Why a falling dollar spells trouble for U.S.

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

from the October 15, 2007 edition

Page 2 of 2

Page 1 | 2

•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.

1 | Page 2