How to avoid greenback grief

By Roger Altman
Published: October 11 2009 15:57 

More poor economic data have put Washington in a nearly impossible fiscal position. The US economy requires more stimulus than provided by the original package passed in March. But the dismal deficit outlook poses a huge longer-term threat. Indeed, it is just a matter of time before global financial markets reject this fiscal trajectory.

That could lead to a punishing dollar crisis. To avoid it, America’s leaders should commit now and in detail to implement deficit reduction once the economy has strengthened. Vague promises will not work.

America’s fiscal dilemma is unprecedented because the short-term need differs so dramatically from the long-term one. Today, all the data are signalling weakness. Consumer spending, which represents 70 per cent of gross domestic product, and employment are especially downbeat. Joblessness, having hit a 26-year high, will not improve much through 2010. That puts pressure on consumers. The pace of recovery, therefore, will be painfully slow.

This requires that policy remain stimulative over the next year. The economy could slip backwards without it. That is why the Federal Reserve is maintaining a zero Fed funds rate. It also explains why the $787bn (£492bn, €534bn) stimulus will expand, perhaps to $900bn.

But for 2011 and beyond, the fiscal challenge is fearsome. A combination of prior tax cuts, years of high spending and a brutal recession have produced the worst budget conditions in 75 years. Through 2019, private forecasts predict deficits averaging $1,000bn a year. In 2019 the deficit would represent 6.5 per cent of GDP and be rising. Worse, national debt will hit nearly 85 per cent of GDP. Annual interest costs on it would exceed the US defence budget and the whole category of discretionary spending. The Treasury’s annual borrowing, including refinancings, would average a breathtaking $4,000bn. All this occurs before the Medicare/Medicaid share of GDP explodes beyond 2019.

This debt surge comes against a fragile backdrop. The national savings rate is essentially zero. Net borrowings are being supplied entirely by foreigners. Foreigners already hold half the national debt. Not only do we know, empirically, that massive deficits raise interest rates, cut private investment and depress standards of living. But there is no precedent for financial markets lending such amounts, over 10 years, at anywhere near current interest rates and exchange rates. Indeed, does anyone think that once recovery takes hold and private demand for capital strengthens, the Treasury will raise $4,000bn a year at below 4 per cent, as it is doing today?

The acute threat is the foreign exchange market. When markets lose confidence in a nation’s financial policy, a sharp and often panicky decline in its currency follows. This has happened before to the dollar and this dire fiscal outlook risks triggering it again.

We saw this in the 1978-79 dollar crisis that shook Jimmy Carter’s administration, in whose Treasury I served. Then, rising inflation and perceived indifference to the dollar’s stability eroded nearly half its value against the yen. Global anxiety rose and an emergency rescue was arranged. It required that the deficit be halved and the Fed raise rates. This was costly to growth and the administration’s goals.

In recent weeks, the dollar has lost 15 per cent against the euro and gold has soared above $1,000 per ounce. There are technical factors involved, too, but these signs are not healthy. They suggest concern over currency stability – and the recovery, with its inflation and financing pressures, has not even begun yet. President Barack Obama and Congress should not risk a replay of the Carter experience. The scale is so much larger now that the impact of a dollar stabilisation programme would be more punitive. It would jeopardise the entire recovery. This is why an overt commitment to deficit reduction should be made now.

It could take the form of legislation creating a bipartisan deficit reduction group modelled on the successful budget summit of 1990 and consist only of administration and congressional leaders. Its recommendations, by law, would be submitted by December 31 2010 and face an up or down vote within three to four months. It would acknowledge the need for higher taxes and spending cuts.

It is true that Mr Obama inherited the deficit. But, like Afghanistan, it is his responsibility now. Only he can forge a process for solving it.

The writer is chairman of Evercore Partners and was deputy US Treasury secretary under President Bill Clinton

Asia steps in to support dollar

By Kevin Brown in Singapore, and Peter Garnham and Chris Giles in London
Published: October 8 2009 15:09 Financial Times

 Asian central banks intervened heavily in the currency markets on Thursday to stem the appreciation of their currencies against the US dollar amid fears that their exports could be losing ground against China.

The mainly south-east Asian countries have been spurred to defend the competitiveness of their currencies by China’s decision to in effect re-peg the renminbi to the dollar since July last year.

Simon Derrick, at Bank of New York Mellon in London, said: “Other Asian central banks outside China are naturally looking to aggressively defend their competitive edge against undesirable currency strength as the dollar weakens.”

After allowing the renminbi to appreciate by about 20 per against the US dollar from mid-2005, Beijing re-pegged its currency to the greenback when export growth contracted.

The greenback hit one-year lows against a raft of regional currencies. The dollar index, which tracks its value against a basket of six main currencies, hit a 14-month low in afternoon trading in New York.

Jean-Claude Trichet, European Central Bank president, issued a warning about the euro’s strength on Thursday and said that authorities on both sides of the Atlantic would “co-operate as appropriate”.

Marco Annunziata, chief economist at Unicredit, said: “He clearly tried to signal as convincingly as possible that the eurozone and the US are united in the desire to limit the rise in the euro versus the dollar – but the market is calling his bluff.”

Gold prices hit an all-time high for the third day in a row, on the dollar’s weakness. Base metals such as aluminium and copper jumped 4 per cent, while crude oil surged almost $3 to more than $70 a barrel.

The central banks identified by traders as substantial buyers of US dollars included Thailand, Malaysia and Taiwan. Hong Kong and Singapore, which both have managed currency regimes, were also buyers.

The moves to limit Asian currency appreciation is ammunition for those who warn that the new Group of 20 framework for strong and balanced growth is toothless. Less than a week after the world’s finance ministers and central bankers agreed to foster more balanced world economic growth in Istanbul, Asian officials have intervened to prevent exchange rates playing their part in the process.

However, traders said that the central bank interventions appeared to be aimed at controlling the pace at which the US dollar declines rather than solely to stop Asian currencies appreciating.

The Obama administration has not altered its refrain that it believes in a “strong dollar” but is seen as unlikely to intervene in currency markets, particularly as the US Treasury recognises the trade-weighted value is similar to where it was two years ago.

Additional reporting by Ralph Atkins in Venice