The cover of The Economist features "The Falling Dollar," with George Washington's jaw dropping. The accompanying editorial frets about the dollar reaching "a 20-month low of $1.32 against the euro" -- noting, with alarm, that this was close to "the record low of $1.36" that lasted four days in December 2004. The Economist and others were equally agitated about the dollar back then. Yet here we are two years later, and the euro is not even as high as it was then, and nothing bad has happened to the economies of the United States or Europe.
The editorial's focus on the euro could make sense only to Europeans. The U.S. dollar has risen against the Canadian dollar and not weakened against the Japanese yen, much less against the currencies of such key trading partners as China, India and Mexico. The Federal Reserve's broad trade-weighted index of the dollar (with 1997 equal to 100) has fluctuated narrowly between 107.5 and 108.8 for the past seven months -- about where it was (108.8) in December 2004, when the euro last peaked (before dropping to $1.19 this March). It would be more accurate to say the euro has been rising for the past seven months than to say the dollar has been falling.
The Economist nonetheless speaks of "a falling dollar, with its implications of American weakness." If a falling dollar predicts economic weakness, what does a rising dollar predict? The broad dollar index rose from 116.6 in March 2000 to 125.4 in March 2001. Far from being an omen of economic strength, that is when stock prices collapsed and the economy slipped into recession. That U.S. recession, in turn, reduced U.S. imports from Europe and Asian and thereby shrunk the so-called "global imbalances." That was not because the dollar had been falling. On the contrary, the dollar had been rising.
In "Dollar Talkers," my October 2003 column, I explained that "the overall current account (trade) deficit is equal to the gap between domestic investment and savings. That means a weaker dollar could only reduce the deficit by raising U.S. savings (which makes no sense at all) or reducing U.S. investment (which is an odd definition of improvement)."
The Economist tries to revive the old "twin deficits" hoax. They claim the U.S. "structural budget deficit (after adjusting for the impact of the economic cycle) has widened sharply ... causing the current-account deficit to swell." On the contrary, the structural deficit fell to 1.8 percent of GDP last year from 2.5 percent of GDP in 2003. In any case, the alleged link between budget deficits and current account deficits is a myth.
The same magazine predicts this year's current account deficit will be 2.8 percent of GDP in Britain, 5.6 percent in Australia and 8.1 percent in Spain. Are those examples of twin deficits? Hardly. Australia and Spain have large budget surpluses. Japan routinely combines huge budget deficits with huge trade surpluses and the world's lowest interest rates -- a combination the Keynesian orthodoxy finds impossible in theory and therefore annoying in fact.
In late October, The Economist opined that "Asia, not America, has been the main driver of global demand, powering the world economy." The argument was that because "Asian consumers are on a spending spree ... even if America drops sharply, the world won't stop." Asians can now afford to buy European imports only by first selling exports, however, and a large share of their exports depends on the United States.
In the latest issue, Asian demand gets no credit for U.S. expansion. America's economic growth is supposedly different from Europe's because it "has been driven by (American) consumer spending." Don't American consumers buy European goods? The Economist admits "a weaker dollar would tend to hurt exporters in Europe and Asia. But the impact on those economies could be offset if central banks hold interest rates lower than they otherwise would."
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