Martin Wolf Commands: "Let the Dollar Fall!"

Martin Wolf channels Maury Obstfeld and Ken Rogoff:

FT.com / Comment & analysis / Columnists - Martin Wolf: Let dollar fall or risk global disorder: A very simple description of the current state of the US economy would be as follows: total demand is 107 per cent of gross domestic product; total output of tradeable goods and services is some 25 per cent of GDP; total demand for tradeable goods and services is 32 per cent of GDP; and total demand and supply of non-tradeables is 75 per cent of GDP. The difference between supply and demand for tradeables, by definition, equals the trade deficit.

Now assume a reduction of only 3 percentage points in the ratio of the trade deficit to GDP. This is just under 10 per cent of total demand for tradeables. Assume, for simplicity's sake, that the incremental demand for tradeable goods and services is proportionate to that for non-tradeables. Without any shift in relative prices, overall demand in the economy needs also to fall by just under 10 per cent, to deliver the desired reduction in the trade deficit. This would generate a fall of about 7 per cent in GDP, all of which would fall upon industries producing non-tradeables. But such a deep recession would create misery, while contributing nothing to the desired improvement in the external deficit.

To avoid the massive recession that expenditure reduction alone would generate, the price of non-tradeables has to fall substantially relative to that of tradeables. Such a shift is a decline in the real-exchange rate. This should move spending towards non-tradeables and potential supply towards tradeables. Under plausible assumptions the real exchange rate changes needed to shift the economy in the desired direction are large. The quicker the adjustment, the bigger they must be. That is a good reason for making those adjustments slowly, which is also a reason for avoiding postponing them indefinitely.

Could these changes in real exchange rates be achieved without moves in nominal exchange rates? The logical answer, again, is yes. But that would require a fall in the nominal price of non-tradeables in the US -- in other words, outright deflation in that country -- and a rise in the price of non-tradeables in the exporting countries -- in other words, rapid inflation there. The former is inconceivable, while the latter is apparently unacceptable. So nominal exchange rates must move.

Comments

[Michael Carroll]

I am becoming concerned that any hope for a gradual change is quashed by the likelyhood there will be a stampede for the exits if anyone blinks. On the one hand we seem to have psychologically adjusted to housing price disinflation and there are not any new clear bubbles in sight but don't we have about three years of excess-excessiveness to clear of the books somehow?

[arbogast]

Yeesh. Double yeesh. Triple yeesh.

After what are tangible, calculable descriptions of the need for an exchange rate adjustment...nothing quantitative about the amount of the exchange rate adjustment!

Yeesh.

Puhleese, if you are going to publish something that is quantitative on one side of the coin, make it quantitative on the other side. Dollar bills say they are worth one dollar on each side.

Same standard for posts in blogs.

How much does the exchange rate have to change? In percentage terms?

[wcw]

Why is there no hope fpor gradual change? Look at the trade-weighted dollar: http://www.federalreserve.gov/releases/h10/Summary/indexb_b.txt
That index is down its high around 130 to under 100 recently.

As for quantification, I don't think it's needed. The column was a nice, pithy encapsulation of just what has Brad Setser so exercised these last few years. I appreciated the excerpt, since I don't pay up for the FT.

[anne]

The value of the dollar against international currencies is remarkably close to where it was 10 years ago, and over the last several years investors have had all the opportunity to sufficiently diversify portfolios to foreign assets. Why then should any further adjustment of the dollar be a problem for investors, and if not for investors why should further changes in dollar value be a significant economic problem? The strength and stability of international economies and reflecting investment market impresses me, and makes me rather hopeful.

[jim]

Elizabeth I: "Little man, is 'must' a word to be used to Princes?"

Or to dollars?

[spencer]

Over the past years we have had the Greenspan condrumdrum where foreign surplus savings came to the US and kept the dollar strong and bond rates low. But now the Japanese depression is over, European growth and rates are accelerating and the Chinese are shifting to consumer lead growth. This implies that the foreign savings surplus is vanishing and with it the ability of the US to keep a strong dollar and low yields. Also note that one aspect of the Greenspan condrumdrum that is not discussed much, but is very important. That is the ability of the Fed to conduct an independent monetary policy --at the margin we are now looking at a one world supply and demand for long bonds and what happens in other economies is now as important, if not more important to the US bond market as fed policy.

