Assessing the global import of the dollar's drop

If you haven't already capitalized on the strength of the dollar with a trip to Europe, your window may be about to close.

The greenback could be ready to tumble. If it does, that transatlantic trip will be more costly by summer.

The new administration in Washington has been busy affirming that it has a "strong dollar" policy, just like the Clinton administration before it.

But the slowdown in the American economy and the fall in interest rates has prompted a widespread expectation in financial circles that the euro - the common currency of 11 European nations - will reach parity with the dollar by midyear.

"As long as the US economy appears to be weakening, the dollar will weaken with it," says J. Paul Horne, London economist with Salomon Smith Barney, a major investment-banking firm.

Last October, a euro cost about 83 cents. The price was about 93 cents last week.

John Williamson, an economist at the Institute for International Economics in Washington, says a "reasonable" euro price would be $1.30 to $1.40.

"That day will come," he says. But maybe not as soon as this summer. His prediction hangs on the view that the dollar is "fundamentally" overvalued.

That's shown by last year's deficit in the current account - the difference between US outgo and income from trade, services, tourism, remittances, investment income, etc. It reached about $438 billion - a record.

This deficit exceeds 4 percent of US gross domestic product (GDP), the total output of goods and services in the nation.

"The US has to borrow $1.5 billion a day to cover that," notes Charles McMillion, a Washington economist.

By "borrow," he means that foreigners use the surplus dollars they have earned to buy up American companies, or invest in US shares and other financial assets, or pile up dollars in the reserves of their central banks.

Mr. McMillion figures that foreigners will at some point become wary of sinking so much money in the US. A huge wave of European purchases of American firms has already slowed.

Forecasting a major swing in currency markets, though, has been far from an exact science.

And unlike other nations, the US can and has run a persistent current-account deficit and gotten away with it. It's had such a deficit every quarter since the start of 1978. The trade deficit dates back to 1974.

It helps that the US economy is the biggest, most prosperous in the world and that the dollar is the currency used most in international trade. Foreign central banks want a growing pile of dollars in their monetary reserves for use in the event of an international-payments crisis. US interest rates are higher than those in other major industrial nations. For all these reasons, foreigners are happy - so far - to hold dollars.

Should foreigners lose confidence in the dollar, its plunge on foreign-exchange markets would have a major impact on the US economy. It would likely boost inflation, as the price of imports rose. To tame inflation, the Fed might raise interest rates, negatively impacting stocks. A weak dollar probably would embarrass the Bush administration, since Americans have become a bit proud of their high dollar.

Manufacturers would probably rejoice, though. The strong dollar has made it tougher to export their products and made imports more competitive.

"We are definitely not for a weak dollar, but for a dollar more consistent with historical norms," says David Huether, an economist at the National Association of Manufacturers in Washington.

Economists figure US manufacturing is already in recession.

Carl Weinberg, an economist with High Frequency Economics, a consulting firm in Valhalla, N.Y., isn't so pessimistic about the dollar. He says foreign-exchange markets have already taken account of the slump in the dollar's price.

And for the long term, the huge US current-account deficit should be seen as a percentage of the entire world's GDP, money supply, or trade volume, not just as a proportion of US GDP. By those measures, the deficit is "not at dangerous levels," Mr. Weinberg says.

Many economists now see the US slump as V-shaped. GDP will slightly shrink in the first quarter, grow a little in the second quarter, and pop up to a healthy rate after that. Mr. Horne predicts a tidy 3.75 percent annual growth rate. If so, economists say, the dollar will bounce up like a rubber ball.

The US will again have the highest growth rate without much inflation, says Chris Widness, international economist for J.P. Morgan Chase & Co. US interest rates will remain internationally competitive, even after more rate cuts by the Federal Reserve. So the dollar will be fine, he says.

We will see.

(c) Copyright 2001. The Christian Science Publishing Society

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