[Senate Hearing 107-881]
[From the U.S. Government Publishing Office]
S. Hrg. 107-881
U.S. DEPARTMENT OF THE TREASURY'S
REPORT TO CONGRESS ON
INTERNATIONAL ECONOMIC AND
EXCHANGE RATE POLICY
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED SEVENTH CONGRESS
SECOND SESSION
ON
THE U.S. DEPARTMENT OF THE TREASURY'S REPORT TO CONGRESS ON
INTERNATIONAL ECONOMIC AND EXCHANGE RATE POLICY
__________
MAY 1, 2002
__________
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
PAUL S. SARBANES, Maryland, Chairman
CHRISTOPHER J. DODD, Connecticut PHIL GRAMM, Texas
TIM JOHNSON, South Dakota RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York WAYNE ALLARD, Colorado
EVAN BAYH, Indiana MICHAEL B. ENZI, Wyoming
ZELL MILLER, Georgia CHUCK HAGEL, Nebraska
THOMAS R. CARPER, Delaware RICK SANTORUM, Pennsylvania
DEBBIE STABENOW, Michigan JIM BUNNING, Kentucky
JON S. CORZINE, New Jersey MIKE CRAPO, Idaho
DANIEL K. AKAKA, Hawaii JOHN ENSIGN, Nevada
Steven B. Harris, Staff Director and Chief Counsel
Wayne A. Abernathy, Republican Staff Director
Martin J. Gruenberg, Senior Counsel
Thomas Loo, Republican Senior Economist
Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator
George E. Whittle, Editor
(ii)
C O N T E N T S
----------
WEDNESDAY, MAY 1, 2002
Page
Opening statement of Chairman Sarbanes........................... 1
Opening statements, comments, or prepared statements of:
Senator Bunning.............................................. 2
Senator Johnson.............................................. 2
Senator Miller............................................... 3
Senator Corzine.............................................. 4
Senator Akaka................................................ 4
Senator Gramm................................................ 12
Senator Stabenow............................................. 51
Senator Hagel................................................ 51
WITNESSES
Paul H. O'Neill, Secretary, U.S. Department of the Treasury...... 4
Prepared statement........................................... 52
Report to Congress....................................... 57
Response to written question of Senator Akaka............ 137
Richard L. Trumka, Secretary-Treasurer, American Federation of
Labor and Congress of Industrial Organizations................. 25
Prepared statement........................................... 66
Report submitted......................................... 68
Response to written questions of Senator Bunning......... 137
Jerry J. Jasinowski, President, National Association of
Manufacturers.................................................. 27
Prepared statement........................................... 101
Response to written questions of Senator Bunning......... 138
Bob Stallman, President, American Farm Bureau Federation......... 29
Prepared statement........................................... 115
Response to written questions of Senator Bunning......... 139
C. Fred Bergsten, Director, Institute for International Economics 31
Prepared statement........................................... 123
Ernest H. Preeg, Senior Fellow in Trade and Productivity,
Manufacturers Alliance/MAPI, Inc............................... 35
Prepared statement........................................... 127
Response to written questions of Senator Bunning......... 140
Steve H. Hanke, Professor of Applied Economics, Johns Hopkins
University..................................................... 37
Prepared statement........................................... 130
Response to written questions of Senator Bunning......... 141
Additional Material Supplied for the Record
Prepared statement of the American Forest and Paper Association.. 142
Prepared statement of the American Textile Manufacturers
Institute, (ATMI).............................................. 154
Prepared statement of the Coalition for a Sound Dollar........... 156
Miscellaneous letters submitted for the record by Senator Paul
Sarbanes....................................................... 159
(iii)
U.S. DEPARTMENT OF THE TREASURY'S
REPORT TO CONGRESS ON
INTERNATIONAL ECONOMIC AND
EXCHANGE RATE POLICY
----------
WEDNESDAY, MAY 1, 2002
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:02 a.m. in room SD-538 of the
Dirksen Senate Office Building, Senator Paul S. Sarbanes
(Chairman of the Committee) presiding.
OPENING STATEMENT OF CHAIRMAN PAUL S. SARBANES
Chairman Sarbanes. The hearing will come to order.
We are very pleased to welcome Treasury Secretary O'Neill
to the Committee this morning to testify on the Treasury
Department's Report to Congress on International Economic and
Exchange Rate Policy.
He will be followed by a panel of representatives of
American manufacturers, workers, farmers, and academics, who
will comment on the impact of the exchange rate of the dollar
on U.S. trade, employment, and long-term economic stability.
Mr. Secretary, we apologize. We had a vote and we had no
alternative in terms of when to start. And I understand that
you have some time pressures and we are mindful of those. So
when the time comes that you have to leave, we will certainly
recognize that.
The Omnibus Trade and Competitiveness Act of 1988 requires
the Treasury Department to submit a report to Congress annually
in October, with an update after 6 months, on international
economic policy, including exchange rate policy.
The Banking Committee originally planned to hold this
hearing last October, at the time of the submission of the
annual report, but delayed it because of the events following
September 11.
This morning's hearing is technically on the 6 month update
of that annual report, but obviously, will encompass the report
as well. It is important to just take a moment, and I will be
very brief here because I know we want to move along, to
understand the
origin of this reporting requirement, so we can understand its
purpose.
The report required in the 1988 Act was a response to the
experience in the early 1980's when the exchange rate of the
dollar rose to very high levels and there was a sharp
deterioration in the U.S. trade and current account balance.
Initially, there was a denial that there was any issue, any
concern. But the Treasury Department--this is in the Reagan
years, Secretary Baker--shifted positions and organized an
effort by the Group of 7 industrial countries in 1985, known as
the Plaza Accord, to address lowering the value of the dollar
and begin to ease the deterioration in the U.S. current
account.
In the aftermath of that experience, the Congress realized
that it did not have a mechanism by which the Treasury
Department would regularly report or testify on the conduct of
international economic policy. There was a recognition that
this was a critical area of economic policy and that a
mechanism similar to the requirement that the Federal Reserve
report to Congress semiannually on the conduct of monetary
policy, was needed. This report was the result of that
rationale. We regard this report as a serious matter. We intend
for the Committee to conduct regular oversight on this
important issue.
I want to commend Secretary O'Neill and the Treasury
Department for the timely submission of the report and its 6
month update since the current Administration took office. In
this regard, they have been quite responsive to the
requirements of the statute. I am not going to go through the
different requirements of that statute, many of which have been
met specifically in the reporting requirement. There are some
that were not addressed and I may make reference to those in
the question session.
The purpose of the report is for Treasury to present its
views in writing to the Congress and the reasoning behind these
views, and we look forward to hearing from the Secretary this
morning.
Senator Bunning.
COMMENTS OF SENATOR JIM BUNNING
Senator Bunning. Thank you, Mr. Chairman. First of all,
thank you for holding this hearing and thank you, Secretary
O'Neill, and all our other witnesses for being here. This is an
important hearing and I would like to thank everyone here for
testifying.
I am entering this hearing with an open mind. There is a
divergent opinion on this issue and we need to hear from
everyone who is affected by this. I believe our economy, though
growing, is still rather fragile and we could slide into what
is known as a double-dip recession if we are not careful. We
need to make sure that we make the right decisions so we do not
jeopardize this recovery.
I believe your testimony today can help us figure out how
to keep the recovery going. I look forward to hearing from you
and all the other witnesses, and I thank you, Mr. Chairman, for
holding the hearing.
Chairman Sarbanes. Thank you, Senator Bunning.
Senator Johnson.
STATEMENT OF SENATOR TIM JOHNSON
Senator Johnson. Thank you, Chairman Sarbanes, and thank
you, Secretary O'Neill, for joining us here today.
This is an important hearing to discuss international
economic conditions and exchange rate policy. Monetary policy
and the strength of the dollar relative to foreign currencies
play a critical role in America's ability to compete in a free
trade environment.
I think it is fair to say that in my home State of South
Dakota, that the appreciating value of the dollar, the
differential that increasingly occurs, is significantly
undermining support for free trade negotiations, as our farmers
and ranchers in particular find increasingly that the problem
that they have that results in an unlevel playing field in
their perspective is not so much the issue of tariffs and other
nontrade barriers, as it is currency differentials.
I want to focus a bit today on the local economic impact
that the strong U.S. dollar has in my State. I am concerned
that, in the face of cheaper meat imports, cattle and sheep
prices continue to fall and exports stagnate. I am also
concerned about small manufacturing firms as well that are
unable to compete effectively against foreign competitors due
to the sustained appreciation of the dollar against other
currencies.
This past year, my State saw an 11.6 percent decline in
manufacturing employment and a 27 percent increase in personal
bankruptcy filings. Some of this, of course, is due to the
business cycle and the recent recession. But the depreciation
of the dollar and the consequent depression in commodity prices
appears to be a principal reason why the ag economy did not
share in the economic prosperity that most sectors enjoyed
between 1995 and 1999.
Last year, I requested the USDA to complete a study on the
U.S. sheep industry, its future and the factors that have led
to its decline. The study focused on the rapid increase in lamb
imports in the mid-1990's that resulted from price manipulation
by New Zealand and Australia. As a result of arbitration, the
United States
established a 3 year tariff rate quota, TRQ, on lamb imports
from these countries in July 1999.
Despite implementation of the TRQ, imports did not slow
because the effects of the tariff were almost entirely offset
by the strong United States dollar and unusually weak
Australian and New Zealand currencies, in 1998, when the United
States dollar appreciated against the Australian and New
Zealand currencies by more than 18 percent and 24 percent,
respectively.
In light of these developments and the impact that it has
on U.S. trade, and the impact it has on the willingness of the
American people to pursue trade agreements that do not take
into consideration currency differentials, I think it is very
important that we take a hard look at this, and I welcome,
Secretary O'Neill, your report and your willingness to testify
to this Committee today.
Chairman Sarbanes. Thank you very much, Senator Johnson.
Senator Miller.
COMMENTS OF SENATOR ZELL MILLER
Senator Miller. Thank you, Mr. Chairman, for holding this
hearing. I will pass on a statement. But I do want the
Secretary to know how glad we are to have him with us and thank
him for his service.
Chairman Sarbanes. Senator Corzine.
COMMENTS OF SENATOR JON S. CORZINE
Senator Corzine. Mr. Chairman, I thank you for holding this
hearing, and it is always good to see the Secretary.
This is an important topic that really has a true impact on
our economy and I look forward to his remarks and the other
witnesses' remarks as well.
Thank you.
Chairman Sarbanes. Good.
Senator Akaka.
COMMENTS OF SENATOR DANIEL K. AKAKA
Senator Akaka. Thank you very much, Mr. Chairman. I will
also be brief.
I want to welcome the Secretary and I look forward to your
report to us on International Economic and Exchange Rate
Policy. I also welcome the other witnesses.
During today's discussion, Mr. Chairman, I am particularly
interested in the current account deficit and the potential
problems that it may cause.
Given the divergence of opinion on the significance of the
current account deficit, I look forward to an examination of
the consequences of the deficit on our economy. Secretary
O'Neill, you have stated that the current account deficit is a
meaningless concept. The International Monetary Fund's chief
economist has called the U.S. current account deficit, and the
possibility of a correction, a significant risk to the global
economy.
The Wall Street Journal described the nightmare scenario
involving the reversal in account deficit and the possibility
of foreign investors withdrawing their money out of the U.S.
economy. This could lead to a weakening of the dollar and stock
markets, and higher interest rates.
I welcome, Mr. Chairman, the witnesses' assessments of the
potential adverse impact of the current account deficit on the
global economic outlook and the consequences of account
reversal.
Mr. Chairman, I thank you very much for holding this
hearing.
Chairman Sarbanes. Thank you, Senator Akaka.
Secretary O'Neill, we would be happy to hear from you.
STATEMENT OF PAUL H. O'NEILL, SECRETARY
U.S. DEPARTMENT OF THE TREASURY
Secretary O'Neill. Chairman Sarbanes, Ranking Member Gramm,
Members of the Committee, thank you for this opportunity to
appear before you to discuss our international economic policy.
With the Committee's permission, I will submit my full
testimony for the record and make an abbreviated oral statement
to allow more time for questions.
Chairman Sarbanes. Thank you very much, that will be fine.
