Why a falling dollar spells trouble for U.S.

Weaker currency hurts nation's ability to 'call the shots' on international economic issues.

The United States dollar is getting sand kicked in its face on foreign-exchange markets. The consequences are many. For one thing, the currency shift is a challenge to what historians dub "American exceptionalism," the view that the US is superior to other nations because of its unique origins, national credo, historical evolution, distinctive political and religious institutions, and economic might.

The US will have to adjust to a changing situation, that it is one among a set of leading industrial powers, but "not calling all the shots" on international economic issues, says Van Doorn Ooms, a senior fellow at the Committee for Economic Development, a nonpartisan research group of some 200 US business leaders and educators based in Washington, D.C.

The US dollar's decline, says Washington economic consultant Charles McMillion of MGB Information Services, "puts pressure on those who think [the US] can pay any price and accept any [international] burden. It certainly makes foreign military operations and embassies abroad more expensive."

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Last week, the Institute of Inter­national Finance, an association of the world's largest private financial institutions, called on the world's finance ministers and central bank governors (they meet in Washington next week) to take action to calm the financial turmoil triggered by the collapse in the US sub-prime mortgage market. Many non-US firms have been hit twice: not only have their investments in US mortgages slipped, but their losses have been compounded by the dollar's decline.

Last month, the Canadian dollar became more valuable than America's. As of Oct. 10, it was worth a penny more. The Australian dollar may be next to pass the US currency. On Oct. 10, the US dollar had slipped 12.8 percent in value against the "Aussie" in the past year. That puts the value of the Aussie at about 90 American cents. And American tourists in Europe are lamenting that their dollar buys only 0.71 euros, the currency of 13 European nations.

To many, the US dollar's decline is rooted in other economic problems, including the massive federal budget deficits of recent years, a huge international trade deficit, the mounting cost of the Iraq war, and the lack of savings by Americans. Here are a few implications of the weaker US dollar:

•The American standard of living could decline or not grow as fast. That's partly because the US dollar buys fewer goods and services from other nations. The dollar has lost 20.6 percent of its value since October 2002, reckons Mr. McMillion, who bases his calculation on the Federal Reserve's "broad" foreign-exchange index (adjusted for inflation), and on the volume of US trade with other nations. During that five year period, the dollar is down 43.9 percent against the euro, down 61.8 percent against the Canadian dollar, down 10.2 percent against the Chinese yuan, down 5.6 percent against the Japanese yen, down 30.6 percent against the British pound, and up 5.8 percent against the Mexican peso.

•The dollar's decline should, over time, reduce America's trade deficit somewhat. US exports have climbed about 15 percent in the last year. But the effect of dollar devaluation on trade will be limited, reckons Peter Morici, a professor at the University of Maryland's School of Business. That's because 40 percent of the deficit is the result of the US trade imbalance with China. And China controls the value of the yuan against the dollar and some other currencies to protect its exports and job growth. Further, another 40 percent of the US deficit arises from its import of oil – and most economists don't expect a major drop in world oil prices. Much of the remaining 20 percent of the US deficit stems from its import of cars from Canada, Mexico, and (to a limited extent) Europe.

•Europeans are uncomfortable with the dollar's weakness, partly because it has pushed up their trade deficit with China. A euro bought 8.17 yuan in Octo­ber 2002; today it buys 10.58 – up 30.5 percent. So when the finance ministers of the Group of Seven (Japan, Canada, Britain, Germany, France, Italy, and the US) meet Oct. 20 in Washington, the Europeans will urge for more pressure on China to let its currency appreciate.

Also, the International Monetary Fund last year launched a "multilateral consultation" of the US, China, the euro area, Japan, and Saudi Arabia to seek a solution to the "global imbalance" that includes the US trade deficit and the big trade surpluses of China, Japan, and some other Asian nations. "They will wring their hands with even more vigor now, and little else," comments McMillion. With the current US administration, "I don't see the IMF having the ability to play a constructive role."

•The approximately $5 trillion of US Treasury investments held by foreign central banks have probably lost billions in value. But that doesn't trouble the central bankers much. Only modest amounts have been shifted to euros.

•Many trade surplus nations have set up "sovereign wealth funds," which invest their extra dollars in not just US Treasuries, but all sorts of foreign investments. Economist Edwin Truman, at the Peterson Institute of International Economics in Washington, lists 18 such funds with nearly $2 trillion in total assets.

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