[spencer]

Over the past few years we have had the Greenspan conundrum where the inflow of the foreign savings surplus kept US bond yields and the dollar strong. But now the Japanese depression is over, European growth and rates are rising significantly and the Chinese is shifting to consumer lead growth. These all imply that the foreign savings surplus is vanishing. One aspect of the Greenspan conumdrum that is little discussed is that it impleis that the Fed is losing its ability to conduct an independent monetary policy. What happens in the rest of the world is now more important to the US bond market then fed policy. We now have a one world bond market and although for the last few years we have benefited from it, we are now starting to see the flip side of this delelopment with significant negative consequences for bond yields and the dollar..

[spencer]

Over the past few years we have had the Greenspan conundrum where the inflow of the foreign savings surplus kept US bond yields and the dollar strong. But now the Japanese depression is over, European growth and rates are rising significantly and the Chinese is shifting to consumer lead growth. These all imply that the foreign savings surplus is vanishing. One aspect of the Greenspan conumdrum that is little discussed is that it impleis that the Fed is losing its ability to conduct an independent monetary policy. What happens in the rest of the world is now more important to the US bond market then fed policy. We now have a one world bond market and although for the last few years we have benefited from it, we are now starting to see the flip side of this delelopment with significant negative consequences for bond yields and the dollar..

[spencer]

Over the past few years we have had the Greenspan conundrum where the inflow of the foreign savings surplus kept US bond yields and the dollar strong. But now the Japanese depression is over, European growth and rates are rising significantly and the Chinese is shifting to consumer lead growth. These all imply that the foreign savings surplus is vanishing. One aspect of the Greenspan conumdrum that is little discussed is that it impleis that the Fed is losing its ability to conduct an independent monetary policy. What happens in the rest of the world is now more important to the US bond market then fed policy. We now have a one world bond market and although for the last few years we have benefited from it, we are now starting to see the flip side of this delelopment with significant negative consequences for bond yields and the dollar..

[psh]

Anne you tug my heartstrings like little Iphigenia among the savage risk-arb Taurians atop the desolate kurtotic precipices of the international financial Euxine Sea

[anne]

PSH, you are a commenting prodigy if ever there was for how telling you can be in how few words. Iphigenia? Oh dear, now I really am worried. Iphigenia?

[anne]

Then, I am to be sacrificed so that we may go to war against Troy even though I always had a thing for Paris, Helen notwithstanding whom I have other plans for in any event. What do I have against Troy?

[anne]

Swimming after all is fine, but I am not much for flying, and Paris, well Paris, well.... Achilles has other things going. "Not that there anything wrong with it."

[anne]

Spencer:

"What happens in the rest of the world is now more important to the US bond market then Fed policy. We now have a one world bond market and although for the last few years we have benefited from it, we are now starting to see the flip side of this delelopment with significant negative consequences for bond yields and the dollar."

Interesting conjecture.

[ilsm]

Gold hit a 26 year high. About 26 years ago we were getting used to the Ayatollah running Iran, the Saudi were terrified and the Russian Bear loaded up and roaming around Afghanistan.

Will our regime collapse like Gorby's?

[ilsm]

Oh, yes. 26 years ago, mortgage rates were around 14%

[Buce]

"there are not any new clear bubbles"

But we still have the threat of New Clear War.

[psh]

But at Tauris you're leading hapless victims
http://www.goofigure.com/UserGoofigureDetail.asp?gooID=6216
to their doom. Home bias is a loyalty test for them.

[Andrew - Money Supply & Debt Blog]

My question is, does the US really want a weaker dollar with the already sky high price of oil?

[wcw]

Yes.

[camille roy]

What has happened is that much of corporate America (that part which outsources to china) benefits from the peg. Our govt is for by and about corporate interests, at the expense of those of us who labor for a living. So the govt whines at the Chinese about the peg but does nothing, because too many of the powerful are making plenty of money off of the rise of China and the hollowing out of America. Elites, like corporations, have lost a sense of national identity.

The ones left out of the party are American workers. We are the ones without representation in the era of globalization and free trade.

[christofay]

kurtotic, not getting a read on this on dictionary.com.

The dollar has weakened a lot against oil if not against the basket of currencies that are also in the life raft. And the dollar has been weakening against gold since W starting acting as president.

The Indians, democratic, nationalistic, looking historically for a way to develop their country progressively, have been calling for investing surpluses at home. Singh did so at the recent ADB meeting.