We appreciate that.
Secretary O'Neill. Thank you, Mr. Chairman.
At the outset, I think maybe it is important for me to say,
because I want to have an opportunity to have a full and clear
engagement with the Chairman and Members of the Committee, that
whatever one might try to imply from what I say today, there is
no intent in anything that I say that should give comfort to
those who think we are going to change our policy today. I say
that to you because, as I read the wire clips from around the
world this morning, there is apparently some breathless
anticipation that I am going to say something to intentionally
indicate a change in policy position or direction.
I want to assure you at the outset that whatever I may say,
that is not the intent. And again, I want to make it really
clear because the people who benefit from roiling the world
currency markets are speculators. And as far as I am concerned,
they provide not much useful value to the furtherance of
advancing the cause of improving living standards around the
world. So, I do not want to give them any ammunition to say
that there is a basis for roiling the world currency markets
out of our conversation here this morning.
I would like to touch on several of the Administration's
policy initiatives for increasing economic growth and reducing
economic instability abroad. They are of vital interests to the
United States.
First, we are working to reduce barriers to international
trade. Total U.S. trade amounts to about one quarter of our
domestic product, and trade touches every part of our economy
and creates millions of American jobs, paying above-average
wages.
To bolster growth and create new exports and job
opportunities for America, the Senate should pass trade
promotion authority so that President Bush can work with
nations around the world to reduce trade barriers and open
markets to U.S. exports.
Second, we are also working with the International Monetary
Fund to give emphasis to their role in crisis prevention. When
crises do occur, we need a more orderly process for resolving
them so that capital continues to flow to emerging markets. We
are working with others in the official sector to implement a
market-oriented approach to the sovereign debt restructuring
process. We also support continued work on the Fund's statutory
approach to sovereign debt restructuring.
Regarding the multilateral development banks, we believe
they can deliver better results by investing in high-impact,
productivity-enhancing activities.
President Bush has proposed that we transform the World
Bank and other development bank funds for the poorest countries
into grants rather than loans. Investments in crucial social
sectors, such as health, education, water supplies, and
sanitation, are crucial to private enterprise-led growth and a
necessary basis for development. But they do not directly
generate the revenues that service new debt. As a result, the
recipient government is forced to repay the loan by taking
resources from citizens subsisting on less than a dollar a day.
By piling loans on these nations, we are simply generating the
next generation's debt-forgiveness program. We ought to
recognize that projects that do not generate economic returns
should be funded by grants and not loans.
President Bush recently announced his new compact for
development, a major new initiative for development based on
the shared interests of developed and developing nations in
peace, security, and prosperity.
The compact creates a new development assistance fund
called the Millennium Challenge Account. To access account
funds, developing countries would have to commit to policies
that promote growth and development, including governing
justly, investing in people, and promoting economic freedom. We
intend to put our development assistance funds into
environments where they can make a difference. Another
important aspect of our international economic agenda is the
financial war on terrorism.
Since September 11, the Treasury Department has thwarted
supporters of Al Quaeda and other terrorist organizations by
freezing $34 million in assets directly and assisting our
allies to freeze
another $70 million. Recent joint discussions with our allies
mark
a new level of coordination in the fight against international
terrorism.
I would like to now turn briefly to global economic
conditions. The world economy is still in the early stage of
recovery. The GDP figures released last week confirm that we
are on the path back to sustainable growth of 3 to 3\1/2\
percent per year.
I also want to reiterate my feelings on the U.S. current
account deficit. The current account represents the gap between
domestic savings and investment. It is financed by
international capital flows which have risen because of foreign
interest in investing in the United States. As long as we
continue to have the best investment climate in the world,
people in other nations will send their savings here, where
those resources fuel our economic growth and job creation.
I believe we should strive in both the private and public
sectors to always be the best place on earth to invest. As long
as we are the most productive economy in the world, our Nation
will continue to be prosperous.
I thank you again for this opportunity to testify and I
would be delighted to take your questions.
Chairman Sarbanes. Well, thank you very much, Mr.
Secretary.
I want to focus on the current account deficit. I am really
seeking a better understanding of your views. The current
account deficit now as a percent of GDP is higher today than it
was at its peak during the 1980's. In fact, we have some charts
that show a really dramatic deterioration in the current
account deficit as a percent of the gross domestic product.
This is back in the 1980's and then this is what has
happened in the 1990's (indicating).
You have been quoted as saying--``I do not know.'' I will
let you address the quote--that you view the current account
deficit as meaningless or irrelevant. Would you explain to us
the rationale behind this view?
Secretary O'Neill. I am sure I must have said that some
place. I am not sure what the context was of when I might have
said something that fits between those quote marks. My view of
the current account deficit is this. I think, first of all, one
needs to examine what the origins of the idea of the current
account deficit are.
I think the answer to that question is, it is a derivative
part of the notions that were put in place in the late 1930's
and early 1940's about how we should assemble data to look at
how the world works, and to try to draw from the data in these
various conventions that we have adopted correlations with good
and bad economic activity in the world. When I look at it, I,
first of all, ask myself, is the world the way it was in 1939
or 1940, when Simon Kuznets and his associates put it together?
My own answer to that is that it is not. And it is not in these
important ways.
I think in the 1930's and 1940's and, in fact, I think one
could argue maybe even through the 1950's, that the world in
fact was relatively aligned with the ideas that suggested that
the world is run on a nation-state basis, and that nations are
basically independent of each other in an economic sense, and
that in fact, it is possible for one nation to substantially
change its economic position by playing off of other nations
because of the separateness.
I do not find that to be the way the world is any more.
Having run a corporation with operations in 36 nations, I will
tell you what--I never spent a minute thinking that somehow, I
could go to some of these, any of these other countries, and
act as though that country were independent of the rest of the
world.
I did not find that it was possible to do that here in the
United States. In fact, I do not think it is possible for
anyone to do it. It is possible for people to continue to think
it, but it is not real world in terms of the way world economic
activities work any more. So, I have a problem with the
construct before I ever get to what the implications of adding
up all of these numbers are? And then I would submit this--that
it is said that the current account deficit is a U.S. current
account deficit.
Now my question is, what does that mean? Does the U.S.
Government have a deficit with other countries? That is to say,
have we in the Federal Government gone out and borrowed money
from other countries that they can jerk out from under us?
The answer to that is no.
Who owns the so-called current account deficit? Millions,
or maybe even billions of individual investors who have made
decisions around the world to own these investments. Again, in
my brief oral statement, I made the point that the reason money
comes here is because it is treated better than any place in
the world, as measured by the risk-adjusted rate of return on
investments that are made in the United States.
I have a lot of trouble with the construct that, if you
accepted at face value that somehow this is a deliberate
decision of the United States to do something, this is an
analogy to an individual deciding to borrow too much money. I
find it is a false analogy. So, when I have said these words
about my problem with the current account deficit, it is this
stream of thinking that I had in mind.
It does not mean that I do not think there is some
legitimate value in thinking about relative capital flows
around the world and the implications that has for interest
rates and other important determinants of where money goes. But
it does mean that I do not think the simple correlations that
are made are not meaningful or useful and, in fact, I think are
a dangerous basis for making policy prescriptions.
Chairman Sarbanes. Let's just sharpen the debate for a
minute. I know you are a man who likes to engage in vigorous
intellectual debate. I want to quote to you from The Economist
just a week ago, an editorial. This is what they say:
The International Monetary Fund says that America's current
account deficit poses one of the biggest risks to the world
economy. Paul O'Neill, America's Treasury Secretary, reckons
that the Fund's economists do not know what they are talking
about. He says the current account deficit is a meaningless
concept. Policymakers should pay no attention to it.
Mr. O'Neill's views fly in the face of experience. A
deficit that will require America to borrow from abroad almost
$2 billion a day by 2003 can hardly be ignored. The
consequences for the dollar if foreigners' appetite for
American assets even wanes would give a Treasury Secretary who
knew what he was talking about sleepless nights.
Now, I put that out there because this is one serious
commentary and I would be interested in your response to it.
Secretary O'Neill. If you do not mind, I have two different
things I would like to say about that.
First of all, last November, the International Monetary
Fund--we got the World Bank and the International Monetary
Fund, the G-7, together--made a public pronouncement that
growth in the United States in 2002 would be 0.7 percent.
And on the spot, I said to the managing director of the
IMF, I am going to bet you a dinner in a restaurant of your
choice that we are going to far exceed that number. They have
now decided that the number is going to be 2.4 percent. So, at
the time, I was saying we were going to be some place like
where, in fact, we are on the glidepath. And so, maybe you
would prefer their economic judgment to mine. So far, they have
not been right.
Now to a different point on this. It is not that I think we
should pay no attention to this issue. But I would ask the
question, if you do not like the current account deficit, what
policy instruments would one use to change the current account
deficit? And then, what is the most meaningful question--are
you willing to suffer the consequences of treating the current
account deficit as the objective variable in the equation?
What I mean by that is this. One way to fix the current
account deficit is to reduce imports. I do not know anyone who
wants to do that because the implications of reducing imports
is we become a more isolated and insulated society. Our
citizens pay more money for goods. The reason goods are coming
here is because they are valued by consumers at the prices they
are offered at, as compared to alternatives.
So if you do not like the current account deficit, we could
say, bugger them, the U.S. citizens. We here in Washington know
better. They should not be buying so much stuff from outside
the country. That would fix the current account deficit. That
does not seem like a brilliant thing to me to do.
If you look at the academic work, what I consider to be the
best academic work on this subject, there is a report I would
submit to you by Allan Sinai that was done in December 2000,
that basically says, if you run all the econometric equations
and treat the current account deficit as the dependent variable
and you seek to reduce the current account deficit, every
single intervention hurts the U.S. economy, as compared to
leaving the current account deficit alone.
I have not seen academic work that suggests itself to me
that produces a different answer. And so, it is part of the
reason why I am mystified that there seem to be so many people
that want to treat the current account deficit as the objective
function for our society, when doing so. This is not a partisan
report from Sinai. This is an academically solid, legitimate
report. I do not know of something to counter Alan's findings.
Chairman Sarbanes. Well, we could go on at great length,
but my time has expired, and I am going to yield.
I would just note that the panel that is coming along
behind you feels pretty strongly, at least a number of them do,
that the currency is manipulated by some of our trading
partners, very much to the U.S. disadvantage, and that is
affecting the balance of trade in a very substantial way. And,
of course, that is one of the things that we are trying to get
at in these reports.
Senator Bunning.
Senator Bunning. Thank you, Mr. Chairman.
Secretary O'Neill, the Treasury Report said there was no
current manipulation by our major trading partners last year.
How does this jibe with the reports saying China purchased $50
billion, Japan bought $39 billion, and South Korea bought $9
billion last year? In other words, if there is no importance to
that fact, how does that jibe with your report?
Secretary O'Neill. By the definitions of law, as we
understand it, the individual actions that have been taken do
not amount to manipulation under the statute. And I think, in a
broader sense, if you look at the Chinese currency against
world currencies, they are running kind of a soft peg.
I do think this. The markets are grinding so finely, and
they are so interlaced any more, that it is not possible any
more to actually fool the market for very long. That is to say,
to create an artificial situation that is not in line with the
judgment of the market about the discounted present value of
productivity improvements relative to other countries.
Senator Bunning. Currently, I do not disagree with you.
What happens with China having that large a reserve of U.S.
dollars--what happens in a time of crisis, such as a
confrontation at the Taiwan Straits that the Chinese could dump
dollars onto the world market in an attempt to destabilize our
economy?
Secretary O'Neill. First of all, it presumes that the
dollars are held by an authority that has the ability----
Senator Bunning. The Chinese government.
Secretary O'Neill. But the Chinese government I think does
not actually hold that money. I think if you go look at how
that money is held, you are looking at first-order effects.
Look at the second-order effects. What did the Chinese do with
that money?
I will tell you one thing that they did with it. They built
new factories. Now where do they get the technology for the new
factories? They bought it in the UK or they bought it here, or
they bought it--you know, it is in German hands or it is in
Brazilian hands. It is in somebody else's hands.
It is another problem that I have with the current account
deficit. It assumes the world is static and that first-order
effects never become second-order effects.
