#265 – His Fiscal Expediencies are Threatening (Again) to Create an Insolvent America

Treasury Secretary John Snow spent last weekend kvetching with the Group of 7 finance ministers in Boca Raton, Florida.

The Europeans are beginning to panic over the sinking value of the U.S. dollar, which is jacking up the price of European exports and slapping around economies across the Continent. Of particular concern is the practice by some Asian countries (notably China) of linking their currencies to the dollar and, because of its current low value, selling off dollars while bidding up the Euro – all of which has increased the dollar’s instability. The Europeans wanted a sharply worded statement from Florida discouraging such “flexibility” in currency trading.

Mr. Snow, however, insisted at the meeting that economic growth is more important than stability, and the result was a watered-down warning maintaining the undesirability of "excess volatility" and "disorderly movements" in exchange rates. [Apparently, this is an economist’s version of Justin Timberlake saying, “Wouldn’t it be better if we just took off this little sequin here.”] Predictably, the boost provided to the value of the dollar by this watered-down statement was short-lived when the markets opened on Monday.

Why would the Treasury Department wimp out on a stronger-worded statement given the current volatility of currency markets?

Three words – Election Year Economics:

In so doing, the Bush administration has made a calculated economic and political choice. By condoning and even encouraging a cheap dollar, the administration is providing a big push to American exporters by making their products less expensive in foreign markets.

That should encourage more hiring and lower unemployment leading up to the election. The only immediate losers are exporters in Europe and Asia who have to choose between cutting prices or losing market share in the United States.

But the long-term risks are substantial. At some point, a weaker dollar will inevitably lead to higher prices for imported goods — almost all consumer electronics bought by Americans, most of their clothing, many of their cars and much of the oil that provides the fuel to drive them.

A much bigger risk is that a plunging dollar could contribute to a rise in interest rates, as foreign investors demand fatter risk premiums before agreeing to buy hundreds of billions of dollars worth of Treasury securities to finance America's high levels of indebtedness.

The United States needs to attract $1.5 billion a day in net capital inflows from abroad — $500 billion a year more than it sends out — which means that the world is being flooded by American I.O.U.'s at levels never seen before. The administration's huge budget deficits could increase that need for foreign capital even more, and higher interest rates would add billions of dollars to those deficits.

But hey, we’re at war, right? Tough times call for blowing the economy.