Thursday, January 08, 2004

Some good news for the dollar, bad news for trade deficit

Here an op-ed by Ignatius in the WaPo discusses why China and Japan continue to accumulate dollars even as their value drops. It apparently is a by-product of their export-led economic strategy. They export more to the United States than they import from it, meaning they accumulate dollars because each exchange nets them money that is denominated in American currency. This raises an interesting question however. Once having cashed in their goods for Greenbacks why don't they then turn around and exchange them for Euro's? This would safeguard them against a further drop in the value in the currency. The only evident answer is that they must think that the dollar will soon straighten out on its own, something that might not happen if they were to start making available huge quantities of the currency on the FOREX markets. This is a vote of confidence for the future stabilization of the dollar at least in the mid-term.

China and Japan could still flush their dollar accounts and cash them in for Euro's if the long-term financial picture of the United States becomes sufficiently shaky. Despite the contra-indicator of the IMF giving a red flag, and therefore being a good sign for the US economy this is a cause for concern. It is also bad news on the trade deficit front because it means that China and Japan have no intention of slowing down their flood of cheap consumer goods in US markets. Here is a relevant section:

"This counterargument was presented to an IMF forum two months ago by Deutsche Bank economist Peter Garber. If an abstruse economic theory can be said to be generating "buzz," that has happened with Garber's work.

Garber argues that Asia's seemingly irrational accumulation of surplus dollars is the inevitable consequence of its export-led development strategy. To increase domestic employment, the Asians keep their exchange rates artificially low and sell cheap goods to the United States -- in the process accumulating those ever-larger surpluses of dollars."

Another thought occurs to me however on the lines of the IMF being so regularly wrong. Since the IMF is known to be wrong so often and they've come out against the budget deficit policy raising interest rates(at least in the short run which is what they focused on) but seem sanguine about the dollar situation, then maybe I've had it in reverse all along. The budget and interest rate situation is going to be fine, but the dollar is about to plummet to new lows and create a currency crisis similar to the Asian currency collapse in the late 90's. If that were to happen, there would probably be a devaluation in many currencies as they attempted to stop hyper-valuation against the dollar and the death of their export markets. So interest rates stay flat short-run, but there's a run on the Greenback.

Another interpretation is that no one knows what is going to happen, since one report by the IMF comes out against US fiscal policy but another says its Treasury policy is sustainable. They cancel each other out so to speak. What a mess!


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