Senator Bunning. I do not consider it static. But I
understand that if they do use that currency as hard dollars to
do other things, that they are replacing them with hard
dollars. And we are talking about a fixed period of time where
they measured the amount of dollars that the Chinese had under
their control. Are you telling me that that is not important?
Secretary O'Neill. I do not think so.
Senator Bunning. You do not think so? In other words, if
they got up to $100 billion, you would not think so? Or $200
billion, it would have no effect?
Secretary O'Neill. No, I do not think it is a material
amount, in an economy that is a $10 or $11 trillion economy.
$100 billion--I am trying to think about it.
Senator Bunning. As long as the situation in the world is
like it is, I do not disagree with you. But if we have a
confrontation, I think it would have a serious effect on the
dumping and devaluing in our economy of the U.S. dollar, if
they dumped that on the world market.
Secretary O'Neill. I think if it is true that one sovereign
had the ability to make an instantaneous decision, you might be
right. I do not think that is the case.
Senator Bunning. In the mid-1980's, our Government worked
on a similar problem through the Plaza Accord. In what
circumstances would you have considered to take a similar
action?
Secretary O'Neill. Well, first, you are going to hear from
panel members and I am sure they will have their own and
probably different views.
Senator Bunning. I want yours. I do not want the panel's.
Secretary O'Neill. I just wanted to say, it is not clear to
me that the implication of your question about the Plaza Accord
has substance behind it, in this sense: I think it is a real
speculation to know, in fact, whether conditions and trends
were moving in the direction that the Plaza Accord simply
hopped on the back of.
What comes to mind is the metaphor of the caterpillar
riding on a log down the stream and thinking they are steering.
I think you have to be really careful in assigning causality to
supposed political interventions. I am not sure that those
causalities exist.
Senator Bunning. In other words, our political intervention
in Afghanistan----
Secretary O'Neill. I did not say that.
Senator Bunning. There is no consequences to Afghanistan?
Secretary O'Neill. No, I did not say that.
Senator Bunning. What are you saying, then?
Secretary O'Neill. I am talking directly about intervention
attempts in world financial markets. I am saying, I think there
is a real doubt about the effectiveness of interventions or
words about interventions--although I would grant you one
thing. It is why I made my statement at the beginning--it was
not my intent to roil the financial markets today. There is
nothing the speculators like better than to roil the financial
markets. And I think it is true, by changing rhetoric, you can
roil or even maybe give direction to the financial markets over
some limited period of time.
But coming from the part of the economy that produces real
tangible things you can take home and put on the table, I
believe at the end of the day, while monetary affairs are not
incidental, the real long-run economics of the world depends on
the physical production of goods and services and therefore,
you can have as much rhetoric as you want; eventually the world
is going to stabilize around the real production of goods and
services.
Senator Bunning. You may believe that, but I will guarantee
you, the Chairman of the Federal Reserve does not believe that.
Thank you, Mr. Chairman.
Chairman Sarbanes. Thank you very much, Senator Bunning.
Before I yield to Senator Miller, Mr. Secretary, I am
prompted to quote President O'Neill of the International Paper
Company in 1985.
The strong dollar has turned the world on its head. We have
suffered a major loss in competition position because of the
loss in exchange rates. And then O'Neill explained that in the
last few years, a strong dollar has dramatically eroded the
U.S. forest products industry's natural advantage in world
trade.
This is what we are hearing from all of your former
colleagues, or people who currently hold comparable positions
in the business world. And of course, that is what you were
saying in 1985.
Secretary O'Neill. Do you have the rest of what I said
then?
Chairman Sarbanes. Well, what else did you say then?
Secretary O'Neill. What else I said then was, ``what we in
the industry need to do is we need to take matters in our own
hands and we need to create conditions in the goodness of what
we do, the exceptional excellence of what we do, so that we can
pros-
per no matter what is happening with exchange rates. We need to
use our brain power to figure out how to create goods in the
cur-
rency that we sell them. And we need to take this
responsibility
on ourself.''
I do not think you will be able to find any place where I
called on the Government to intervene in the financial markets.
I was
basically calling attention to the fact that, indeed, currency
rela-
tions had changed and those who were going to prosper were go-
ing to have to assume the responsibility for their own
individual
companies and industries to fix the problem, not look to
Govern-
ment to make a temporary intervention that would make life
sweeter for us.
Chairman Sarbanes. Well, Paul H. O'Neill, Los Angeles
Times, International's President, doubts that paper prices will
rise in step with the dollar's decline. But he definitely sees
happier days ahead. ``Exchange rates moving back to normal
levels would be very good news for our industry, he says. We
would recoup most, if not all, of our export volume.''
Secretary O'Neill. That is a statement of fact. It is not a
prescription for the Government to intervene.
And if you go look at the record, which you will find both
at IP and Alcoa, there is a performance. Let me remind you of
rate spread. The Japanese yen-United States dollar rate, as I
recall, in 1985, was 240 or something on that order of
magnitude. We reached a low relationship of 80 yen to the
dollar, I think, a couple of years ago.
Through that whole time, the companies I was associated
with prospered, became leaders in the world. And we did not do
it by coming down here asking somebody to fix the world, to
make it easier for us. We did it with our fingernails in 36
different countries around the world.
Chairman Sarbanes. Well, it doesn't square. You have the
Plaza Accord and that helped you tremendously, you and other
export-
ers, and John Gorges, who was with you at International Paper.
Correct?
Secretary O'Neill. He was the Chairman.
Chairman Sarbanes. Yes. One of the toughest problems we
face is the very strong dollar, which impacts our export
products and prices a good deal. There are major uncertainties.
If the dollar weakened, we could compete better. And it is not
just us. It is other exporters, too.
Senator Miller.
Senator Miller. Mr. Secretary, I guess I am going to
continue along that same kind of questioning. I want to say
that I understand how you have to look at the really big
picture. I appreciate that and I respect that.
As a Senator from Georgia, though, I have to be a little
bit more parochial. I have to look at those 8 million people in
Georgia. There are some industries in our State, forestry is
one of the key ones, agriculture, textiles. They all have
complained to me pretty loudly that the dollar is making it
difficult for them to export profitably, and making it easier
for imports to take the market share here in the United States.
Continuing on this line the paper industry which the
Chairman mentioned, has seen more than 90 percent of the growth
in their U.S. markets captured by imports, they tell me. I
guess my question is, and I know you have to look at it from a
different angle, but how would you respond to my constituent
industries that are so very concerned about this matter?
Secretary O'Neill. You know, when I come around and I sit
on your side of the table, I understand the pressure that not
just you, but you are reflecting what your constituents are
telling you. I understand the pressure that creates.
I said that while I was at Alcoa, we prospered. But it does
not mean that we did not have dislocations. In fact, we did
have dislocations because not in every place were we able to
push our costs down enough to compete in the whole world on a
competitive basis with changes in exchange rate positions over
time.
I know these are issues where your heart breaks for the
people that are directly affected by these things. And I
suppose it is no solace at all to the individuals who are
directly affected. But I think it is demonstrably clear that in
fact we in the United States, the U.S. citizens as a body, and
the world as a body, are better off if we let competition and
best value products lead the world.
It is not an easy thing to follow in practice and that is
why we have lots of people coming to Washington to tell us how
they are hurting. And I think we have to be sympathetic with
that. But I think at the same time we are better off to help
the casualties if it produces a better economic outcome for the
whole society than to let the casualties become the control on
our ability to succeed as a total country.
Senator Miller. Thank you. I do not have any other
questions.
Chairman Sarbanes. Senator Gramm.
STATEMENT OF SENATOR PHIL GRAMM
Senator Gramm. Well, Mr. Chairman, I was over trying to
participate in the negotiations to bring our trade promotion
authority bill to the floor, and so I missed our opening
statements. So, I would like to take my time to make a
statement.
First of all, every day on the world currency market, as I
understand it, there are about $1.2 trillion worth of dollar
transactions. This is the purest market in the world in that it
has the most participants and it has the largest volumes.
My own belief is that even a country as rich as the United
States of America could affect currency values, could affect
the value of the dollar, only for a very short period of time,
just as I could lower real estate values in my neighborhood if
I were mad at everybody else and wanted to hurt them, by
selling my house for $100. But once the house is sold, then
real estate values are basically back as they were.
I not only believe we cannot affect the value of the
dollar, except by changing policy that would affect people's
perception and the reality of the American economy, but also
that currency intervention is a nonfeasible policy, even if it
were desirable, would be my first thesis.
Second, this is a perfect market, for all practical
purposes, where every day people are buying and selling
dollars. Why do they buy dollars? They buy dollars to buy
American goods and they buy dollars to invest in America. And
they sell dollars and buy foreign currency to invest abroad or
to buy foreign goods.
So when we say we have a current account surplus, by
definition, we have a capital account. We have a huge inflow of
capital. Were that not the case, the value of the dollar would
change and the surplus would be eliminated. What you are seeing
is a mirror image of capital inflow versus a current account
deficit. Now is the capital inflow bad? Who's against
investment? Every once in a while people say, well, my God,
foreigners own some building in New York. I have found
ownership is not what it is cracked up to be.
[Laughter.]
First, try moving that building back to Japan. Second, I do
not think anybody is willing to come out here and say:
Investment is a bad thing and we want less of it. Then what
about loans? Aren't you a debtor when you get a loan?
Well, it depends on what you do with the loan. If you
invest it productively, it is an avenue to riches. If you
invest it poorly, it is a path to poverty. The only kind of
loan I would be concerned about is if our Government were
borrowing money to invest in Government and they expected value
of the investment would be far less than the service cost
alone. And exactly the opposite is true.
This idea about what you said about forest products in my
mind is totally consistent with what you are saying today.
There is no doubt that at any given time there are many
industries that would benefit if the dollar was cheaper. There
are industries that would benefit if the dollar were more
valuable. But the question--you are not here today representing
the forestry industry.
Secretary O'Neill. That is right.
Senator Gramm. You are here today representing the American
economy. And the point is that if you could snap your fingers
and make the dollar cheaper, there would be some people who
would gain. There would be some people who would lose. So, I do
not see an inconsistency there.
Finally, I, quite frankly, do not have a problem with what
The Economist says. For the world economy, looking at the world
now, is it good that all this investment is coming to America?
If you just look at the world economy now, maybe you would
want to redistribute this investment differently. It may be
risky for the world that America gets richer and more
prosperous and our real wages rise and we become more dominant
in the world, depending on your perspective. But our question
is not the world. Our question is the United States of America.
It seems to me that when we look at American interest, that it
is very clear that we want investment, that we want to have
open markets, and that we are succeeding economically as a
result of it.
So, I do not disagree with my colleague from Georgia. We
have 60,000 jobs in Texas in the forestry industry. A lower
value for
the dollar, if you could just wish it and have it, would be
beneficial
to them.
But for everybody going to Wal-Mart, it would be a bad
thing. And in this case, there is nothing that we could really
do to change it, other than we could have our Navy blockade our
ports. That would improve our situation. The enemy would do it
in war, but we could do it in peacetime. Or we could stop
foreign investment. I would submit, we do not want to do either
one of those things.
I think we need to keep our eye on current account deficit.
If it becomes clear that it is a Government policy that is
driving it, such as we are getting foreign loans to finance
Government or foreign investment--if something artificial is
happening, then I think it is something that we should be
concerned about.
But the thing I am never concerned about is that somehow,
somebody is going to manipulate a market where there is $1.2
trillion worth of transactions every day. Even as much money as
you control, you would be a bit player in this market. And
foreign countries that try to manipulate the value of the
dollar are trying to get water to run up a rope. It just cannot
be done.
The only final point I would make is that we could have a
dollar for exports and a dollar for imports. You could have one
that was valuable and you could have one that was cheap.
The problem is that then you would have to have an exchange
rate between the two dollars. And in the end, I think this is a
thing where individual industries can say, I wish markets were
different. But, A, I do not think there is anything you can do
about it and, B, even if you could do something about it, you
might want to do it if you were in the paper industry. But if
you are Secretary of the Treasury, you do not want to.
I would say that we have been blessed with Rubin and
Summers and with you, Secretary O'Neill, that on this one
issue, that there has never been an equivocation. There has
never been any politics involved in it. I think that the
country has benefited a great deal, even though individual
parts of the economy might benefit, but at a great expense to
everybody else. I guess that is my view. I worry about this.
