It’s never good to be compared with the Carter years

Greg Ip has a front-pager in the Wall Street Journal on whether the weakening dollar will help or hurt the economy.

Up to a point, a falling currency is a blessing. After that, it’s a curse. The dollar has fallen 16% against a basket of its trading partners’ currencies over the past three years. In theory, that should, with time, make U.S.-made goods more competitive with those made abroad, boosting U.S. growth and employment. But a growing chorus warns that the U.S.’s gaping budget and trade deficits will lead to a crisis in which the dollar falls much more sharply, driving up interest rates and squeezing the economy. There are plenty of troubling precedents. Over the past decade, a dozen smaller economies from Mexico to Thailand have gone from growth to deep recession when their currencies collapsed. Even rich countries like Canada have been forced to adopt austere budget policies to cope with currency-induced turmoil. “We are increasingly vulnerable to the kind of sudden stop, where the capital inflows dry up all at once, that’s been the bane of emerging markets over the years,” says Barry Eichengreen, an economic historian at the University of California at Berkeley. Could it happen here? It certainly hasn’t yet. In a crisis, foreign investors dump stocks and bonds, fearing depreciation will cause further losses. Yet U.S. Treasury bond prices, and thus long-term interest rates that move in the opposite direction, have changed little in the last year — and stocks are higher. A review of past crises world-wide suggests the U.S. has enough going for it now to avoid a similar fate. Yet the magnitude of the imbalances hanging over the dollar is also without precedent, suggesting a crisis remains possible…. The U.S. has an additional advantage over any other country when it comes to crisis prevention: Its economy is too important for the world to passively accept a dollar collapse. That’s one reason many countries prop up the dollar. China runs a large trade surplus with the U.S., something that would normally force its currency, the yuan, to rise against the dollar. To prevent that, China buys billions of dollars in Treasury securities. That protects its exports and helps keep U.S. interest rates low. The increased depth, reach and sophistication of markets is one reason Federal Reserve Chairman Alan Greenspan is optimistic the U.S. can avoid a crisis. “An ever more flexible international financial system” means global imbalances are more likely to be “defused with little disruption,” he argued in November 2003. Indeed, as imbalances have grown in the past decade, currency markets, by some measures, have become more orderly. It’s been a decade since the dollar’s drop seemed dangerous enough to spark a concerted response from the U.S. and its allies. On the morning of March 2, 1995, Ted Truman, then top international staffer at the Fed, was getting reports of massive dollar sales, some triggered by derivatives strategies, driving the U.S. currency down sharply against the deutsche mark and yen. Bond yields were rising. Mr. Truman went to see Mr. Greenspan and recommended the Fed and Treasury intervene in the markets to buy dollars. “I don’t think it’s going to do any good,” Mr. Truman recalls telling Mr. Greenspan. “But by not being there we are saying we totally don’t care what the conditions of the markets are.” Mr. Greenspan agreed, and that afternoon the Fed and the Treasury waded in, buying $600 million worth of dollars in exchange for marks and yen. The next day it repeated the action, joined by 13 central banks. The dollar stabilized. Bond yields dropped. The U.S. intervened to support the dollar a few more times that year, but hasn’t done so since; markets have generally been smooth, and the Clinton and Bush administrations came to see intervention as being of limited use. Mr. Truman, now a scholar at the Institute for International Economics in Washington, predicts that in the next five years, the U.S. will have to intervene again “either because it’s a period of disorder or because we can’t withstand the political criticism from our partner countries.” He adds: “The very richness and increased flexibility of markets that Alan Greenspan has emphasized probably translates into fewer episodes of disorder, but when they come, they’re going to be bigger.”

I don’t want to reprint the entire article, but one troubling comparison in the piece is a section that compares the current moment with “the last dollar crisis, in the late 1970s.” On the whole, it’s a mixed bag, but what should worry Republicans is that the comparison is being made at all. A good political rule of thumb for any administration is to do one’s upmost to prevent the press from being able to make a valid economic comparisons to the Carter era.