Will the fallen U.S. dollar set the stage for a global economic boom a year or two from now?

• Position: A Symposium of Views

Background: The conventional view is that the weakening of the U.S. dollar is the result in large part of global market concern with the negative effects from growing twin. U.S. deficits. Yet could the fallen dollar, particularly if it continues a weakening pattern, set the conditions that force the world's other central banks to cut short-term interest rates further? Could such a development set the stage for a competitive monetary reflation and expansion? In other words, could a weaker dollar represent a "way out" for a global system plagued by disinflationary pressures?

KARL OTTO POHL

Chairman and Managing Partner, Sal. Oppenheim jr. & Cie.; and former President, Deutsche Bundesbank

The depreciation of the dollar against a number of currencies is useful and unavoidable in light of the huge current account deficit of the United States. It is certainly a stimulus for American exporters and will support expansionary fiscal and monetary policies to get the U.S. economy to faster growth.

However, from a European point of view the devaluation of the dollar is not without problems: it is somehow unbalanced. In other words, Europe has to carry most of the burden in the adjustment process. On a trade-weighted basis, the dollar has lost less than 10 percent of its value at the end of May 2003 compared to February 2002, but 36 percent against the euro. This is two-thirds of the total depreciation. Canada, which is the second biggest trading partner of the United States after Europe (17 percent versus 17.4 percent), has contributed only one-third, Japan (share of trade 12 percent) even less. China, which has a rapidly rising trade surplus with the United States, has pegged its currency to the dollar. Its share of foreign trade with the United States has increased dramatically to 9 percent.

So far the devaluation of the dollar against the euro is rather a normalization. Markets have, however, a tendency to exaggerate, as we have seen again and again in the past. A devaluation which goes too far cannot be excluded because of the bandwagon effect, a loss of confidence in the markets as a consequence of the "twin deficit," a diversification of financial investments, etc. This could have very unwanted consequences in the United States, in Europe, and for the world economy. In Europe it would aggravate deflationary pressures and prolong the stagnation. Finally, political tensions which already exist could be intensified. So, a devaluation of the dollar is unavoidable, but it may be a mixed blessing.

RONALD MCKINNON

William D. Eberley Professor of International Economics, Stanford University

The emerging macroeconomic threat to the world economy is generalized deflation. The fall of the dollar (mainly against the euro) will, as everybody notes, make American producers in world markets more competitive, and thus have some short-term buoying effect on the American economy. And low American interest rates with large fiscal deficits may provide further stimulus. However, because of a fundamental asymmetry in the world's money machine, coping with deflation in other industrial economies is much more difficult.

In a deflationary world, each foreign government is paranoid about having its currency appreciate against the dollar with a consequent loss of mercantile competitiveness against its neighbors. So its central bank intervenes to buy the "excess" dollars from private holders. For example, the Bank of Japan has intervened quite massively in 2003 and earlier to sell yen for dollars in a desperate attempt to prevent the yen from appreciating--buying US$34.4 billion in May 2003 alone. Japan's official foreign exchange reserves now total an amazing half trillion dollars. The People's Bank of China has been selling yuan for dollars so that the recent run-up in its exchange reserves, which are now more than $300 billion, has been proportionately faster. And each central bank is more or less forced to cut interest rates to stem the conversion of private dollar assets into yen or yuan. The Bank of Japan has cut the short-term interest rate in Japan's money market to virtually zero. However, if either of these intervention efforts were to break down, with a sharp appreciation of the yen or the yuan, the deflationary impact would be substantial in Japan or China.

The other major player, Western Europe with its new euro, is a huge economy somewhat better--but not completely--insulated from the dollar standard. Its foreign trade and international lending is denominated in its home currency, the euro. Traditionally, the European Central Bank does not intervene to keep the euro stable against the dollar and has been more sanguine, and probably too willing to ignore, the deflationary impact of the rise in the euro over the past two years from about US$.85 to US$ 1.17. True, on June 5, it cut its interbank rate sharply down to 2 percent partly in response to the euro's rise. But that might be too little and too late--given the weak state of the German and French economies.

