Cover Story: COMMENTARY
THE DOLLAR DOESN'T DESERVE THIS THUMPING
Do the U.S. economic fundamentals justify the collapse of the dollar?
On the face of it, the answer is a resounding no. In theory, a country's currency should be related to the economic fundamentals--in which case the dollar should be strong. U.S. business productivity has been rising at a heady annual rate of 2.1% since the current upturn in the business cycle began some four years ago, better than either Germany or Japan. Corporate operating profits are at their highest level in more than two decades. As for inflation, forget it. Unit labor costs rose a mere 0.9% in 1994, the smallest yearly gain since the '60s, and consumer prices are hardly rising at all.
To be sure, America piled up too much debt over the past 15 years to finance both government and trade deficits, and there is a huge overhang of dollar-denominated debt throughout the world. But here, too, the U.S. is making important strides. The nation's total debt is growing at around a 5% annual rate, a shadow of the double-digit rates of the '70s and '80s. The growth in federal-government debt has fallen from the 13% pace of the '80s to 6.4% in 1994. The current-account deficit is shrinking as a share of gross domestic product. And, over the past five years, the Japanese stock market has tanked by 45%, while the U.S. market is up some 40%. "The U.S. economy, in competitive terms, is in a better position today than it has been for 30 years," says E. Gerald Corrigan, a senior adviser at Goldman, Sachs & Co.
GOOD SHAPE. And by many financial measures, the U.S. government sector is reasonably healthy--at least compared with the rest of the world. For instance, in 1995 net public debt (all levels of government) in the U.S. is projected to be 40% of GDP, compared with 47% in Germany and an average of 43% among the world's seven largest industrial nations, according to the Organization for Economic Cooperation & Development. Budget deficits in America are forecast at 1.8% of GDP this year, vs. 2.4% in Germany and an average of 3% for all the major industrial countries. "We're in far better fiscal shape than many other countries," says David Hale, economist at Kemper Corp.
Of course, a number of factors are coming together to weaken the dollar. The yen is appreciating because some investors assume the U.S. government wants the yen to rise in order to treat chronic trade imbalances. Then there's Mexico. The U.S. is acting as lender of last resort to the battered Mexican economy, and its crisis is fueling investor fears that the U.S. could end up paying out more to prop up its economy and discredited government.
Still, the fundamentals suggest there should be no dollar crisis. The problem lies elsewhere--in the psychology of the foreign exchange markets. The real fear is that with the balanced budget amendment defeated, U.S. policymakers will be loath to grapple with difficult choices on the spending side. At the same time, last November's ballot-box revolt made it likely that there will be tax cuts this year. A reduced capital-gains tax. A $500-per-child tax credit. Expanded individual retirement account allowances. The markets are worried that Congress will cut taxes without offsetting spending cuts. And in today's quicksilver global capital markets, currency markets can gather a powerful momentum all their own.
In the 1980s, before the Berlin Wall came down and the Soviet empire collapsed, the free world put up with Washington's profligacy because of shared national-security interests. Today, fear of communism no longer binds the globe. Instead, markets tie the world together. Global investors have decided that Congress can't backtrack on reducing the budget deficit. If Washington heeds the market and enacts real spending cuts before lowering taxes, America's economic fundamentals will assert themselves and the greenback will stand strong.By Christopher Farrell