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Will a Skidding Dollar Be Our Achilles' Heel?

A sharp decline in the greenback could trigger mayhem in the stock market.

July 02, 2002|JAMES P. PINKERTON

Americans are justifiably focused on the rotten state of American corporate financing, and President Bush is going to New York City next week to give the fat cats a spanking. But maybe it's too late to avoid substantial damage because foreigners have reached a negative judgment about the U.S. economy--a judgment that has already eroded the value of our money and could even cause a crash in our stock market.

As the London-based Financial Times noted last week, in 2000 the inflow of foreign investment into the United States was $228 billion. In the second half of 2001, the inflow had reversed; the U.S. suffered an outflow of $16 billion.

Should ordinary Americans be worried? After all, growth in our gross domestic product in the first quarter of 2002 was recently revised upward to a sizzling 6.1%.

The best single measure of any economy in a worldwide context, however, is the worth of its currency. Put simply, strong economies have strong currencies. In the 1970s, as the U.S. slumped, the dollar fell by a quarter against the world's currencies. Yet for most of the last two decades, strong growth brought the dollar up again.

And so smug Americans dismissed the euro, the new trans-European currency that debuted in its preliminary electronic form in January 1999. The euro started trading at 117% of the dollar, but it skidded to just 83% in October 2000. Why? Because the globalized money markets concluded that Europe's economy was stagnating, while the United States' was booming. In the last few months, however, the euro has shot back up to parity with the dollar as speculators figure that maybe Uncle Sam isn't so great after all. The dollar is even weakening against the long-sick Japanese yen.

Some say that a falling dollar is good because it makes American exports cheaper. At the same time, of course, imports--from electronics to oil--get more expensive. And, over the long run, a cheaper dollar stokes inflation because, as each dollar can purchase less, sellers raise their prices to stay even.

Indeed, the weaker dollar has already started a vicious cycle of disinvestments in the United States. Foreigners believe that the dollar is going to be worth less, so they hold fewer dollar-denominated assets, such as U.S. stocks or bonds. And yet, as they scale back investment, the weakening demand depresses the greenback further.

So where will this dollar depreciation lead? A June 19 study published by four Goldman Sachs economists asserted, "We have long regarded the strength of the U.S. dollar as unjustifiable." The report goes on to forecast that the dollar will decline by an additional 8% against world currencies over the next 12 months. Even then, the study continues, the dollar still will have further to fall.

Given the rotten state of corporate America, such a further dollar decline might be inevitable, and yet the Goldmanites note a greater danger if our money loses too much too soon. Their report recalls a brief interlude of dollar deterioration, from 1985 to 1988, when the dollar fell by about a third. During those years, the decline in the dollar destabilized financial markets in the U.S., and this destabilization was "the trigger mechanism that helped to generate the 1987 stock market crash."

Yikes. Remember Black Monday, Oct. 19, 1987, when the Dow Jones industrial average fell 508 points--22.6%?

Could that happen again? The Goldman folks don't think so because they don't see a sharp decline in the dollar. But others do. Famed currency trading tycoon George Soros told the Wall Street Journal on Friday that he wouldn't be surprised to see the dollar lose a third of its value over the next few years. And since a one-third drop in the dollar helped trigger the '87 crash, a dollar-watching doomsayer could predict another black day for the market sometime soon.

In today's numbers, such a fall would clip off about 2,000 points from the Dow. That would be ruinous to many investors, but it's not so hard to imagine because it's happened before. So of course Bush should lecture Wall Street, but he should also keep in mind that the world market is watching too, looking for signs that he is focused on the economy, stupid. And that means keeping the dollar strong, dammit.


James P. Pinkerton writes a column for Newsday in New York.

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