My guess is that further significant ratcheting up of the euro will eventually elicit official intervention in the foreign exchanges by European governments, and more interest rate cuts by the ECB, to prevent further appreciation. But, of course, once interest rates approach zero, this avenue will no longer work. Then, Western Europe will be in the same financial trap as its neighbors in East Asia: massively intervening to keep their domestic currency from appreciating while not being able to do much to stimulate their internal economies.

So everybody will be "waiting for Godot," waiting for the huge U.S. economy to recover and once again start attracting private capital from the rest of the world. Only then may foreign governments withdraw from intervening to keep their currencies from rising, and make use of a more buoyant world economy to expand their exports and recover.

Notice that in either of these scenarios, the United States has no problem in covering its own massive current-account deficits. If the American economy recovers, it will again attract private capital inflows. But if the American economy continues to languish, then official capital inflows--the result of foreign governments intervening to prevent their currencies from appreciating--provide the finance for America's external trade deficits.

BARTON M. BIGGS

Managing Partner, Traxis Partners

My intuition is that the weakening of the dollar is bullish for the global economy, reflation, and for equity markets. Since the bubble burst, the world has been sick, afflicted by an increasingly vicious spiral of sluggish growth mixed with whiffs of deflation and desultory policy responses. The U.S. economy is still the main engine of world growth, and the strong dollar and the huge and widening trade deficit was sapping the incipient recovery. At the same time, the European Central Bank was so obsessed with the weakness of the euro that it procrastinated on the rate cuts Europe so desperately needed, and the authorities in Japan wallowed in indecision. Stock markets, sensing the paralysis and the danger, traced out a pattern of failed rallies and new lows.

Suddenly the equation changed. As the decline of the dollar began to gain momentum, intended and unintended consequences began to set in motion what could be a virtuous circle. Here are my assumptions in short hand as there is not space for detail. First, the weaker dollar combined with massive fiscal and monetary stimulus will shortly begin to revive the faltering U.S. economy. Second, the resurgence of the euro with its positive psychic but deflationary effects will embolden and compel the ECB at long last to aggressively cut rates which eventually will revive the Euroland economy. Third, them will be a whole series of unintended consequences as the decline in the dollar shocks central banks into action. An example is the huge buying of long-term government bonds to brake the decline of the dollar. This should trigger another spun of refinancing and a revival of capital spending.

It all this healthy? Yes for now, but probably not in the long run. Is it dangerous? Certainly, if the decline in the dollar gets out of hand and triggers competitive devaluations. But will it set the stage for competitive monetary reflation and expansion? I think so.

ALLAN H. MELTZER

Professor of Political Economy, Carnegie Mellon University, and Visiting Scholar, American Enterprise Institute

Few topics in economics are more subject to nonsense than discussions of exchange rates. The dollar has been floating, more or less freely, for years. A floating dollar can appreciate--be "strong"--when underlying conditions dictate or be "weak" when those conditions change.

Floating is a policy. But a country cannot have a policy of floating and a strong or weak dollar policy. Either it intervenes to strengthen or weaken the exchange rate, or it doesn't. Whatever U.S. Treasury Secretaries Rubin and Summers said to bamboozle reporters about their policy, they had the same policy--floating--that we have now. The economic conditions, not the policy, changed.

The effect of dollar depreciation against the euro is a change relating to 20 or 25 percent of our trade. Much of the rest is done at managed or fixed exchange rates. Leading trading partners such as Japan, China, Mexico, Canada, Taiwan, and others in Southeast Asia either don't let their dollar exchange rate change, or they don't let it change much. This limits the effect on the U.S. economy of reported exchange rate movements.

Five principal reasons suggest that the right answer to this question is "no." First, every change in the exchange rate has two effects--expansive for some, contractive for others. No chance of a global monetary reflation from that.

Second, Bretton Woods ended long ago. Countries on floating rates can control money growth. It's up to the Federal Reserve, the European Central Bank, and their counterparts...