Nov 19, 2004
<>Global: Why the World Needs a Weaker Dollar
Stephen Roach (New York)
A $40 trillion world economy is dangerously out of balance and seriously in need of a fix. A decline in the dollar is not a cure-all for all that ails the world, but it should go a long way in sparking a sorely needed rebalancing. That adjustment may now be under way.
Global imbalances are a shared responsibility that requires a joint resolution. America is guilty of excess consumption, whereas the rest of the world suffers from under-consumption. Growth in US consumer demand averaged 4% annually (in real terms) over the 1995 to 2003 period, nearly double the 2.2% gains elsewhere in the industrial world.
America’s consumption binge has not been supported by internally-generated income growth. Instead, US consumers have borrowed against the future by squeezing saving to rock-bottom levels. The personal saving rate stood at just 0.2% of disposable personal income in September 2004 — down from 7.7% as recently as 1992. Moreover, large federal budget deficits have taken the government’s saving rate sharply into negative territory — pushing the overall national saving rate of consumers, businesses, and the government sector to historical lows.
America’s saving shortfall has major consequences for the rest of the world. Lacking in domestic saving, the US imports saving from abroad in order to fund the ongoing growth of its economy. And it must run massive current-account and trade deficits to attract such capital from overseas. The United States balance-of-payments deficit hit an annualized $665 billion in mid-2004, or a record 5.7% of GDP.
The flip-side of America’s consumption binge is an overhang of excess saving elsewhere in the world. This shows up mainly in the form of sluggish consumption growth and current-account surpluses in Asia (especially Japan, China, and Korea), Europe, and the Middle East. For now, America draws freely on this reservoir — currently absorbing about 80% of the world’s surplus saving by attracting an average of about $2.6 billion of capital inflows from abroad per working day. Not only has the United States turned increasingly to offshore production platforms and labor markets in recent years, it is now outsourcing its saving, as well.
This is a highly unstable arrangement. For starters, America’s current-account deficit seems set to widen further over the next few years, moving into the 6.5% to 7.0% vicinity by late 2005 or early 2006. As such, the US will be asking more and more of its global financiers to fund budget deficits and excess consumption. That may be asking too much. Private overseas investors have already turned skittish in providing capital to the US, leaving overseas central banks to fill the void. Over the 12 months ending September 2004, foreign monetary authorities have accounted for 28% of total net foreign purchases of long-term US securities — nearly double the 15% share of the prior 12-month period.
The day will come when foreign investors simply say "no" to this arrangement — refusing to fund America’s consumption binge without getting a meaningful concession on the terms of financing. That’s when the dollar collapses, US interest rates soar, and the stock market plunges. Under such a crisis scenario, a US recession would be all but inevitable. And a US-centric global economy would undoubtedly be quick to follow. Unfortunately, with America’s current-account deficit now in the danger zone, that day of reckoning could well come sooner rather than later.
The only way to avoid this wrenching endgame is for the world’s major central banks to move preemptively on the dollar, carefully managing a gradual but significant depreciation over the next several years. There are several advantages of such an approach:
First, it would trigger a gradual rise in US interest rates — in effect, sparking a price concession on bonds that is probably the only way that foreign investors can be enticed to keep sending capital to America. That, in turn, would suppress growth in those sectors of the US economy that are most sensitive to interest rates, such as housing, consumer durables such as cars, and business capital spending. That would result in higher domestic US saving and a reduced need for foreign saving — the essence of a classic current-account adjustment.
Second, a weaker dollar, of course, means other currencies need to strengthen. So far, the euro has borne a disproportionate share of the adjustment. Asian currencies have barely budged — especially those of Japan and China. That reflects the role that cheap currencies play in supporting export-led Asian growth — and the desire of Asian authorities to keep buying dollar assets in order to keep the magic alive. A failure of Asia to adjust and accept some of the burden of a weaker dollar will put increasingly intense pressure on the euro — leaving an already fragile Euroland economy in even tougher shape, with a growing sense of resentment toward Asia. Asia’s monetary authorities — including those in Japan and China — now seem resigned to more flexible approaches in managing their currency regimes. That could go a long way in relieving the burden on Europe.
Third, as the currencies of Asia and Europe strengthen in response to a weaker dollar, there will be downward pressure on exports in these two regions — the main drivers of their growth in recent years. This will force Asia and Europe to push hard to stimulate domestic demand in order to compensate — resulting in a reduction of saving and a related narrowing of current-account surpluses. This is easier said than done, of course — especially since it entails increased effort on labor market and other structural reforms in order to unshackle long-dormant domestic demand.
A fourth and final reason to welcome a weaker dollar is that it would be an especially potent force in defusing mounting global trade tensions. Dollar depreciation provides support to US exports that, together with an interest-rate-induced slowdown of domestic demand and imports, should reduce the trade deficit and temper protectionist risks that still seem quite evident in many quarters of the US Congress. To the extent a weaker dollar forces greater currency flexibility out of Asia, that would reduce the possibility that Europe could turn up its own protectionist campaign. A weaker dollar provides better balance to the tradeoff between economic and political forces.
In the end, a lopsided world needs a jolt to find this healthier state of balance. A weaker dollar is the functional equivalent of a major shift in the world’s relative price structure that could well lead to greater balance. Given America’s gaping and rising balance-of payments deficit, dollar depreciation is all but inevitable. There are two options for the world’s financial authorities — remain in denial and get blindsided by a dollar crash or move ahead of the markets and manage the downside. With the dollar now back in play and depreciation proceeding at a gradual pace, there is more reason for hope than despair. Yet if the world’s politicians and policy makers step in to arrest this trend — either by stabilizing the dollar or allowing it to appreciate — then all bets would be off. Today’s unbalanced global economy needs a weaker dollar more than ever.
Dollar depreciation has long been central to the global rebalancing framework that drives my view of the world economy. It’s not that a realignment of foreign exchange rates is the cure-all for a lopsided world. If anything, currency-related impacts on trade flows and inflation have actually diminished over the past decade. But, in my view, a shift in the world’s relative price structure is a powerful signaling mechanism that puts a number of other forces into play — economic as well as political — that are essential for the urgent rebalancing of an unbalanced world. Provided the currency shift doesn’t get out of hand, a sustained but managed weakening of the dollar is good news for the global economy and world financial markets.
