Feldstein: Let the Dollar Fall

Martin Feldstein continues his warnings on global imbalances as he outlines the changes needed to reduce the current account deficit, a higher saving rate and a fall in the dollar, changes he says market pressures are already bringing about. To avoid a global slowdown or a protectionist backlash as these changes occur, other countries must avoid the temptation to prevent the fall in the dollar through exchange rate interventions and focus instead on increasing domestic consumption to replace falling exports to the U.S.:

Falling dollar sets test for Asia and Europe, by Martin Feldstein, Commentary, Financial Times:  Recent statements by the Group of Seven industrial nations and the International Monetary Fund underscore the growing pressure to reduce the massive US international deficit. Doing so will require both a higher national saving rate in the United States and a more competitive value for the dollar. Neither alone would be sufficient... The good news is that the saving rate of American households is beginning to rise and is likely to gain momentum during the coming year...

The saving rate began falling in the early 1990s as households increased consumption in response to their rising level of wealth – initially a rising stock market and, more importantly, double digit increases in house prices. More recently, this wealth effect was reinforced by the rise in mortgage refinancing that was induced by falling interest rates. Households extracted trillions of dollars ... from the value of their homes and a substantial part of that cash found its way into consumer spending.

The forces that lowered the US saving rate are now being reversed. House prices nationwide are down from the peak reached in the middle of last summer. The Federal Reserve has reversed its low interest rate policy... It will only be a matter of time until the household saving rate is at least back to the 2.4 per cent level of 2002. To convert this higher saving to a reduction in the current account deficit requires increased exports and a shift in Americans’ spending from imports to domestically produced goods and services. A lower dollar will provide the necessary incentive for both of those changes to occur.

Natural market forces are already causing the dollar to fall against the euro, the yen and other currencies. The dollar’s fall is responding to the narrowing gap between US interest rates and those in Europe and Japan. It also reflects a shift in the market’s focus from short-run cyclical conditions to the fundamental trade imbalance. Past experience shows that a more competitive dollar can substantially reduce the trade deficit. The last big fall of the dollar, a 37 per cent decline in the mid-1980s, was followed by a 40 per cent fall in the trade deficit.

A lower US trade deficit will of course mean a decline in the exports of our trading partners around the world. Countries that lose exports need to adopt policies to stimulate domestic spending in order to prevent a decline in their GDP and employment levels. Where this all ends will depend not only on market forces but also on the policies of the governments and central banks of Europe and Asia. It will be tempting but wrong for them to resist the decline in the US trade imbalance by using a combination of monetary policy and exchange market intervention to prevent the dollar’s shift to an appropriately competitive level.

Without that competitive dollar, the higher saving rate in the US will mean slower US growth and rising unemployment. If that happens, the American political process is likely to turn to protectionist measures to shrink the trade imbalance and maintain employment. It would be far better to allow the natural market forces to bring about the needed currency realignment. Instead of seeking to resist the dollar’s shift to a more competitive level, governments in Europe and Asia should focus on developing policies to maintain aggregate demand in their individual economies as their export sales decline...

Comments

[Robert]

That's all well and good, but I am left wondering what kind of domestic "consumption" the esteemed Dr Feldstein wishes the European and/or Japanese fiscal and monetary authorities to stimulate when Japan already has had 6-years of ZIRP and running 7% of GDP fiscal gaps, and the Europeans already have short rates half those prevailing in the US, foaming property markets (ex-Germany), and wtd avg aggregate Community fiscal gaps of nearly 3% of GDP?

While it is true that the household sectors in Europe and Japan could probably bear more leverage, is this really what we want? Pass inflation & the leverage asset-bubble baton [back] to them? And then what....US imbalances are "corrected" only to be left with asset & debt bubbles in the rest of the OECD? What kind of solution of this?

