Thursday, February 12, 2004


"Against a broad basket of currencies of our trading partners, the foreign exchange value of the U.S. dollar has declined about 13 percent from its peak in early 2002. Ordinarily, currency depreciation is accompanied by a rise in dollar prices of imported goods and services, because foreign exporters endeavor to avoid experiencing price declines in their own currencies, which would otherwise result from the fall in the foreign exchange value of the dollar. Reflecting the swing from dollar appreciation to dollar depreciation, the dollar prices of goods and services imported into the United States have begun to rise after declining on balance for several years, but the turnaround to date has been mild. Apparently, foreign exporters have been willing to absorb some of the price decline measured in their own currencies and the consequent squeeze on profit margins it entails."

Yes, but just who absorbs the cost of adjustment is wholly a political issue, as witnessed by last weekend's row over the crptic G7 ministerial statement. Yes, the dollar has come down, but nearly as much as it needs to. And the cost of this adjustment has been borne almost entirely by Europe (and to an extent Mexico and Canada). But the countries that are causing the imbalances are those in Asia with fixed and managed exchange rates, who incidentally account for about half of the overall US trade deficit (and even more if we net out oil imports).

Here is what the FT had to say about Japan today:

"The government last year spent an unprecedented Y20,000bn intervening in foreign exchange markets and made clear at last weekend's Group of Seven meeting that it was prepared to continue."

The Yen has hit a high of Y105 versus the dollar; I just heard a Japan analyst say at a brown bag lecture that by Japan's fundamentals the exchange rate should be around Y50 (a lower Yen value means a stronger currency).

In order for the dollar to return to sustainable levels and to stave off the threat of a dollar-induced global financial crisis, the dollar must fall against these Asian currencies, primarily the Yuan and the Yen. Unfortunately, the Bush administration continues to show its unwillingness (or perhaps ineptitude) at engaging in effective international financial diplomacy.


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