From Fleckensteincapital, a site that I have been reading, a quick note, "Powering the upside were two stories out of China. The first, from a group of academics/economists, called for China to quadruple its gold reserves. The second, carried on Dow Jones, said that China plans to build reserves of uranium, iron, copper, bauxite, and coal. The story described it as part of China's official five-year plan for 2006-2010. The latter was released on April 28, but due to the Chinese holiday, it was only just picked up. If true, it's proof-positive of the Chinese extinguishing their dollars for "stuff." Other Asian dollar-bag-holders, please copy."

From the Setser site I gather that the Chinese trend would not be a general sell off but directing new flows into alternatives to the dollar.

I'm afraid that what will drive Bush's support numbers into the 20s are friction in our U. S. stock market and commodity price markets in the next few months, afraid for our country not for Bush.

[reason]

Anne,
I think what some people (like me) are scared of now (as against before - I remember for instance the long overdue big fall in the US Dollar at the end of the Reagon years) is that now the US household sector is loaded up to the eyeballs with debt, at exactly the time when babyboomers see retirement approaching.
A fall in the dollar means a fall in real living standards for US households (most obviously due to energy and food costs) that they cannot afford together with their debt commitments. A massive increase in bankrupcies is the danger. I'm not an American, but it looks to me that although your Federal debt is not extraordinary (yet), the country is in terms of its export potential essentially bankrupt. The problem is the size of the exports versus imports, especially given that in the short term many imports (oil) are relatively price inelastic. The high value of your currency hides that at the moment. It is like somebody who is mortgaged up to the eyeballs and takes a salary cut.

[wkwillis]

Arbogast
The "classical rule of thumb" is that the exchange rate must fall 10% for every 1% of trade deficit.
This is meaningless in America's case because we are such a large part of the world economy (unlike some banana republic in size, at least) that the change is reflexive. IE, as we stop importing and start exporting, the world will lose it's least efficent factories. We are chasing a moving target in increasing our exports and decreasing our imports.
So it's not a 70% change in the dollar against the rest of the world's currencies, but much more. How much more is an interesting question with no clear answers.
Why not ask an American manufacturer how much the dollar will have to go down against the Yen, the Loonie, the Euro, the Peso, and the Renminbi before he is capable of competing with the most efficient companies with those currencies in third markets?
Start with GM.

[anne]

Reason, thank you :)

http://www.nytimes.com/2006/05/10/opinion/10wed3.html?ex=1304913600&en=3a49608ea877f32f&ei=5090&partner=rssuserland&emc=rss

May 10, 2006

Barely Staying Afloat

President Bush's advisers say that the administration should receive more credit for the state of the economy, which, over all, is growing at a strong clip. But voters don't base their opinions on aggregate statistics. They react to their own paychecks and benefits, weighed against their fixed costs, like housing, health care and gasoline. For all but the wealthiest Americans, the latter are rapidly outpacing the former.

In a time of plenty, more American workers are in danger of slipping into outright poverty. As Erik Eckholm reported this week in The Times, about 37 million Americans lived below the poverty line in 2004: $19,157 a year for a family of four. An additional 54 million lived between the poverty line and double the poverty line: $38,314 for a family of that size. They are the "near poor," and they generally receive little attention. But they are often one injury or layoff away from slipping into poverty themselves.

If the "near poor" feel insecure, they have good reason to. A group of academics found that during the 1980's, 13 percent of Americans in their 40's spent a year or more below the poverty line. In the 1990's, that percentage nearly tripled, reaching 36 percent. While workers once believed that pensions would provide for them in their old age, now they fret over underfunded 401(k) accounts. Houses are supposed to provide stability, but those with adjustable-rate mortgages are watching their payments rise, and some fear losing their homes....

[anne]

http://www.nytimes.com/2006/05/08/us/08poverty.html?ex=1304740800&en=20393d1c41b90f6b&ei=5090&partner=rssuserland&emc=rss

May 8, 2006

America's 'Near Poor' Are Increasingly at Economic Risk, Experts Say
By ERIK ECKHOLM

ANAHEIM, Calif. — The Abbotts date their tailspin to a collapse in demand for the aviation-related electronic parts that Stephen sold in better times, when he earned about $40,000 a year.

He lost his job in late 2001, unemployment benefits ran out over the next year and he and his wife, Laurie, along with their teenage son, were evicted from their apartment.

They spent a year in a borrowed motor home here in the working-class interior of Orange County, followed by eight months in a motel room with a kitchenette. During that time, Ms. Abbott, a diabetic who is now 51, lost all her teeth and could not afford to replace them.

