George W. Bush's foreign policy is simple: Don't mess with America. The same, it appears, applies to economic policy as well. On Friday, the dollar fell sharply against the euro. That was unsurprising, since the downward lurch followed comments from Alan Greenspan that -- by his own cryptic standards -- were unambiguous.
"It seems persuasive that, given the size of the U.S. current account deficit, a diminished appetite for adding to dollar balances must occur at some point," Greenspan said. This was hardly a novel statement for the Federal Reserve chairman, but the timing was interesting. It came on the eve of a meeting of the G-20 -- a conclave of developed and developing nations -- in Berlin at which the recent fall in the dollar was a hot topic.
Moreover, it came three days after John Snow, U.S. Treasury secretary, poured cold water on the idea that the world's central banks might get together to arrest the dollar's fall. The history of "efforts to impose nonmarket valuations on currencies is at best unrewarding and checkered", he said in London.
Europe got the message. Eurozone policymakers are growing increasingly alarmed about the fall in the value of the dollar, since it threatens to choke off exports -- the one area of growth in the 12-nation single-currency zone. They would like nothing more than to wade into the foreign exchanges in concert with the Fed and the central banks of Asia to put a floor under the greenback, but they know that Washington has no interest in such a move.
Joaquin Almunia, Europe's monetary affairs commissioner, said last week: "The more the euro rises, the more voices will start asking for intervention. It has to be a coordinated effort, but it seems that our friends across the Atlantic aren't interested."
That sums things up rather nicely. There are two reasons why the Bush administration is not willing to play ball with the Europeans. The first is that it sees a lower dollar as inevitable given that the U.S. current account deficit is running at $50 billion-plus a month. A lower dollar makes U.S. exports cheaper and imports dearer.
According to this interpretation, the Americans are now simply bowing to the inevitable. Stephen Lewis, of Monument Securities, says the markets have finally lost patience with the laxity of Washington toward the twin trade and budget deficits, pumped up by cheap money and tax cuts. "The truth is that the U.S. fiscal and monetary excesses, which have been essential to keeping the global economy afloat in recent years, are no longer tolerated in the foreign-exchange markets," he said. "The status quo is not an option. The only question is how the pain of adjustment will be apportioned."
The second reason is that the Bush administration has neither forgotten nor forgiven France and Germany for the stance they adopted over Iraq. Jacques Chirac and Gerhard Schröder weren't interested in helping the U.S. to topple Saddam, and now it's payback time. If the European economies are suffering as a result of the weak dollar, why should the U.S. care? What's happening in the currency markets is simply American unilateralism in a different guise.
In the short term, therefore, the dollar looks like a one-way bet. City analysts are already talking about it hitting $1.35 against the euro, and given the tendency of financial markets to overshoot, nobody would be that surprised if it fell to $1.40 over the coming months. A smooth and steady decline -- which is what Snow is trying to finesse -- would do little damage to the U.S. economy, but it would hit Europe hard.
This might seem perverse, given all the fuss there was when the euro was falling against the dollar immediately after its launch. Then, however, the problem was one of credibility for a fledgling currency because the impact of a weak euro was to boost demand for European goods. With a strong euro, there will be a direct impact on European exporters. Given that the latest figures show that Germany and France both grew by only 0.1 percent in the third quarter, a sharp drop in exports could quite easily push the eurozone's biggest economies back into recession.
Growth forecasts for the eurozone -- already modest -- are likely to be scaled down over the next few months, and budget deficits are likely to get bigger. A fresh downturn could prove the death knell of the stability and growth pact, which would be no bad thing, and higher unemployment would intensify resistance among workers to structural reform of the eurozone economies.
Washington may have another reason -- apart from getting its own back -- for allowing the Europeans to suffer. The U.S. is desperate for the Chinese to revalue the yuan, but has so far utterly failed to get Beijing to agree to abandon its dollar peg. The Chinese, for political as well as economic reasons, are determined to resist American pressure.
Europe -- the French, in particular -- have influence in China. As one analyst noted last week, China has never been censured by the United Nations Security Council -- even over the massacre in Tiananmen Square -- because Paris has always vetoed any such moves. France, so the theory goes, might have more success in persuading the Chinese to revalue than the Americans have had.
It has to be acknowledged, however, that you would be hard-pressed to find a financial analyst who believes Snow is capable of this level of sophistication. After his performance in London last week, one said: "I would sell the currency of any country of which he was the finance minister." The likelihood is that even if the Americans were to use the Europeans as a proxy, the Chinese would still resist. Certainly, all the evidence is that China's central bank is still intervening aggressively to keep its currency stable. Without that action, the dollar's fall in recent days would have been even more rapid.
Talking the dollar down is easy enough, but the strategy depends on a smooth descent that boosts U.S. growth without scaring off the overseas investors who fund the twin deficits. Should it turn into a disorderly rout, then there would inevitably be a spillover into other markets and into the real economy.
Washington, in other words, is relying on a soft landing for the dollar. History shows, however, that there is a better than even chance of this process ending in a full-scale crisis, as it did in the mid-1980s, when the weakness of the dollar culminated in the stock market crash of 1987. And that, of course, was at a time when the G-7 was acting in concert. As Lewis said, the crisis could be triggered by a seemingly minor event, as when the Nigerians precipitated the run on the pound in 1976 by switching into dollars.
The U.S. is happy to go it alone for now, since this is the Forex equivalent of the quick push to Baghdad. Life is likely to get tougher later -- and when it does, multilateralism will have its attractions.