to correct its current account deficit. But given the dollar's role as a currency of last resort, some wonder if its decline heralds not just an economic adjustment by the US but a crisis of sorts in the value of paper money itself."

Ever since the dollar was delinked from gold and allowed to float in the early 1970s, it has been on a roller-coaster: After an initial spell of weakness, the dollar became strong in 1975, weak in 1978-79, progressively stronger in 1981-85, again weakening in 1985-87, weaker still in the mid-1990s, then strengthening until early 2000, again weakening thereafter till the present day.

This dollar money game is fascinating as it has been performing a unique circus act "without any net under it" for a longish period, providing thereby a fertile opportunity to international money managers to speculate against it rather effortlessly and make quick money.

It should be pointed out that the US way of choosing to hide and fence behind the forces of global finance — the rescue act led by the central banks of Asia to lend support to US Treasury Market — has emboldened the US to show a continued heightened indifference towards ballooning budget and current account deficits. Hence there is going to be a rethink on parking of funds in the US bond market.

With the exception of an exceptionally high growth profile of the US during the 1990s — in what seemed to be an endless unstoppable expansion of the roaring 1990s, the US economic performance has been only lacklustre overall and continually shown signs of its own macroeconomic weakness and vulnerability, not to speak of its fiscal slippages.

A carefully calibrated strong dollar policy just to provide a false sense of prestige and power to the US has eventually boomeranged and backfired, landing the economy into the quicksand of export fatigue, and protectionist war cry over stealing of jobs by foreigners on the eve of presidential elections.

Even after the evaporation of the New Economy triggered growth and bursting of asset market bubble, holding on to the strong dollar policy became a farce. The US cannot afford to hold on to a rate that it does not deserve and also not consistent with its requirements of current account balance. A relatively free trader of the 1960s and 1970s has turned into a fiercely protectionist nation since the 1980s bullying the weak nations to open up their markets.

Slapping of duties on steel, and a host of other items, while simultaneously engaging in the task of entering into bilateral regional free trade agreements with many to the relative neglect of strengthening multilateral Doha Round of WTO negotiations exemplify the knee-jerk reaction of the US borne out of its unrealistic exchange rate policy of dollar pursued thus far.

A strong dollar policy articulated by successive American Presidents and the perpetually debt-fuelled US economy sitting on a volcano of trillions of dollar debt mountain are contradictory and, hence, cannot and should not go together for long.

They need to be addressed, repaired and corrected by the free market discipline — a doctrine more dearer to the heart of the US economy.

The reluctant and, yet, the relentless march of the euro to dizzy heights and a rise in the price of the yellow metal, and oil, with all built-in speed breakers are only an indicative trend of the discipline of free market.

Unless this crucial step of pricing of the dollar to the market — the inevitable downsizing and right sizing of exchange value of dollar is sustained for a longer period without resorting to policy co-ordination attempts and carried forward to effect a cut in both spending, and real wage rate levels in the US the economic ailment afflicting the US cannot be just resolved.

There are reasons to believe that Plaza type accord of policy coordination of 1985 to short-circuit market discipline cannot work in 2004-2005; greater flexibility in exchange rate for the dollar in a unidirectional fashion has arrived and any tall talk of stronger dollar policy to reverse the weak dollar will only help inaugurate another round of steeper dollar in the not-too-distant future.

Let the dollar exchange rate move like walking over a staircase for some time, until tangible evidence shows itself in the BoP adjustment process.

The excessively fluctuating dollar in either direction for an extended time span in an alternative fashion has been exerting a more powerful and devastating influence on the entire world economy, inclusive of the US economy.

The world is indeed ruled by little else. This meaningless exchange rate and interest rate cycle must end, by forcing the US to begin reform at home. The US must learn to live with the depreciating dollar, with all its attendant consequences.

The US too wants it, but the rigid dollar peg of many currencies, effectively preclude that possibility. The dollar's dilemma will persist for some time.

The time has come for the US to set its economic house in order. It is time it behaved like any other ordinary debt-ridden economy and looked inward to correct its economic distortions, without searching for scapegoats such as China and Japan as the contributory factors for its fiscal stress and macro chaos. Free lunches cannot be had forever.

Let the US usher in wage-price deflation to supplement dollar depreciation and make it work instead of putting more pressure on the euro. Let the burden of global adjustment be also shared by the Chinese yuan, the Indian rupee and few economies that are on good wicket. A prolonged exchange rate misalignment under floating is causing ripples of discontent elsewhere.

In the IMF's language, for global stability as also its own, the US must undergo a thorough macro economic and fiscal restructuring — an IMF agenda, which the US has always disregarded for itself, but preached others.

And, then, there is no escape route for the US as it can no longer suffer from the illusion of borrowing at cheap interest rates. The market will put pressure on the US to behave and force it either to pay a higher interest and/or withdraw support to the US Treasury bond market.

As the days of the strong dollar are numbered, the US' steps must be measured. The ongoing dollar crisis is only America's `Asia 1997', thesooner it learns the lessons of currency crisis, the better for it, and also for the global economy.

(The author is on the faculty of School of International Studies, Pondicherry University.)