IHT.com Article: A weak dollar and the Fed

A weak dollar and the Fed
The New York Times
Wednesday, August 8, 2007

Despite the Federal Reserve's latest stay-the-course message, investors are betting on at least one interest-rate cut by January, intended to quell turmoil in the markets and to juice the slow economy. But with the dollar also weak - recently hitting its lowest point in 15 years against an index of other major currencies - the Fed may be reluctant to oblige.


A declining dollar is a source of inflationary pressure because it can boost the cost of imports. So if the Fed tried to rev up the economy with a rate cut at the same time the dollar is falling, it could end up provoking even more inflation. That would be a drag on economic growth rather than a boost. In an extreme case, it could result in a toxic combination of weak growth and high prices that is a central banker's nightmare.


How did the Fed lose room to maneuver? The answer is rooted in the Bush administration's misguided economic policies.


Over the last several years, America's imbalances in trade and other global transactions have worsened dramatically, requiring the United States to borrow billions of dollars a day from abroad just to balance its books.


The only lasting way to fix the imbalances - and reduce that borrowing - is to increase America's savings. But the administration has rejected that responsible approach since it would require rolling back excessive tax cuts and engaging in government-led health care reform - both anathema to President George W. Bush. It would also require revamping the nation's tax incentives so that they create new savings by typical families, instead of new shelters for the existing wealth of affluent families - another nonstarter for this White House.


Stymied by what it won't do, the administration has gone for a quicker fix - letting the dollar slide. A weaker dollar helps to ease the nation's imbalances by making American exports more affordable, thus narrowing the trade deficit.


But to be truly effective, a weaker dollar must be paired with higher domestic savings. Otherwise, the need to borrow from abroad remains large, even as a weakening currency makes dollar-based debt less attractive. That's the trap the United States is slipping into today.


Among other ills, it could lead to a deterioration in American living standards as money flows abroad to pay foreign creditors, leaving less to spend at home on critical needs. Or, it could lead to abrupt spikes in interest rates as American debtors are forced to pay whatever it takes to get the loans they need.


In volatile economic times like now, leadership is crucial - and notably absent with this administration. Officials have made no effort to orchestrate a more coordinated and comprehensive realignment of the world's currencies, in part, it seems, because the administration is unwilling to have America do its part by saving more.


Until the administration - either this one or the next - is willing to acknowledge the source of the economy's imbalances, and starts addressing them seriously, the dollar is likely to remain weak. And the Fed's ability to maneuver will be constrained.



http://www.iht.com/articles/2007/08/08/opinion/eddollar.php