[anne]

While America managed quite well after the September 1985 Plaza Accord took down the relative values of the dollar from 30% to 50%, there was serious disruption to economies in Europe and to Japan. The disruptions were masked for a while by terrific stock and real estate market increases, but the economic damage done is clearly remembered and not likely to be tolerated again. I would expect significant intervention in currency markets if the dollar were to decline sharply from here. The dollar, by the way, after the recent declines in relative value is just about where it was 10 years ago.

[anne]

While there have been declines in international stock markets in domestic currency terms recently, the declines in developed markets have been entirely muted, and in dollar terms European stocks have held completely. I am continually surprised by the absence of volatility in developed investment markets. Possibly this will change, but this is calm calm calm :)

[Bruce Wilder]

A falling dollar implies higher prices for both commodities (i.e. oil) and manufactured goods (Wal-Mart: "Sometimes slightly higher prices"?).

If Feldstein were at all concerned about the pressure on middle class incomes from simulatneously increasing the prices of oil and imported manufactured goods (e.g. all clothing, almost all electronics) and also trading away 2 or 3% of consumption for "savings", you wouldn't notice it in his discussion. We are talking about (what? 2% decrease in consumption from additional savings plus a ~3% reduction in consumption from a big fall in the dollar -- I welcome correction) reducing the real American standard of living by 5% or more. That's substantial, I think. People are going to notice and be unhappy.

And, then there are the effects of reallocating resources in the economy. Feldstein's charming focus on "savings" rates is a nice way of distracting us from the reality that record corporate profits have not inspired record corporate investment, and huge government deficits are not financing any appreciable strengthening of infrastructure or education or science (or anything, really, except 500 family fortunes).

What has America been investing in? Housing, for one; at least housing for rich people. (What percentage of house sales are second homes? 40%?) And, of course, health care. Whatever tiny gains there have been in middle class incomes have been completely swallowed by increases in the allocation of resources to health care, already a hugely over-invested sector of the U.S. economy. Housing and health care have been the growth sectors of the U.S. economy, sucking up what little investment there's been: how are we going to "export" either of those? We're not, of course. Nor is either one going to contribute much to increasing American incomes; new 3 bedroom homes in the far ex-urbs are not that valuable in a world where gas is $3.50/gal and rising.

Health care is not producing much value at the margin, either; we could spend half as much and be healthier, if the examples of other industrialized countries are any reasonable guide. The self-insured are already flying off to Thailand for elective surgery.

Housing and healthcare and what else have we been investing in? Oh, yeah, the government is doing its part to boost savings and investment by borrowing huge sums and pouring the money down the rathole of Iraq? I am so cheered to read in USA Today that the military is enjoying high re-enlistment rates, despite the risk of death and dismemberment, because they are able to offer job security, health care and pensions, no longer available in the private sector.

So, let's see: the U.S. could put its house in order, and preserve the incomes of the middle class, if we massively re-allocated resources away from the war in Iraq and from healthcare. We withdraw from Iraq jolly quick, and nationalize healthcare, cutting in half what we spend on a broken healthcare system. The peace dividend and the healthcare refund could total a 5% to 8% offset to increased savings and increased import prices. The American Standard of Living: let's keep it.

If Feldstein were not such a whore, he could plainly say healthcare should be nationalized and the U.S. should withdraw from Iraq, but he is, and he can't. Too bad. His presentation would be so much clearer, if he just became a Democrat.

[bailey]

It seems pretty obvious that a LOT of people are buying GM stock thinking the dollar's going to fall enough to make GM vehicles an attractive alternative. Good Luck!

[anne]

Bruce, a passionate comment :) There are times when what a person will not address is the topic at hand after all. Iraq and healthcare are topics underlying who we are on so many levels.

[algernon]

Bruce Wilder,

When you call Feldstein 'a whore', you may be inadvertantly saying more about Bruce Wilder than you are about Feldstein.

[anne]

Oh, I really should have mentioned that I do not care for using the word in question on any side :)