Watch the Dollar
Dean BAKER
The housing bubble was the first to burst, but it will not be the
last in this global recession. These days, it’s the impending bust of
the dollar bubble that should be getting more attention.
The U.S. dollar has been severely overvalued since the late 1990s,
which has led to an enormous trade deficit that peaked at almost 6
percent of U.S. GDP in 2006 ($900 billion in today’s economy). This is
unsustainable. Eventually, it will force the dollar to fall to a level
where trade is close to balanced.
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The
crashing Dollar |
That process was already gradually under way. The recent crisis,
however, has sent investors scrambling to the dollar for safety, causing
it to soar against most other currencies.
The rising dollar, coupled with recessions in much of the rest of the
world, will cause the trade deficit to rise again.
But once the financial situation begins to return to normal (which
might not be in 2009), investors will be unhappy with the extremely low
returns available from dollar assets.
Their exodus will cause the dollar to resume the fall it began in
2002, but this time, its decline might be far more rapid. Other
countries, most notably China, will be much less dependent on the U.S.
market for their exports and will have less interest in propping up the
dollar.
For Americans, the effect of a sharp decline in the dollar will be
considerably higher import prices and a reduced standard of living. If
the U.S. Federal Reserve becomes concerned about the inflation resulting
from higher import prices, it might raise interest rates, which could
lead to another severe hit to the economy.
As for 2009, the ongoing collapse of the housing bubble, the coming
collapse of the commercial real estate bubble, and the ensuing wave of
bad debt will all be major sources of drag on the U.S. economy-even if
the dollar bust happens later.
Indeed, subprime mortgages were just the trigger for a much broader
crisis. Plunging house prices are now leading to record default rates on
prime loans as well, with most of the fallout ahead of us. We’ll also
see much higher default rates on car loans, credit card debt, and other
forms of consumer debt, because homeowners can no longer draw on their
home equity to pay other debt.
Commercial real estate faces its own reckoning. When the housing
market began to fade at the end of 2005, it kicked off a boom in
nonresidential construction. In less than three years, this sector
expanded more than 40 percent.
There is now considerable excess capacity in retail space, office
space, hotels, and other nonresidential sectors-leading to falling
prices, plunging construction, and another major source of bad debts for
banks.
In short, beware the happy talk from those who say we are “turning
the corner,” ignore the daily ups and downs of the market, and tighten
your belts. This is going to hurt.
Dean Baker is the co-director of the Center for Economic and Policy
Research (CEPR). He is the author of The Conservative Nanny State: How
the Wealthy Use the Government to Stay Rich and Get Richer. He also has
a blog on the American Prospect, “Beat the Press,” where he discusses
the media’s coverage of economic issues. |