But by the time I get to it on my list, every night I am
asleep.
[Laughter.]
Chairman Sarbanes. Senator Corzine.
Senator Corzine. Well, I do not fall asleep thinking about
the dollar, either, in that particular category of concerns.
But I do wonder when you think about the current account,
which I basically think is reflective of the underlying trade
imbalances that we have, and it has some other elements in it,
that a lot of the financing that goes on in the world, these
flows which are covered by this $1.2 trillion, which you say is
a lot of--I am a little more comfortable with speculators based
on where I came from than maybe you are.
[Laughter.]
In the sense that it allows for the transition of the flow
of dollars from one place to another, or assets. But it strikes
me that while managing the dollar is not necessarily the issue,
worrying about that underlying trade deficit is a real issue.
And if it were to change our views with respect to how
people look at the capital markets in the United States because
they do not feel they are as secure as they might have thought
they were at another point in time, which can happen for
political reasons or it can happen for underlying economic
conditions, the kind of deficits that Senator Gramm is
concerned about, which, by the way, seemed to be reappearing in
relatively substantial amounts.
You can then have a completely serious series of events,
like changing price levels and higher interest rates. I think
we will hear Mr. Bergsten talk about that kind of scenario.
Those things do happen. They have happened in history, that
other countries ran large trade deficits. I think that there
are reasons to be concerned about underlying trade conditions
that work against our Nation, even at a macrolevel. Get away
from the forestry because, cumulatively, these things end up
setting a vulnerability that is actually more serious than the
Chinese reserves building up $50 billion, which I think is a
drop in the bucket.
But if the investors in American stocks and bonds decide to
get out, that is a lot easier to do than selling that building.
Only one holder of those is the central banks or the reserve
holders. And that is a serious concern. It is a serious concern
if we see an erosion in our stock market because people do not
have confidence in our accounting systems or our financial
policies.
That to me is a bigger worry than where the dollar is at a
given point in time. And that is why it concerns me when you
say it is irrelevant because it is relevant to the underlying
economic conditions, which I agree with you, ultimately, are
what determine where people want to put their money.
There are issues here that could change people's
perceptions about the United States, our fiscal policy, the
management of our internal structures that surround our
markets, the accounting issue being one that I am concerned
about. And so, isn't that shock issue a real concern for anyone
who is responsible for policy, and shouldn't we do things that
try to advance more security with regard to those in the long
run?
Secretary O'Neill. Indeed, I think I am very sympathetic to
your notion that we should look at underlying trade
relationships. I also am frankly much more interested in what
we can do to advance the cause of more exports from the United
States. And with that, the development of the world.
I am sure you all know this, there is still 1.2 billion
people in the world living on less than a dollar a day. And if
you can imagine raising their standard of living so that they
could demand plywood from the United States and plumbing
fixtures and the other things that we all take for granted, we
would quickly get rid of the worry about current account
deficit because we would be exporting goods and we would be
creating well-paying jobs for people here in the United States
that are demanded by people who are growing into something
approaching our standard of living.
So, I see this in a fuller sense because I am not really
infatuated with finance as the prism for thinking about
everything. For me, it is a derivative question. Finance is a
derivative question, not a primary question.
I am very interested in your notion that, yes, we should be
worried about this and we should be working on passing the
trade promotion authority so we can get on with opening up
markets to U.S. goods. And we can be helping people to realize
a decent life instead of the misery so many of them are living
in today.
On your other question about the concern that investors
would make what I would characterize as a cliff decision to
withdraw from the U.S. market, indeed, I do think that we have
to be very careful about the mix of monetary and fiscal policy
so that investors outside of the United States look at what we
are doing and take comfort in what we are doing, that we are
not running unsustainable excesses that would weaken their
claim on U.S. goods and services because we are running policy
that is a folly.
So, I think, indeed, we have to pay a lot of attention at
the Government level to running sensible, sustainable fiscal
and monetary policies and giving every bit of encouragement we
can to the continuation of the extraordinary level of
productivity growth that we are seeing now.
We are expecting when the final numbers are completed, that
the first quarter rate of productivity growth in the United
States is
better than the 5.2 percent that we saw in the fourth quarter,
which is truly extraordinary and I think should give lots of
comfort
to investors around the world, that the differential rate
between
productivity growth in the United States and every place else
is just phenomenal.
And when I sit down and talk with the chancellor of the UK
and Eddie George, the Governor of the Bank of England, they
just cannot figure out how we can be doing so extraordinarily
well in productivity growth while they are still limping along
in the 2 percent range, and have been for a very long time. It
is not even a subject in Continental Europe. They just cannot
imagine how their productivity growth could begin to approach
what we have demonstrated we can do.
Senator Corzine. Two observations.
First, these shocks do occasionally happen. We had one in
1987 that was pretty clear when people evacuated markets at a
given point in time. And it has real impact on the underlying
economy. I know you are aware of that.
Second, if you are concerned about the underdeveloped
world, the United States--and I think investment is great for
the United States. But the idea that we are sucking up most of
the capital that is freely formed is an issue that I think can
be a concern for the development of a lot of the underdeveloped
world.
Frankly, I do not know that that relates to TPA. I think it
has a lot to do with those internal structures and viabilities
and political stability of a lot of the countries. So one has
to figure out what is the most important ingredient to actually
change what those conditions involve.
Secretary O'Neill. I believe, these things are very much
related to each other. And it probably escaped your notice
because it did not get much attention, but when the G-7 was
here 10 days ago, we did something which I think is profoundly
important.
We resolved that we are going to work with the developing
world to move them all toward a condition of investment grade
sovereign debt. And you will understand and you have indicated
by what you just said, in order to do that, there has to be a
real rule of law and there has to be enforceable contracts, and
there has to be an attack on corruption. And with those
conditions, we can begin to help them create a basis for better
competing for capital flows.
Now, I also believe this. I do not believe economics is a
zero-sum game. I think the amount of money that is available
for capital formation and capital investment is not limited to
the amount that we are now producing.
If we can grow our own economy at 3\1/2\, or maybe even a
little better than that percent of annual growth, we will throw
off more capital and that capital in turn, if it is properly
invested, will produce more economic growth and more economic
growth will throw off the capital that is required to bring
others along.
I really do believe the idea that capitalism at its best is
a perpetual motion machine, or as close as the mind of man has
been able to come, and that we are not doomed to live with the
amount of capital that is now available as a limit for the
whole world's growth.
Senator Corzine. Thank you. Mr. Chairman.
Chairman Sarbanes. Mr. Secretary, I want to come back to
this basic point. I am really taken aback that we have a
Secretary of the Treasury who does not perceive any problems
associated with this large current account deficit. Now that
flies directly contrary to what virtually every other economic
observer is telling us.
Business Week recently ran an article: ``U.S. Debt Overseas
Stirs Up Trouble At Home.'' The growing current account deficit
might set the United States up for a fall. And they say the
following:
The United States mounting external debt is clearly the
most crucial structural problem facing the economy. And unlike
other recent economic troubles, there may be no easy way out.
The January and February increase in imported goods was the
largest 2 month rise in two decades. Last year's current
account gap hit 4.1 percent of gross domestic product and it
could reach 5 percent by the end of 2002. That would be the
largest rate in the industrialized world and larger than in
many emerging market nations.
Now, we asked Chairman Greenspan about this at the Joint
Economic Committee, the consequences to the U.S. economy of a
growing current account deficit. This is what he responded.
The current account deficit is also a measure of the
increase in the level of net claims, primarily debt claims,
that foreigners have on our assets. As the stock of such claims
grows, an even larger flow of interest payments must be
provided to the foreign suppliers of this capital.
Countries that have gone down this path have invariably run
into trouble. And so would we. Eventually, the current account
deficit will have to be restrained.
Do you differ with that?
Secretary O'Neill. That is all he said? He did not say at
what level he thinks we have to do restraint or how he would
restrain the current account deficit?
Chairman Sarbanes. Are you prepared to concede that at some
level it would need to be restrained? At some point is it a
problem? Are you saying to me, it is not a problem right now,
but it could be a problem? Or, are you saying to me, look, this
is a meaningless concept. It is really irrelevant. It is not
something we should worry about now or in the future or at any
time. Forget this kind of thinking. That is the approach you
originally took, I think. Is that your position?
Secretary O'Neill. Well, I would want to look at the
composition of where the money is and the circumstances that
exist in the rest of the world.
The implication of saying, yes, we should constrain the
current account deficit is, as I said, as I have looked at the
best academic work I know of, all the interventions that have
been modeled would do damage to the U.S. economy if we decided
to reduce the size of the current account deficit.
I do not find it very appealing to say that we are going to
cut off our arm because some day we might get a disease in it,
and this is an anticipatory move. I just do not understand the
thinking that treats what I consider to be an artificial,
intellectually useful construct, and then take it to a policy
conclusion that does damage, that we decide to do damage to our
own economy because of this artificial construct. I do not find
that appealing, no.
Chairman Sarbanes. Let me go to another line of
questioning. This issue leaves me very concerned because we
have a Secretary of the Treasury who just says there is no
problem. Everyone else is telling us there is a problem in
varying degrees, and they have different approaches as to how
to deal with it. But they are not saying, look, just forget
about it. Just go on about your business.
On the currency manipulation, and the Treasury found that
there wasn't any, but there is a general view that the net
purchases of foreign exchange by the Bank of Japan in recent
years probably held the yen at a significantly lower level than
would have prevailed based on market forces alone.
China, which has had a running current account surplus of
about 2 percent of GDP, so they are running a very large trade
surplus, they have also had an enormous inflow of foreign
direct investment. In fact, the Treasury found that their
bilateral trade surplus with the United States was $46 billion,
just for the second half of 2001.
Ordinarily, with a sizable trade and current account
surplus, and a large inflow of foreign direct investment, your
currency would appreciate. But that has not happened in China.
They have avoided that by acquiring huge amounts of foreign
assets, in effect, doing what the Japanese are doing. In fact,
your own report says that they expanded foreign reserves by $32
billion in just the second half of 2001.
Now why doesn't this represent a concerted policy on the
part of China, to get the trade surplus, to get the foreign
direct investment and sustain that position by making the
purchases, huge purchases of foreign assets, in order to hold
their currency in place, all to their advantage? That is not
the workings of the market forces. They are intervening in the
workings of the market forces in order to sustain an advantage,
are they not?
Secretary O'Neill. I do not know. What would you prescribe
as a policy intervention? Which one of those things would you
see us changing somehow?
Chairman Sarbanes. I think you have to look at something
like the Plaza Accord again. You have to address, in effect,
the overvalue of the U.S. dollar in relationship to that. If
they won't, in effect, allow their currency to depreciate, if
they seek to sustain it in this way, then you have to do it on
the American side.
You are putting our manufacturers in an incredible
position, it seems to me. They may be quite competitive. You
talked about the productivity improvements. It is a real
tribute to labor and to management that have been doing that.
But they are coming and they are saying to us, look, we are
just at a 25, 30, 35 percent handicap because of the currency.
Not because of the underlying economic
realities.
Then you say, well, the currency value is going to be set
by the market. But then we look at what some of these major
trading partners are doing who are running these very large
trade surpluses with us and it looks as though, pretty clearly
to me, that they are intervening in ways to affect the currency
relationship in order to sustain a very substantial and
significant trade advantage.
I will concede to you, on many of these problems, just as
you said earlier about the current account deficit, it is a
very difficult call to figure out what to do. I do not gainsay
you on that. But that is different than saying there is no
problem here. That is different than saying, it is all
irrelevant. It really dosn't matter. The whole concept is
faulty and we are just not paying any attention to it.
Secretary O'Neill. I think, just as you said, it makes a
lot of sense to pay attention to this issue, but at the level
of detail that we are talking about it now.
When you mentioned the elements of what China is doing, I
would submit to you, at least for myself, looking at this data,
it is not at all clear to me that China has been able to change
the relation of its currency to the dollar because of the
combination of policies that they are running. In fact, it is
not clear to me that any nation has enough reserves any more to
run even an intermediate length intervention program that the
market does not believe is associated pretty directly with the
expectations for discounted productivity expectations as
between countries.
