Desmond Lachman

A July 22 AEI conference addressed the decline of the dollar, with participants contending that the ramifications will be felt from Asia to Europe.

AEI fellow Desmond Lachman cited several factors that make the downward trend in the dollar's value noteworthy: "First, the dollar decline is occurring at a time at which we've got generalized global slowing [for the first time since 1982]. The second is we're in a very low inflation environment and, in fact, we've got deflation in two of the major G3 countries. . . . So a dollar move raises questions as to whether or not the U.S. is exporting deflation, and this could be politically contentious. The third factor . . . is that there are huge imbalances in the global economy right now," exemplified by the U.S. current account deficit, which is at a historic high.

America, Japan, and Germany all seem to want a weaker currency. "We get statements or we get intervention to that effect," Lachman said, "and not being a mathematician, I can nonetheless figure out that not all three of them can have weak currencies against one another at the same time, so there is a problem there."

Impact on Europe

The dollar's decline and the resulting appreciation of the euro are negative indicators for the European economy, said AEI scholar Allan H. Meltzer. "Instead of being very happy that the euro has appreciated against the dollar and celebrating about the great strength of their currency and other kinds of nonsense, what [Europeans] should be worrying about is that they don't have a flexible adjustment system for Europe and they're not in the process of getting one."

Edwin M. Truman, a senior fellow at the Institute for International Economics, seconded these views. He also argued that the American current account deficit is unsustainable and has been for some time. Europe will absorb much of the adjustment because its currency is floating and because Europe is such an important trading partner for America. "The deficit is unsustainable and at least half and probably more will have to be corrected at some point, largely by the exchange rate," Truman said. "Europe will and should bear a disproportionate burden of this correction." The appreciation of the euro over the past few months indicates that the trend Truman predicted has already begun.

"The appreciation of the euro comes at exactly the wrong time for European economies, particularly core European economies," said Mickey D. Levy, chief economist for Bank of America. "It raises their relative unit labor costs and [will have] a big and growing negative impact on the net export position at the same time the monetary and fiscal authorities in Europe seem to be tied up in knots and seem to not be able to stimulate domestic demand." Europe's problems, Levy continued, cannot be blamed on the strengthening euro. Rather, lawmakers should consider reforming the restrictive fiscal, tax, and regulatory policies: "The strong euro now seems to be accentuating or highlighting core Europe's problems, but it isn't the major source of the problem."

Asian Policies

Michael R. Rosenberg of Deutsche Bank weighed the impact of decreasing private and official capital flows to America, saying that shift creates upward pressure on foreign currencies. "What you have is a situation where the Bank of Japan and the Chinese central bank . . .  are pushing more of this pressure onto the euro and some of the other currencies." Yusuke Horiguchi of the Institute of International Finance rejected criticism of Japan, saying: "Look, Eurozone countries, forget about complaining about the Asian countries messing around with the adjustment process. What matters for the Eurozone countries is really to strengthen their domestic demand through macro policies and structural policies. . . . Europe's problems [are] independent."

Rosenberg offered a prediction for the future: "The second leg of dollar weakness is about to start, maybe towards the end of this summer. Usually you go through corrections, and the dollar's going through a temporary upward correction in what I believe is a long-term downward cycle for the dollar. So the yen I think will become a participant in the next leg of dollar weakness and if there's going to be a third leg . . . my feeling is that eventually you will see some [Chinese currency] participation in the third or the fourth leg, as well as some of the other Asian currencies."