Since the beginning of the year, the U.S. dollar has fallen significantly, especially against the euro. By raising the cost of imports, the declining dollar could pose a challenge to the Federal Reserve Board in its quest for noninflationary economic growth. On May 31, AEI's Desmond Lachman moderated a discussion about the likelihood of a further fall in the dollar and the actions that industrialized nations should take to minimize the risk of a disruptive dollar decline.

Anne Krueger, former first deputy managing director of the International Monetary Fund (IMF), said she does not think economic growth will slow as a result of the falling dollar. She noted that the U.S. economy, which has been flexible enough to withstand problems and adapt to changes since the 1980s, will weather the dollar's decline. According to Krueger, America's real problem is neither global exchange rates nor the falling dollar, but rather its low savings rate and the strain its aging population places on public goods such as health care. Worldwide, the problem is that trade has become highly imbalanced. Only a multilateral approach can address imbalances within the world economy. Curbing protectionism, she added, "seems to be the big challenge" for the major players in the global economy.

AEI's John H. Makin said he sees no causal relationship between the falling dollar and global economic health. What is important, he said, is that asset markets globally--especially in China--have been booming. He cited the massive flows of funds into the Chinese stock market, in which, he said, traders have "speculative fever" due to the high liquidity that results from China's reluctance to allow its currency to appreciate. This high liquidity, in turn, stimulates global markets. The falling dollar, Makin said, "is perhaps just a sideshow" to China's rapidly growing asset markets. A major problem is that in Chinese markets, the riskiest assets have appreciated the most. Consequently, investors are underpricing risk in global asset markets.

Kenneth S. Rogoff of Harvard University said it is "an open question" whether the booming Chinese economy is sustainable absent substantial reform. The yuan must appreciate at least 200 percent over the next forty years for the current boom in China to continue. The most pressing concern, Rogoff said, is the uncertain stability of the global political economy. We must view the global political economy not as a natural system, he said, but as a highly artificial one whose problems necessitate multilateral intervention. One of the most troubling issues is that a number of Asian nations feel excluded from the IMF and the World Bank.

Brad Setser of University College, Oxford, said that "a strong global economy is in some sense a threat to the dollar." He based this argument on three points: First, relative to the global economy, the U.S. slowdown has not caused much adjustment in current accounts. Second, the U.S. slowdown has led to a meaningful decrease in private investors' willingness to finance the U.S. deficit. Finally, the adjustment of the Chinese exchange rate is crucial to the global adjustment and should become a key policy focus. According to Setser, two major potential problems remain for the global economy. It is unknown whether global private investors will regain their appetite for U.S. currency-denominated assets, especially if U.S. investors increase their appetite for foreign currency-denominated assets. Furthermore, booming economies like China's are especially vulnerable to inflation.

Edwin M. Truman of the Peterson Institute for International Economics addressed international attitudes toward the falling dollar. He criticized Europe for failing to recognize that even a static euro rises whenever the dollar falls. He also criticized the IMF, which he said has "abdicated its role as the umpire and regulator of exchange rate policies." The falling dollar, he said, has encouraged some states to adopt protectionist policies. Amounting to sterilized intervention, such policies are a threat to free markets; thus, greater government transparency in this area is needed. Ultimately, he added, the falling dollar does not threaten global economic expansion.

For a video and summary of this event, visit www.aei.org/event1520/.