It is true that I think it is clear on the face of it, I
have been to China and sat down with the Governor of the Bank
of China and talked with them about their currency regime and
their intentions toward the rest of the world. And it is true
that they are running what I would characterize as a semisoft
peg. But I do not think, however much of their reserves may be,
that they can get away very long with, in effect, defeating the
market or producing a different relationship between their
currency and the other major currencies in the world by using
reserves to do it. And I think if it were true, then Argentina
would not be where it is today.
Chairman Sarbanes. First, I think the Chinese and Japanese
are very skillful about this.
Second, if the United States is not resisting what they are
doing, but, in effect, is going along with it, which is
essentially what would flow out of an attitude that says, this
is an irrelevant concept and there is no problem here, it makes
it easier for them to work this game to their advantage. That
is what is happening.
The figures just will not sustain, it seems to me, the
position you are coming from. I think there is a problem. You
keep saying, no problem. Manufacturers say that there is a
problem. Economic commentators say there is a problem. You say,
no problem. Well, look, as long as you say no problem, then
their ability to have an impact is enhanced, not diminished, in
my view.
Secretary O'Neill. Senator, may I say just one word to
that?
Chairman Sarbanes. Sure.
Secretary O'Neill. Again, I look at the objective evidence
and I hear Japan. And I noticed this. In the last 12 years, the
Japanese economy has performed dismally at something close to
an average GDP growth of zero, as compared to a spectacular
performance by historical measure for the U.S. economy over the
same period of time. And we appear to be headed back toward our
potential rate.
The same facts pertain to Western Europe. I do not find a
basis for deciding that what we have been doing is
fundamentally wrong in the experience that we have had as an
economy as compared to any other economy in the world.
Chairman Sarbanes. We have heard you talk about short-term
benefits and long-term vision and so forth in a different
context in talking about the budget, having sort of self-
discipline and so forth. The fact of the matter is that we are
building up these large obligations. We will have to pay or
service those obligations into the future. So the gap between
what we must produce and what we can reserve of that production
for ourselves is growing because more and more of it is going
to have to be committed to servicing these foreign claims that
we have built up.
You may say, well, the economy is going well. Everything's
hunky dory, and so forth and so on. But, nevertheless, this
burden continues to build. And it carries with it, it seems to
me, potentially very severe problems in the future. And you are
the only one I find who denies that. Alan Greenspan says, at
some point, we have a problem. Most everybody says that. I
cannot even get you to say here today that at some point, we
would have a problem. It is still no problem.
Senator Gramm.
Secretary O'Neill. As you know, Senator, I am not reluctant
to be alone.
[Laughter.]
Chairman Sarbanes. I understand that. That is pretty clear.
But you worry when the Secretary of the Treasury of the leading
economic power in the world is pursuing an attitude and a
policy that no one else thinks is on all fours.
Senator Gramm. First, I would like to say, Paul, that I
appreciate what you said today. I think it is very important,
it is very tempting in this world we live in, in politics, what
I guess would be the politics of political correctness, for
people to say, oh, yes, there is a problem.
You fall in love with somebody and they fall in love with
you. Well, there is a problem because something could happen to
them. There is a problem at the bottom of every good thing. To
me the problem with going around talking about the problem is
that there are people who have a vested interest to create a
problem for their own benefit. I do not blame them. I am not
being critical of them.
It seems to me that the cold reality is that even if you
wanted to manipulate the value of the dollar, that you could
manipulate it maybe for a week. And that is for our financial
position, and it would be money completely squandered. I think
that that is the first place I am coming from.
Second, we are all accustomed from early age, neither a
borrower, nor a lender be. The plain truth is our country was
built with foreign money from the time the first Pilgrim
stepped on Plymouth Rock. At least until a couple of years
after World War I, we were far and away the greatest debtor
nation in the world.
The British built our railroads. They built our canals.
They built post roads. They invested in our manufacturing. But
all those were good investments. So it was true, we had to pay
all this money to Britain, but we made more money. Maybe I am
so poor because I have never been a debtor. But I was never
confident enough that I would have known what to do with the
money any way.
The one thing we could do that would clearly lower the
value of the dollar would be increase domestic savings rates,
no question about it. If we could get Americans to save more
money, we would depress real interest rates and we would change
the flow of capital. And that would be a positive for the
world, as well as for us. So trying to create incentives or an
environment to encourage thrift, I think all those would be
very positive things. But I think, in the end, when you get
right down to it, obviously, there are a combination of
circumstances whereby current account deficits could become a
problem.
Chairman Sarbanes. Were you nodding your head to that?
Secretary O'Neill. I was. I agree with this formulation.
[Laughter.]
Senator Gramm. It depends on what is causing it.
Secretary O'Neill. Right.
Senator Gramm. That is the factor. Looking at the
underlying things. And as I look at this trade deficit, I do
not see anything right now we would want to change that is
causing it. It is not as if it doesn't accrue benefit to some
people.
The other day, I had left a shovel I was using in a truck,
the shovel was gone. I had a limited amount of time, so I went
to Home Depot and I was going to buy a shovel. I bought a
shovel for $4.52. Now, I would say that never in the history of
the world, has a quality product sold for less than that. The
plain truth is we live in a golden age. Now if I were
manufacturing shovels, I would be damned unhappy about it.
[Laughter.]
I would be calling me up, if I were a manufacturer in
Texas--I do not think we have any shovel manufacturers in
Texas. But,
I would be saying, we need to do something about it because I
am going out of the shovel business. And if you are in the
shovel
business, it is a terrible thing. But if you are buying
shovels, it
is not a terrible thing. And Government has got to balance all
these
interests.
The only way I know to balance them is do it in a way that
in the long-term benefits the most people. And it seems the way
to do that is freedom and trade and that in the long-term, that
is what benefits people the most.
So there is a dark side of it. If you are trying to sell
products on the world market or compete against imports, this
high-value dollar with this massive inflow of capital, which,
God knows, we
do not want to stop and we could use more of it in Texas. The
dark side of it is it does hurt some people. But any change in
any
policy hurts somebody. The vacationer is hurt by rain. The
farmer is helped by rain. Anything you do has advantages and
disadvantages.
I guess if you are going to worry about it, you can. But in
the end, I do not know under the circumstances we face now, I
guess my view, and I will stop, Mr. Chairman, is I do not know
what we could do differently other than better Government
policies that would encourage more thrift in the United States.
I do not think we ought to be discouraging people from
investing in America. I do not think we ought to blockade our
ports or impose tariffs. In fact, I am not sure a tariff would
do anything to this problem. If you put a tariff on everything,
exchange rates would change and it would have no effect. Only
if you put it on some things not on others, do you help
anybody.
So, I think it is so tempting to say under these
circumstances, yes, there is a problem. And I do not know
exactly what Chairman Greenspan was referring to, but I just
think that it is important to have somebody, and this happens
to be you today, who says, I do not see a problem as to where
we are now with this that we would want to fix. I think that is
right. And I agree with it. But I do not agree with you about
speculators.
Secretary O'Neill. You do not?
Senator Gramm. No. I knew you were a manufacturer when you
said that.
[Laughter.]
Speculators are public benefactors who make money by making
markets work better. And God bless 'em.
Secretary O'Neill. Let me substitute manipulator for
speculator.
Senator Gramm. Well, manipulators in a market like this
lose their shirt.
Secretary O'Neill. That is what I want.
Senator Corzine. Senator Gramm, I have never loved you so
much.
[Laughter.]
Senator Gramm. Well, I give credit where it is due.
[Laughter.]
Secretary O'Neill. May I make just two quick points?
Senator Gramm. You did not get rich without providing
value.
Secretary O'Neill. Just two quick points, Senator. Thank
you very much for your comments.
First, on the issue of current account deficit.
Economists--we did not know what this was back in the 1800's.
But it turns out we had a huge, overwhelming current account
deficit in the late 1800's. I guess it is a good thing that we
did not know about it. We might have stopped the British
investment.
Chairman Sarbanes. Well, does the same thing work today?
The world's most advanced economy, as opposed to a nation
seeking to develop itself. You apply the same test.
Senator Gramm. You develop it.
Secretary O'Neill. One of the things that I find, frankly,
a little disconcerting about the notion of a current account
deficit, and, again, I think it is a static concept.
I have to tell you what I was doing when I was running
Alcoa. Yes, I was borrowing money and getting more equity
investment. But I was taking it around the world. So the idea
that it was stuck here, the fact that ownership here did not
mean it was stuck here. It was helping to create economic
development around the world.
Second, the other point I wanted to make was about this
issue of savings. Inherent in that is a sense that we here in
Washington know better than what individuals are now doing
collectively they ought to do. I think that if you really stop
and think about it, you really believe we here in Washington
know better what individuals ought to do about savings and how
we measure savings.
Many people think their home is a savings and in fact, the
evidence has demonstrated that people are getting real savings
and ascension into the middle class by homeownership, which is
an important form of savings. The other face of that, of
course, is that we have more savings and we have less
consumption. So these are not questions without consequence.
Chairman Sarbanes. Senator Bunning.
Senator Bunning. Chairman Sarbanes, thank you. I have heard
enough conversation. I pass.
Chairman Sarbanes. Jon.
Senator Corzine. Mr. Secretary, I want to go back.
Chairman Sarbanes. I told the Secretary that we would have
him out in short order. Go ahead.
Senator Corzine. Okay. It strikes me that we have a risk by
this current account cumulative element that has built up over
the years. And that is a dynamic. It keeps growing and our
trade issues are ones, and it is a problem at a microlevel for
a lot of individuals. There is no trade adjustment kinds of
facilities that are
accompanying a lot of the problems that end up occurring as a
function of exchange rates. And if they are sustained at
relatively
high levels, whatever that might be, then I think we have
reason
as public policymakers to wonder whether the system is working
fairly.
We have talked about China with the soft peg. And the fact
is that that is an intervention into the market, not because of
their purchases of dollars on the market, although, you know,
at the margins some place, that increases the value. But if
their currency depreciates versus the dollar, even within their
pegged range, it undermines our manufacturers' ability to
compete fairly in a marketplace, if one is talking about fair
markets.
So, I think that is a legitimate problem. And if you put
that cumulatively across a lot of different countries in the
world, and there are places where there are soft pegs in other
areas--you look in a lot of the developing world, there are
soft relationships on what currencies are.
I do not know. I think that is the case in Korea. I think
that is the case in Taiwan. I think that is the case in the
Hong Kong manufacturing areas.
And with smaller currencies, it is easier to manipulate and
opposed to how it is with respect to the yen or the dollar or
the Euro.
I think that there are other structural elements of the
marketplace which you are trying to address here. But I think
our manufacturers and our workers end up on the short end of
the stick with regard to how these systems work.
I am not arguing that we ought to be in the manipulation of
the currency markets. But I think we have a real policy
responsibility to do something about changes in some of these
structures that work to the disadvantage of American workers
and American business. I do not think that all of those are not
necessarily in the trade arena. They are in structural reforms
that I think we have the impact to have real change brought to
bear on how some of these markets work.
A lot of these things do not even hit the radar screen of
trade agreements. They are the regulations that slow down the
flow of how people can participate in the markets. And that I
think is a serious problem and I think it contributes to the
long-term risk which has to do with what is the nature of the
structure of American markets, whether people lose confidence
in our markets because our accounting statements do not make
sense or that we end up running huge deficits at the Federal
Government that competes for that flow of inflow of capital. I
think these things are serious and they are potentially riskier
in a dynamic context because we build up these current account
deficits over a period of time. I guess I am siding with the
Chairman here that we have something to be concerned about.
Senator Gramm. That is a smart thing to do. That is a very
smart thing to do.
[Laughter.]
Chairman Sarbanes. Mr. Secretary, we promised you that we
would have you out, actually a little sooner. This has been a
very interesting session, as it invariably is when we have the
opportunity to exchange views with you. As you depart, I want
to leave you with one image in your mind. This is the real
foreign exchange value of the dollar. This is 1980. This is
2002.
This was the Plaza Accord. And we have heard this morning
that if you try to do something, it won't sustain itself. But
it worked for quite a period of time. Now, we are back up here.
My anticipation is that this is going to go, it will be above
where we were at the time of the Plaza Accord. So, I leave that
with you. The Treasury, in effect, brought others together and
took an initiative to try to address that.