"Since I didn't have a smile," she recalled, "I couldn't even work at a checkout counter."

Americans on the lower rungs of the economic ladder have always been exposed to sudden ruin. But in recent years, with the soaring costs of housing and medical care and a decline in low-end wages and benefits, tens of millions are living on even shakier ground than before, according to studies of what some scholars call the "near poor."

"There's strong evidence that over the past five years, record numbers of lower-income Americans find themselves in a more precarious economic position than at any time in recent memory," said Mark R. Rank, a sociologist at Washington University in St. Louis and the author of "One Nation, Underprivileged: Why American Poverty Affects Us All."

In a rare study of vulnerability to poverty, Mr. Rank and his colleagues found that the risk of a plummet of at least a year below the official poverty line rose sharply in the 1990's, compared with the two previous decades. By all signs, he said, such insecurity has continued to worsen.

For all age groups except those 70 and older, the odds of a temporary spell of poverty doubled in the 1990's, Mr. Rank reported in a 2004 paper titled, "The Increase of Poverty Risk and Income Insecurity in the U.S. Since the 1970's," written with Daniel A. Sandoval and Thomas A. Hirschl, both of Cornell University.

For example, during the 1980's, around 13 percent of Americans in their 40's spent at least one year below the poverty line; in the 1990's, 36 percent of people in their 40's did, according to the analysis.

Comparable figures for this decade will not be available for several years, but other indicators — a climbing poverty rate and rising levels of family debt — suggest a deepening insecurity, poverty experts and economists say....

[anne]

http://www.nytimes.com/2006/05/10/world/europe/10letter.html?ex=1304913600&en=3473076cb5192747&ei=5090&partner=rssuserland&emc=rss

May 10, 2006

An Economy With Safety Features, Sort of Like a Volvo
By ALAN COWELL

NYNASHAMN, Sweden — When people talk of "the Nordic model" as Europe's panacea they may consider places like this ferry port in southern Sweden, where the Baltic wind lofts the sigh of seagulls over a stilled and silent Ericsson plant.

The factory closed last year after years of job cuts as the telecommunications company reduced its global work force of 107,000 to about 63,000. But for people like Marie-Louise Nordstrom, 53, who lost her position as a purchaser after 35 years in the same factory, the change has been relatively painless.

Under a deal between bosses and labor unions, she and some of the 450 other workers who switched off the lights in December will remain on full pay for 12 months, she said. Then she will qualify for unemployment benefits worth 80 percent of her salary. In the meantime, a private company sponsored by Swedish employers is helping her retrain and recover from the shock of losing her job. "I have learned to be self-confident," she said. "I am not worthless."

At a time when major nations in Continental Europe — France and Italy in particular — are questing in vain for release from the economic doldrums, Mrs. Nordstrom's confidence does not seem misplaced.

The Swedish economy is set to grow by 3.7 percent this year — almost twice the rate forecast even for Germany, the only one of the big Continental European economies showing signs of confidence. Unemployment, though higher than the Social Democratic government admits, is still lower than the nearly double-digit joblessness of France or Germany.

Yet, defying conservative American beliefs, the economy prospers — even though taxes here remain high and big government administers cradle-to-grave social programs that absorb more than half of the national output.

It is called the Nordic model. The question some Europeans are asking is: Would it work farther south, in Germany or France, or even Italy?

The roots of Sweden's current prosperity lie in the early 1990's when the Scandinavian nations were buffeted by recessions that sent unemployment and budget deficits soaring.

In response, businesses from telecommunications to airlines to banking were deregulated and sold on the open market. State spending was capped, and the budget moved to surplus. Labor laws, which still protect full-time workers, were modified to permit temporary work. The state pension system was overhauled, adding private accounts and encouraging workers to postpone retirement in return for higher pensions.

Technology and service companies flourished even as manufacturing jobs were lost. Labor unions, said Ingemar Goransson, a blue-collar union negotiator, saw their mission as "not trying to save jobs."

"Our job is to create a society where people are protected and suffer as little as possible and get new chances in society with education and training," Mr. Goransson said....

[liberal]

christofay wrote, "kurtotic, not getting a read on this on dictionary.com."

I think it's meant as the adjective form of "kurtosis":

http://dictionary.reference.com/search?q=kurtosis

[christofay]

Liberal, thanks