PAUL SOLMAN: For more than a year now, the U.S. Dollar has been falling in value against other currencies. And when the dollar drops, it has economic implications for us all. But how serious is it? At a recent meeting of finance ministers in France, U.S. Treasury Secretary John Snow made the seemingly casual comment that the recent drop has been "modest." But that prompted the further dumping of dollars on world currency markets, driving the value even lower. To understand why the dollar's been drooping, and whom it affects, we sat down to talk with international economist Fred Bergsten.
Fred Bergsten, welcome.
C. FRED BERGSTEN: Glad to be here.
PAUL SOLMAN: What's happening to the dollar?
C. FRED BERGSTEN: The exchange rate of the dollar against other world currencies has been dropping for about 15 months. It's come down 25 percent against the European euro. It's only come down about 10 percent on average against the whole basket of currencies we deal with, and that suggests to me it's only gone about half way; we've got another 10 percent or so to go over the next six to 12 months.
PAUL SOLMAN: And that means that when we Americans buy things with dollars, we have less that we can buy. We have less purchasing power because the dollar is worth less against those currencies.
C. FRED BERGSTEN: Right. When the dollar goes down in value, it costs more dollars for an American to buy euros or yen to in turn buy products from Europe or Japan. So those products become more expensive to us, less attractive to us as a result.
PAUL SOLMAN: Why is the dollar weakening?
C. FRED BERGSTEN: I think the main reason the dollar is weakening is because the U.S. has run huge trade deficits over the last couple of years.
PAUL SOLMAN: So we buy more from them than they buy from us.
C. FRED BERGSTEN: We have been buying about $500 billion a year more from them than they buy from us. That's over 5 percent of even our huge economy. That's a big deficit, clearly unsustainable. That's the main reason why the dollar has been coming down for over a year.
PAUL SOLMAN: And mechanically, how does that work? Why does that drive the dollar down?
C. FRED BERGSTEN: When the U.S. buys $500 billion a year more from foreigners than they buy from us, it puts a huge amount of extra dollars in the hands of the world.
PAUL SOLMAN: So we ship out $500 billion a year to the rest of the world...
C. FRED BERGSTEN: Right, and then they have to decide what to do with it. If they turn around and buy U.S. financial assets-- treasury bills, bank deposits, U.S. stocks-- then there's no effect on the exchange rate.
PAUL SOLMAN: Also, and if they buy Pebble Beach or Rockefeller Center, same thing.
C. FRED BERGSTEN: Exactly, and they still buy a lot of those, but not enough to finance equally this huge trade deficit that we've been running for the last couple of years.
PAUL SOLMAN: So in other words, some of those dollars that we ship abroad, they say, "hey, I don't want these, and I don't want to buy anything in America; I'm going to put them up for sale, or I'm going to resell them somewhere else." And that then means big supply of dollars, not as much demand for the dollars, like any other product...
C. FRED BERGSTEN: Exactly.
PAUL SOLMAN: ...Or commodity, the price goes down.
C. FRED BERGSTEN: The exchange rate of a dollar is floating. It's a flexible exchange rate, not fixed like in the old days. It's determined by supply and demand in the daily market-- incidentally, a trillion and a half dollars or more every day transpiring. And out of that mix of supply and demand comes the exchange rate.
PAUL SOLMAN: So, then why didn't this happen sooner? If we've been running these huge deficits, why hasn't the dollar been going down?
C. FRED BERGSTEN: The deficits were not quite so huge until a year or so ago, but the main reason that the dollar did not go down previously was that the U.S. economy was doing so well, and U.S. financial assets looked so attractive. In the late 1990s, our economy was growing 5-6 percent. The stock market was booming. Interest rates were a lot higher than they are today, and higher than they were in Europe or elsewhere. So at that time, U.S. financial assets looked very good. And not only they took the amount of our amount of trade deficit and put it in here, they actually put more money in here. That's why the dollar exchange rate went up, which in turn hurt our competitive position, made the trade deficit worse.
PAUL SOLMAN: Yeah, but our stock market has been in the doldrums for years now. They were just sticking with us on the chance that we were going to come back?
C. FRED BERGSTEN: They stuck to us for about a year after the economy slowed down and the stock market peaked in early 2000, but that was partly because Europe itself looked weak, Japan looked weak. There were no great alternative markets. But then when our interest rates started to come down, and when doubts started to arise about how fast we were going to come back, and when the trade deficit got to these really huge levels, that's when they started to sell dollars on balance, about a year and a half ago.
PAUL SOLMAN: So I see. So it's a critical mass phenomenon-- the trade deficit is getting bigger-- and interest rates not as attractive in the United States. Just like any of us look where to put our money, the foreigners look there, too, and say, "the United States is not as attractive as Europe is now, and so we'll not lend our money to the United States."
C. FRED BERGSTEN: Right. And one more effect: The market dynamics themselves. The rule in the currency market is, "the trend is your friend."
PAUL SOLMAN: So the psychology of it?
C. FRED BERGSTEN: The psychology of markets is crucial. Herd mentality. The dollar had been going up already for five, five-and-a- half years. It continued for a whole other year after we went into recession, after the stock market tanked. Then a little over a year ago, it turned around. Now it's been declining for over a year. That trend is likely to be the friend of the market. That's a key reason why it's likely to continue going down for a while.
PAUL SOLMAN: Once it starts going down, it keeps going down. Finally, who's happy, who's not? Or maybe who should be happy, and who shouldn't be happy about this phenomenon?
C. FRED BERGSTEN: The happiest people from the lower dollar are the American firms who compete with foreign goods and services. American exporters get a price cut out of the decline of the dollar, so they can sell their product abroad much more competitively. American firms who compete with imports here get a price cut, while the foreign price actually goes up. So now they can sell more competitively. So those firms and workers like it. American importers who like foreign products to put in their own machinery, or who want to buy foreign cars, or who want to take foreign trips on the Riviera...
PAUL SOLMAN: This is... this is... not the Riviera, but importers, you mean like me or you who buy foreign products, after all, maybe visit abroad as well.
C. FRED BERGSTEN: You and I buy lots of foreign products now. It's a globalized world. When the dollar exchange rate goes down, it means it takes more dollars to buy Japanese yen or euros. That means a European or Japanese product is more expensive to an American.
PAUL SOLMAN: So if I was thinking about buying a Toyota, six months ago, it was a lot cheaper than it's going to be today, and maybe even today, is cheaper than it's going to be in the future.
C. FRED BERGSTEN: That's right. The price of those foreign products is up, so we as consumers don't like it. We as a country might not like it if the dollar's decline went far enough that it began to push up inflation in the economy as a whole. We have not seen that. Inflation is under control. I don't think that will happen, but it could be an adverse result of the lower dollar over time.
PAUL SOLMAN: But meanwhile, in the final analysis: Good for our exporters, but it hurts your and my standard of living, doesn't it?
C. FRED BERGSTEN: It hurts our standard of living just because our money doesn't go as far. On the other hand, our money was going artificially far for the last five or six years when the dollar got so strong. What we want is to find a level that will be stable and sustainable. As I say, I think it's got a ways to go before we hit that level.
PAUL SOLMAN: Fred Bergsten, thanks very much.
C. FRED BERGSTEN: My pleasure.