Secretary O'Neill. May I make one observation about the
basing point in the chart for 1980?
Chairman Sarbanes. Sure.
Secretary O'Neill. I would remind you, that around 1980,
the interest rate in the United States was 20 percent and the
unemployment rate was 11 percent.
And so, if 1980 is a desirable position, that is not my
notion of desirable economic circumstances. In fact, if you
look at the period since--it is hard for me to see from here,
but it looks like 1994, 1995, when the value started rising. We
have arguably had among maybe the five best years in our
economic performance in modern history.
Chairman Sarbanes. Well, accepting all of that, we still
have, it seems to me, a real problem here.
Thank you very much.
Secretary O'Neill. Thank you. I will read the transcript of
what follows very carefully because I want you to know that I
do not have a closed mind on these subjects. I am open to
listen to information and insights that can help us advance
policy in a constructive way. So, I do not want you to take
from what I have said that I think I have the answer. No one
else knows what they are talking about. I just have not seen
compelling evidence that is connected to possible public policy
levers that would advance the cause of our society.
Chairman Sarbanes. We have some very good panelists coming,
and I am encouraged to hear that you intend to look carefully
at their testimony and the transcript.
Thank you very much for being with us this morning.
Secretary O'Neill. Sure.
Chairman Sarbanes. If the panel would come forward and take
their places, we will continue.
[Pause.]
Chairman Sarbanes. We are pleased to have a distinguished
panel now to address this issue. I believe they were all here
at least during part of the Secretary's testimony and exchange.
So, we will proceed now, and I will introduce each as we move
across the panel, instead of everyone at once.
First, we will hear from Richard Trumka, the Secretary
Treasurer of the AFL-CIO.
STATEMENT OF RICHARD L. TRUMKA
SECRETARY-TREASURER
AMERICAN FEDERATION OF LABOR AND
CONGRESS OF INDUSTRIAL ORGANIZATIONS
Mr. Trumka. Thank you, Mr. Chairman, and Members of the
Committee.
Chairman Sarbanes. And I would say to the panel, your full
statements will be included in the record, and if you can
summarize them, we would appreciate that very much.
Mr. Trumka. I will do just that, Mr. Chairman.
I am glad to have the opportunity to talk with you today on
behalf of the 13 million working men and women of the AFL-CIO,
about the economic impacts of the overvalued dollar.
As we struggle to escape the grip of recession, the
overvalued dollar represents a serious problem. It is also
causing long-term damage by destroying our manufacturing base.
Failure to redress the problem risks undermining our fragile
recovery and pushing us into a double-dip recession.
Manufacturing is ground zero of the recession, and its
troubles are intimately connected to the dollar. Since March
2001, we have lost 1.4 million jobs, of which 1.3 million have
been manufacturing jobs. Manufacturing has therefore accounted
for 93 percent of all job losses despite being only 14 percent
of total employment. Today, manufacturing employment is at its
lowest level since March 1962.
Business has slammed on the brake of investment spending,
but fortunately the American consumer has kept the recession
milder than anticipated. However, a strong recovery that
restores full employment needs a pick-up in investment
spending, and that will not happen as long as currency markets
give a 30 percent subsidy to our international competition.
Over the last 5 years, our goods trade deficit has
exploded, costing good jobs across a wide array of industries.
Last year, in the paper industry there were mill and machine
closures at 52 locations, all considered permanent, indefinite
or long-term. In the textile industry, 2 mills per week closed
in 2001, and closures continue this year.
The weakening of the yen has given Japanese car companies a
huge price advantage. The result has been loss of market share
by our Big Three automakers that threatens some of the best
jobs in America.
Boeing, which operates at the cutting edge of technology,
is losing market share to Europe's Airbus. And losses today
mean future losses because airlines work on a fleet principle.
They will therefore order Airbus aircraft 5 years from now when
they expand their fleets.
Moreover, job losses are not restricted to manufacturing.
Tourism and hotels are hurt by the strong dollar, and film
production is moving offshore to cheaper destinations such as
Canada, Australia, and New Zealand.
Many of these jobs will never come back. These are high
paying jobs that have been the ladder of the American Dream for
millions of Americans. But now we are kicking the ladder away.
Manufacturing has faster productivity growth, and
productivity growth is the engine of rising living standards.
But now we are shrinking our manufacturing base, and that is
bad for future living standards.
The Administration, as previously noticed, has refused to
address these problems. Arguments for a strong dollar, in our
opinion, simply do not wash.
Inflation is not a problem, and there is no evidence that a
lower dollar will lower the stock market or raise interest
rates. Those who say we need a strong dollar to finance the
trade deficit have the reasoning backward. We need to finance
the trade deficit because we have an overvalued dollar.
It is time for a new policy that puts American jobs and
American workers first. It is unacceptable that Japan
depreciates its currency. This will not solve Japan's problems,
and will only export them to its neighbors and to us.
China exemplifies all that is wrong with currency markets.
It has a massive trade surplus and vast inflows of foreign
direct investment. In a free market, China's currency should
appreciate, but it does not because of government manipulation.
This is a problem that appears in different shades in many
countries.
American workers are paying the price for currency
manipulation. Trade cannot be fair when we allow countries to
manipulate exchange rates to win illegitimate competitive
advantage.
Those who argue that we can do nothing about exchange rates
abdicate, I believe, the national interest. The historic record
and the 1985 Plaza Accord intervention show that we can.
Academic research shows the same. Just as we manage interest
rates, so too we can manage exchange rates.
Currency markets are speculative and respond to policy
signals. The Treasury and the Federal Reserve must take
immediate action with their international partners. The
upcoming G-7 summit provides an appropriate moment to do so.
Beyond intervention today, we must avoid a repeat of
today's overvalued dollar, just as today's problems are a
repeat of mistakes made in the 1980's. The dollar must be a
permanent focus of policy, and the Treasury and the Federal
Reserve must be made explicitly accountable.
Every trade agreement, Mr. Chairman, must include strong
language that rules out sudden currency depreciations that more
than nullify the benefits of any tariff reductions.
The Senate Banking Committee has a vital oversight role to
play in ensuring that the Treasury and the Federal Reserve live
up to these obligations.
Thank you for the opportunity to testify and submit a
report, and I would be happy to answer any questions that you
may have.
Chairman Sarbanes. Thank you very much. We appreciate your
testimony.
Next, we will hear from Jerry Jasinowski, President of the
National Association of Manufacturers. Jerry has been before
the Committee a number of times in the past. We are pleased to
welcome him back.
STATEMENT OF JERRY J. JASINOWSKI
PRESIDENT, NATIONAL ASSOCIATION OF MANUFACTURERS
Mr. Jasinowski. Thank you very much, Mr. Chairman, Senator
Gramm, and all the other Members of the Committee for your
leadership on this important issue.
I have enormous respect for Paul O'Neill. He is an old
friend. I think his leadership and his dedication to the
country have been extraordinary. And I think that it is only in
the spirit that he himself invoked, which is to say, he is
welcoming a debate, that I would like to confine my oral
remarks to a fairly direct response to what the Secretary said,
because I think that will be the most useful thing to the
Committee.
My prepared statement makes the case for why we think the
dollar has run amok, not just for manufacturers, but also for
this broad coalition here--and why it is bad for the economy.
It is not just a matter of a few special interests indicating
that this is important. There is a growing global consensus.
Let me make five points that go fairly directly to what
Secretary O'Neill talked about, that I think will be useful to
the Committee. The points all go to the argument that,
essentially, the Secretary is not addressing the reality that
we see and the growing consensus in the world sees.
The first reality is, there is an extraordinary consensus
now of academics, business leaders, union leaders,
international leaders, and others, who say the dollar is
overvalued. And in my statement, I talk about everybody from
the IMF to particular economists who say it is overvalued by
historic standards.
I think for the purposes of the Committee, though, the Big
Mac index illustrates most dramatically the reality. This is an
index the Economist Magazine uses to determine the extent to
which the dollar is overvalued. It is the cost of a Big Mac in
places around the world. The index is, according to the
Economist Magazine now, more overvalued than it has ever been
in history.
I think the chart you showed, Mr. Chairman, reflects this.
The Big Mac index reflects the reality in terms of real
products and is similar to the kinds of issues associated with
products that manufacturers and agriculture face very broadly.
The second reality that I think the Secretary really does
not address is the fact that the current account is a growing
problem and that it is directly related to the exchange rate.
I have here a chart, which is in my testimony as well. The
chart essentially tracks, as you can see, the ratio of imports
to exports, and the exchange rate for the dollar index.
What you see is an unequivocal correlation between----
Chairman Sarbanes. Which line is which in that?
Mr. Jasinowski. The top line, the darker line, shows you
the ratio of imports to exports, and that is a rough proxy for
the trade deficit.
Chairman Sarbanes. Right.
Mr. Jasinowski. What we are talking about is the current
account. Unequivocally, you see that the dollar exchange rate
affects that.
Now the Secretary says in his report, and others will say,
that the current account and our trade problems are affected by
interest rates, growth, and all the things you, Mr. Chairman,
and the Committee, know very well. But I am here to say that,
right now, the most important thing affecting the current
account problems, the growing trade deficit that we have heard
so much about, and our enormous loss of exports, is the
exchange rate.
The third reality that the Secretary does not address is
the enormous negative effect that this is having, not just on
manufacturing, but also on the entire economy. It affects the
trade deficit. It affects employment. It affects growth. It
affects the international global stability on which we are all
resting our hopes for a recovery in the economy. That is why
the IMF and many others have suggested there is a problem.
The fourth reality, and this gets to the heart of what do
you do about this, is that the Secretary is a major part of the
problem through his statements that fail to recognize the
problems associated with the dollar trade and the current
account. This misinformation distorts the markets that in fact
are supposed to be functioning correctly.
I am here to argue that we do not have a perfect market in
terms of the currency markets. We do not, principally because
the Treasury has taken the policy position that it is not a
problem. Second, and most importantly, by being for a strong
dollar, you put a floor under the currency. So, I would argue
that we do not have a perfect market in the exchange rate for
that reason, and that the Treasury is part of the problem.
My final point, Mr. Chairman, is that the solution is
therefore, at least in a first instance, pretty simple. That
is, that the Treasury ought to simply acknowledge that the
current account is a problem, the dollar is a problem, and it
ought to get out of advocating a strong dollar and instead say
it is for a sound dollar based on market fundamentals. If we do
that, I assure you we will not have a huge drop in the dollar.
We will have a gradual movement back toward the equilibrium
that all of us that are part of a sound dollar coalition are
for. And I think that would mean less Government intervention
in this market, in some respects, and a return to a truly
perfect market.
Thank you, Mr. Chairman.
Chairman Sarbanes. Thank you very much. Also, we want to
thank you for this very well considered prepared statement,
which we very much appreciate having. But I think it was
helpful for you to directly address some of the points that the
Secretary made.
Our next witness is Bob Stallman, President of the American
Farm Bureau Federation. We do not usually have you before our
Committee, Mr. Stallman, but we are pleased you are here today.
We would be happy to hear from you.
Senator Gramm. Mr. Chairman, could I just say a word about
Bob Stallman, and I will be brief ?
Chairman Sarbanes. Certainly.
Senator Gramm. I have known Bob since he was a rice farmer
in our State. He started out as a farmer talking to his
neighbors, became involved in the county farm bureau, became
President of the Texas Farm Bureau, and became President of the
American Farm Bureau.
I am sure Bob and I are not going to agree on the subject
today, but I would like to say that Bob Stallman is living
proof that talent wins out in America, if you have ability and
ideas and you feel passionate about stuff, that your neighbors
will elevate you and that starting out as a rice farmer in
southeast Texas, you can become the spokesman for American
agriculture if you have what it takes to become that. So it
just reassures me, having known somebody this has happened to.
Bob, we appreciate your being here.
Chairman Sarbanes. Thank you.
Mr. Stallman.
STATEMENT OF BOB STALLMAN
PRESIDENT, AMERICAN FARM BUREAU FEDERATION
Mr. Stallman. Mr. Chairman, Senator Gramm, thank you for
the kind words. Incidentally, for the record, I still am a rice
farmer, though just not to the extent I used to be. It is a
pleasure to be before this Committee today.
As the Nation's largest agricultural organization, our
farmer members produce nearly every type of farm commodity
grown in America and depend on access to foreign markets for
our economic viability.
We certainly appreciate this opportunity to testify on the
importance of the exchange rate to U.S. agriculture. The
exchange rate is the single most important determinant of the
competitiveness of our exports. U.S. farmers and ranchers have
been losing export sales for the past 3 years because the
dollar is pricing our products out of the market, both at home
and abroad.
Agriculture is one of the most trade-dependent sectors of
our economy. Our sector has maintained a trade surplus for over
two decades, but that surplus is rapidly shrinking. One of the
primary factors affecting our declining trade balance is the
strong value of the dollar.
We are also deeply concerned about countries that engage in
currency devaluations in order to gain an export advantage for
their producers. The real trade-weighted exchange rates for
agricultural exports from our major competitors have exhibited
a long-term trend of depreciation against the dollar, leaving
it hard to conclude that this is not a deliberate monetary
policy of these and other
governments.
U.S. agriculture relies on exports for one-quarter of its
income. In addition, and coincidentally, about 25 percent of
the agricultural production in the United States is destined
for a foreign market. With a strong dollar, we have the double
challenge of our products being less competitive in foreign
markets, while products from other countries are more
competitive in U.S. markets.
There is a strong relationship between the value of the
dollar and the domestic price of our commodities. As the value
of the dollar rises, foreign buyers must spend more of their
currency to purchase our exports, which causes them to decrease
their consumption of our commodities, or buy from our
competitors instead. The resulting drop in consumption drives
U.S. commodity prices down even further.
The increasing strength of the dollar, and steady
depreciation of the currencies of our major export competitors,
has had a profound impact on our ability to export. In fact,
the rising appreciation of the dollar is one of the primary
reasons why the agricultural economy did not experience the
economic prosperity that most other sectors of the U.S. economy
enjoyed between 1995 and 1999. This is also a jobs issue. USDA
estimates that 14,300 jobs are lost for every one billion
dollar decline in agricultural exports. As a result,
agricultural employment lost 87,000 jobs between fiscal years
1997 through 2000, a period wherein the real agricultural
exchange rate was rising rapidly and U.S. agricultural exports
were stagnating.
For some commodities, the rising value of the dollar has
directly contributed to the export competitiveness of our
foreign rivals. The strong dollar enables our competitors to
expand their production and gain market share at our expense.
Let me give you a few commodity-specific examples.
Beef: Since 1995, the dollar has appreciated 42 percent
against the currencies of beef producing countries. And I know
we had the Big Mac index over here, but that U.S. McDonald's
Big Mac is going to have more foreign beef in it, given their
recent announcement to purchase more beef from Australia. The
relative exchange rate, strong value of the dollar, has caused
that economic decision to be implemented.
Fruits: From 1995 to 2000, U.S. imports of fruits and nuts
jumped 33 percent, largely due to the dollar's 18 percent gain
with respect to the currencies of foreign suppliers of these
commodities to the United States.
Corn: The U.S. dollar appreciated 39 percent relative to
the Japanese yen from 1995 to 1998, adversely affecting our
corn exports to that market.
Soybeans: The cost of U.S. soybeans to Japanese buyers
increased 8 percent from 1996 to 1998, due to the appreciation
of the U.S. dollar, even though U.S. prices fell 18\1/2\
percent during the same period.
In conclusion, America's farmers are the most productive in
the world. However, the comparative advantages that our
producers generally enjoy are certainly mitigated by the rising
appreciation of the dollar.
Exchange rate issues are certain to increase in importance
for our sector, and if these issues are not resolved by
macroeconomic policies, there will be continued pressure to
find solutions in traditional farm and trade policies.
The effect of long-range financial planning at the farm and
ranch level and the overall economic health of U.S. agriculture
depends on more stable exchange rates that do not overvalue the
U.S. dollar against our competitors' currencies.
Thank you, and I look forward to answering any questions at
the conclusion of the presentations.
Chairman Sarbanes. Thank you very much, sir.
Our next panelist is Fred Bergsten, who is the Director of
the
Institute for International Economics, and a frequent
contributor to our discussions. We are very pleased to have you
here, Fred.
STATEMENT OF C. FRED BERGSTEN
DIRECTOR, INSTITUTE FOR INTERNATIONAL ECONOMICS
Mr. Bergsten. Mr. Chairman, thank you very much. As I
listened to the discussion this morning, there seemed to be two
questions before the House.
Chairman Sarbanes. Before the Senate.
Mr. Bergsten. Excuse me? Sorry. Before the Senate.
[Laughter.]
Bad error.
[Laughter.]
Change the words in the transcript.
[Laughter.]
Two questions before the Senate. One, is it a problem? And
two, is there something you can do about it?
My answer to both is a resounding yes, and let me briefly
summarize my statement in trying to answer those questions.
First, is it a problem?
We have to keep clearly in mind that there are not one, but
two problems, a real economy problem and a financial risk
problem.
The real side problem is the loss of output, loss of jobs,
and loss of agriculture that were talked about. The financial
risk problem is the possibility that all this could come
crashing down in a huge financial crisis with enormous
consequences for the economy.
Now what is the size of the problem?
Since the dollar hit its all-time record lows in 1995, it
has risen by 40 to 50 percent against the various trade-
weighted averages that the Fed calculates every day. And that
is like a rise in 40 to 50 percent in prices of the entire
economy in world trade. When a company sees its prices go up 40
to 50 percent in a few years against its main competition, it
is usually in Chapter 11. That is what has happened to the
United States as a whole.
Every rise of 1 percent in the trade-weighted average of
the dollar produces an increase of at least $10 billion in our
current account deficit. And so it is clear that this rise of
40 to 50 percent in the exchange rate over the last 6 or 7
years explains the vast bulk of the half-trillion dollar trade
deficit that we face today and which is getting bigger.
Indeed, we have projected the current account over the next
few years on reasonable economic assumptions, and assuming no
policy change, more of what we heard from the Secretary this
morning, and no untoward external events, the deficit would hit
7 percent of GDP--that is $800 billion--by 2005 or 2006.
Every study ever done, including by the Federal Reserve
itself, and they published this, shows that once you hit 4 to 5
percent of GDP, you are in the danger zone.
Indeed, the big crashes of the dollar which have occurred
once per decade since the early 1970's, have occurred without
our current account deficit ever getting to 4 percent of GDP,
the all-time high in the mid-1980's, before the Plaza Accord
Agreement, and the 50 percent correction in 2 years, was 3.8
percent. We are well beyond that. We are headed toward twice
that. We are clearly on an unsustainable path.
Now, in financing terms, what this requires is even worse
than you think because we not only have to import $500 billion
of capital each year to finance our current account deficit but
we also have to cover our capital outflows.
Remember that the United States itself invests lots of
money abroad. This is a good thing. I am certainly not
criticizing it. But that amount is another half-trillion
dollars a year. So the result is that the U.S. imports a
trillion dollars of foreign capital per year, to balance the
books, which is a little more than $4 billion every working
day.
It is certainly not a bad thing. The point is, if that $4
billion per day dropped to just $3 billion, let alone reversed
into an outflow, the dollar would fall sharply. And it would
fall, by our calculations, at least 20-25 percent to get back
to some kind of sustainable equilibrium level. Since markets
overshoot, it would probably go much more than that in the
short run.
That would cause sharp inflation, a sharp rise in interest
rates by several percentage points, and a sharp fall in the
stock market--a triple-whammy that would hit the economy. That
is why I agree with the statements you made before that this is
the single biggest risk to the U.S. economic outlook, and that
the Secretary of the Treasury certainly ought to be concerned
about it.
It is stunning that he said the things you quoted this
morning that he did say. It is reminiscent--this is a
nonpolitical statement, just an economic analysis--of what
happened in the first Reagan Administration, with Secretary Don
Regan and Beryl Sprinkel, which was the epitome of benign
neglect.
That turned out to be so wrong and so costly to the economy
that the second Reagan Administration had to reverse it, do the
Plaza Accord Agreement, and drive the dollar down by 50 percent
in the next 2 years. So it is not as if we have not seen this
happen before. We have seen exactly this happen before. The
Administration that permitted it to happen then had to reverse
itself 180 degrees, enlist the rest of the world to help to
save us from the enormous costs of that policy.
Second question, is there something we can do about it, as
Senator Gramm, Secretary O'Neill, and others raised, and you
yourself acknowledge? That is the more difficult question.
I believe there are policy changes that can rectify the
situation substantially without significant adverse costs
elsewhere in the economy. And that is because I believe, and I
will try to document briefly, that sterilized intervention in
the exchange markets works and can change currency movements in
important terms.
The Secretary mentioned Allan Sinai and economic theory.
There is something now in economic theory called multiple
equilibria.
Economists have now realized that for any given set of
economic fundamentals, there is in fact, a large set of
possible market outcomes, glorified by the term multiple
equilibria, indicates there is firm theoretical basis for what
I am about to say. I would suggest a four-part change in
policy.
First is what Jerry Jasinowski just said--change the
rhetoric,
absolutely.
Second, if the dollar were to rise further, as it may
because of the rapid U.S. recovery, the United States and the
G-7 should certainly lean against the wind of any new dollar
rise. That would make it worse.
Third, however, and more importantly, we should now begin
easing the dollar down toward equilibrium levels, and I will
explain briefly why I think now is the time to do it.
Fourth, we should of course make it very clear to other
countries that we will not tolerate efforts to competitively
depreciate their currencies.
The Treasury Report is stunning in that it acknowledges
huge intervention by the Japanese, but does nothing about it. I
can tell you that immediately after the rise in the yen last
fall, the Japanese began talking it down. I thought they had
quit, but they are at it again this week.
The leadership of Japan's Ministry of Finance has been
saying very clearly this week, after the yen rose four or five
yen against the dollar, that any further rise would be
inconsistent with our economic fundamentals and they are
against it. They are again trying to avoid any rise in the
exchange rate of the yen. And we should make clear that that is
verboten and will not be accepted.
On U.S. currency policy itself, it was encouraging that
Secretary O'Neill today, as for many months, did not repeat the
term, ``strong dollar.'' You will notice that he has
assiduously avoided saying that for some time now. However, he
said, there will be no change in policy, so I suppose it has
the same implication.
I would agree with what Jerry Jasinowski said, that the
Administration should change the wording and now start
supporting a sound dollar or some equivalent that made clear
that they wanted to see it in sustainable equilibrium terms, in
terms of our external position.
The presumed reason they do not want to change is they are
afraid that the dollar would then collapse. But at a time when
the U.S. economy is booming, as the Secretary said, with huge
pro-
ductivity growth, at a time when there is no dramatic growth in
Europe or Japan to suck money away, I think it is very unlikely
that a change in rhetoric would lead to a free fall, and that
is why this is the ideal time to make the change--when we are
doing well, when we are recovering strongly, and when the
others are not doing so well, unfortunately. Now is the time to
do it.
The worst policy is to wait until there is an inevitable
change in economic circumstances that drives the dollar down
when we are not in such good shape, when we cannot accept it so
well, which would cause enormous costs to our economy. And so,
it seems to me that now is the time to do it.
Final point, again, how do you do it? Change in rhetoric
and direct intervention.
Notice that the Rubin-Summers Treasury intervened on three
and only three occasions, from 1995 through the end of its
tenure in 2000. Every one of those changes, in my view, worked
like a textbook.
In 1995, when the yen was rising too far, got to 80, the
dollar in fact was at its all-time record lows against both yen
and Deutschmark. We intervened jointly with the G-7. We stopped
the rise of those other currencies, stopped the fall of the
dollar, turned it around, and within a few months, the dollar
was headed up, and in fact, it has never stopped since. We were
100 percent successful.
In 1998, the yen was becoming too weak, just like it is
today. It got to 145. The United Stated intervened, along with
Japan, and stopped the decline of the yen. It stabilized in
that range for a couple of months and then rose back to 100. It
was a total success.
Third intervention, September 2000. The Euro fell to its
all-time lows. The Europeans got upset. Again, that was pushing
the dollar to get further overvalued. Joint U.S.-E.U.
intervention stopped the decline on a dime. The Euro turned
around, rose 10 percent, subsequently fell back halfway. It has
been there ever since.
On my reading, in all three cases, three out of three, it
worked. I believe, incidentally, the Plaza Accord was a huge
success and the notion ex-post that it was just riding along
going down the stream, frankly, is post hoc ergo propter hoc
reasoning, and was not clearly in the minds of the people who
did it at the time, who saw an enormous need to change the
trend and do something about it.
There has been scholarly work by Franckel and Domingues at
my institute. The Banca d'Italia's working with classified data
suggested that every major intervention in the 1980's and
1990's worked and turned the currency relationships around in
the desired direction.
So my conclusion is very simple. There is a big problem and
there are policy tools available to deal with the problem
without adversely affecting other parts of our economy.
At a minimum, we should try it. The costs are too high. The
risks of trying this I think are very modest if it were to
fail, but the prospects for success are very strong and I think
that alternative policies should be pursued.
Thank you.
Chairman Sarbanes. Thank you very much.
Our next panelist is Ernest Preeg, who is the Senior Fellow
at the Manufacturers Alliance. We would be happy to hear from
you.
STATEMENT OF ERNEST H. PREEG
SENIOR FELLOW IN TRADE AND PRODUCTIVITY
MANUFACTURERS ALLIANCE / MAPI, INC.
Mr. Preeg. Thank you very much, Mr. Chairman. It is a
pleasure to be here today.
I will focus my remarks on one particularly disturbing
aspect of the trade deficit, namely currency manipulation to
commercial advantage by certain trading partners, and in
particular, by China.
I do want to say, though, as in my written statement, that
I see the current account deficit and accumulated foreign debt
as a problem. The most immediate concern is that a rapid rise
in our trade deficit this year, almost all of which will be in
the manufacturing sector, could be the Achilles's heel for the
hoped-for sustained recovery because it is hitting our
investment sector particularly hard, and that is the lagging
sector.
As for currency manipulation, the IMF clearly proscribes
it. There is an IMF statute that members should not be
manipulating their exchange rates to gain an unfair competitive
advantage. And a principal indictor of such manipulation under
IMF surveillance procedures is very precise. It says that
members should not make protracted, large-scale interventions
in the market in one direction--namely, to buy dollars and
other foreign currencies--to keep their currencies down and to
gain an unfair competitive advantage.
Japan has gotten the most attention on this because for
several years, they have made such protracted, large-scale
interventions, $250 billion all told. Fred has given some
examples of this.
And I should state here, to clarify earlier discussion,
what I call the great asymmetry in central bank intervention.
If you are trying to keep your currency up, as Argentina did
with the peso, you have to sell dollars. Everybody thus knows
when you are going to run out of dollar holdings, and it is a
limited time.
In the other direction, as we are talking here, when you
want to keep your currency down low, that is manipulate it
down, you can buy unlimited dollars year after year,
indefinitely, as Japan and China have been doing--as much as
$50 billion each year--to offset the market forces in the other
direction stemming from a trade surplus, for example.
Turning to China, they have also manipulated their
currency, but it is a more complicated situation. It has not
received as much attention perhaps for that reason, because
China has a fixed rate, but the currency is not convertible on
capital account. In effect, the exchange rate is not really
market-oriented.
But the facts are nevertheless very clear, as was cited
earlier by Senator Bunning. Last year, for example, China had a
$25 billion trade surplus, globally, and a $45 billion inflow
of foreign direct investment. This would put major upward
pressure on the exchange rate. At the same time, however, the
central bank bought $50 billion, to take dollars off the market
and ease the pressure.
More precisely, the Chinese central bank has taken away
three-quarters of the upward pressure on its currency from the
trade surplus and foreign direct investment. And here, again,
another technical comment on the earlier discussion. What
counts are not the gross flows in markets, a trillion dollars a
day. Most of this is just in and out, offsetting. It is the net
flow of trade and foreign direct investment, and the net
borrowing of central banks that needs to be considered. And on
this net basis, the numbers for Japan and China have been very
large and have had substantial impact in keeping the exchange
rate down.
So the net result, in my judgment, is that China has a
substantially under-valued exchange rate for the yuan and the
direct impact, of course, is a larger trade surplus with us--
export jobs they gain and export and import-competing jobs we
lose. There are several other benefits to China from its
currency manipulation in my statement. I won't go into detail.
One was mentioned earlier, that perhaps at some future point,
they could use their excessive currency holdings for foreign
policy leverage.
A more immediate benefit for China is that with $220
billion in their central bank--fungible money--there is no
financial constraint to buying large amounts of armaments from
Russia or elsewhere. They have huge amounts of money in the
bank that they could use it for this, and for several other
reasons as explained in my statement.
I agree with the others that we need a clear and forceful
response to this now chronic trade deficit. It is headed toward
record levels over the next couple of years. And a $3 trillion
net foreign debt accumulation is headed toward $5 trillion by
mid-decade. What should we do?
First, as Senator Gramm mentioned, we have to save more
because we are currently living beyond our means. The foreign
borrowing is not being used for investment, as was indicated,
but mostly for immediate consumption. Eighty percent of our
foreign borrowing, more or less, is for immediate consumption
and we leave the consequent foreign debt to our children and
grandchildren to pay interest and principle. I do not think
that is right.
So, we need to save more. And at the same time, we have to
get trading partners such as China and Japan to save less and
consume more, so that their economies do not have to be
dependent on a large trade surplus, for which they manipulate
their currency. They don't now have a domestic economy growing
fast enough, and thus rely on a chronic trade surplus to
maintain growth. We need to achieve a better balance, to save
more and not spend beyond our means. And others need to do the
opposite.
The other immediate objective, in my view, is to stop
others from manipulating their currencies so as to have bigger
trade surpluses than they would have based on market forces
alone.
We have a clear opportunity to do this in the IMF based on
very explicit surveillance criteria. All we have to do is ask
for a consultation to say that the others should stop their
currency manipulation. We have never done that.
There is even an article in the GATT and the World Trade
Organization, I believe Article XII, along the same lines. We
have never thought seriously about that, either.
We should take steps, both through bilateral consultations,
and within the IMF context in a more formal way, to try,
particularly with East Asians including Japan and China to stop
further currency manipulation, which distorts exchange rates
from what markets would determine.
And for China, finally, the bilateral consultations should
be a very high priority. We have a mutual interest in reducing
the very lopsided, 5:1 trade imbalance, with $100 billion U.S.
imports and only $20 billion exports, last year, and we should
begin with the question--why is the bilateral trade so
imbalanced?
We should request, clearly, of China, that the central bank
stop buying dollars at $50 billion a year, and that they bring
their exchange rate up by 10 percent, 20 percent, or whatever
is a reasonable first step.
The longer-term transition of China to a fully convertible
floating rate relationship with the dollar should also be
discussed. We should look at this seriously because that is
what I believe the longer-term objective should be. It is a
mutual interest and it is the best way to avoid trade conflict
from further unjustified Chinese currency manipulation.
Thank you, Mr. Chairman.
Chairman Sarbanes. Thank you very much.
Our concluding panelist is Steve Hanke, a Professor of
Applied Economics at Johns Hopkins University.
Mr. Hanke.
STATEMENT OF STEVE H. HANKE
PROFESSOR OF APPLIED ECONOMICS
JOHNS HOPKINS UNIVERSITY
Mr. Hanke. Thank you, Mr. Chairman, Senator Gramm.
Let me just briefly make a few points that pick up on some
of the things that have been discussed in the morning session.
My remarks will highlight points that are developed in my
prepared statement.
Chairman Sarbanes. We will include your full prepared
statement in the record and we appreciate your condensing it.
Mr. Hanke. Thank you, Mr. Chairman.
We have hearings in which ``exchange rate policy'' is
stated, as one of the phrases in the title of the hearings
themselves. And interestingly enough, if you look at the U.S.
evolution of exchange rate policy in general, we really did not
have any coherent policy stated in the United States, until
1999, when Secretary Rubin, in April, articulated the policy.
Then Summers followed in September 1999, after he was
appointed Secretary, and Stanley Fischer at the IMF weighed in
with essentially the same conclusion in January 2001.
Now what did they say about exchange rate policy and why
are their statements important?
There are three generic types of exchange rates--a floating
rate, which Rubin and company said was suitable for the United
States. And that is a rate in which the exchange rate itself is
on autopilot. You only have a monetary policy. You have no
exchange rate policy under a floating exchange rate regime.
At the other extreme, you have an absolutely fixed exchange
rate regime in which an exchange rate policy exists, but
monetary policy is on autopilot. And that would be things like
orthodox currency boards or dollarized systems.
Rubin, Summers, and Fischer came to the conclusion that I
think all economists have come to, and that is, in a world of
mobile capital and free capital flows, those two extreme free-
market, automatic systems are desirable. And everything else in
between is undesirable.
Now what is in the middle?
A pegged-type system is in the middle. For example,
Secretary O'Neill mentioned that China has a soft peg. Well,
they do have a soft peg. And the reason the thing doesn't blow
apart is that China has extremely rigorous capital controls--
the capital account is completely controlled.
So those are the three systems and as you can see, as a
matter of principle, the Chinese system would be undesirable,
according to Rubin, Summers, Fischer and most economists,
certainly the major consensus.
What does this have to do with the hearings?
Well, it has a couple of things to do with the hearings.
The Bush Administration has never gotten around to articulating
and reaffirming what Rubin and Summers did. And Krueger has
never reaffirmed what Fischer did. So, we need some clarity. I
think you should push Secretary O'Neill to come forward with
some clarity on the U.S. broad policy position.
For the United States, we accept floating. Now that has
some implications, especially for the strong dollar rhetoric.
Our exchange rate policy is a floating exchange rate. It is not
a strong dollar policy. A strong dollar policy is nothing but
rhetoric and absolute economic nonsense. It doesn't mean
anything in economic terms. The dollar's value is determined in
the market and under a floating exchange rate, that
determination is on autopilot.
So, I would agree with Jerry and Fred on this thing. Any
adjective for the dollar--whether it is strong, sound, or
weak--doesn't mean anything if you accept free capital mobility
and a floating exchange rate because the dollar's price is
simply on autopilot.
I think, Mr. Chairman, I see a red light on your little
gauge.
Chairman Sarbanes. Why don't you go ahead if you have a few
more points you want to make.
Mr. Hanke. This rhetorical point would be one thing on
which, oddly enough, Fred, we are in agreement.
Now let me mention something on which Fred and I probably
would not agree. The world is already very much unofficially
dollarized. That means that 90 percent of all foreign exchange
transactions have the dollar on one side of the trade. Ninety
percent of all commodities traded in the world are invoiced in
dollars. So, you do not have this so-called exchange rate
problem that we have been discussing. They are buying and
selling in dollars and invoicing in dollars.
Now, in terms of manufactured goods, Mr. Chairman, the
issue gets a little bit tricky to sort out and make
generalizations. But I can tell you that about 35 percent of
exports from Japan are actually invoiced in dollars. They are
dollarized. And almost 65 percent of all the imports going into
Japan are dollarized.
The point here is, if you really want to get around these
problems with exchange rates, Fred, and the competitiveness,
uncom-
petitiveness, competitive devaluations and so forth, what we
should do is try to encourage the official dollarization of
most smaller countries--I am not suggesting Japan or Euroland
because that would put them in the same currency bloc as the
United States and we would not have to spend much time with
these conversations because everyone would be buying and
selling and invoicing and dealing in dollars. I would point out
that, generally, the U.S. dollar can be characterized as a
vehicle currency in the world that is truly dominant in
staggering ways.
We had an earlier conversation about dollar reserves held
at the Chinese central bank, as well as the Bank of Japan and
changes in those. About 66 percent of all the foreign reserves
held at central banks in the world are in dollars or assets
denominated in dollars. So, I think if we go after every
central bank using dollars in this way, in an official way, we
have a lot of villains out there that we are going to have to
go after, just not Japan and China.
Mr. Chairman, I appreciate your letting me overindulge on
time. I think I have made some of the main points I wanted to
make, in any case. Thank you for giving me the extra time.
Chairman Sarbanes. Thank you very much, Professor Hanke.
I might mention that the Committee has received a number of
letters from across the country from various manufacturers and
producers with respect to this hearing, expressing their
viewpoint which has been expressed by some of our earlier
panelists here today, which we will place in the hearing
record. What is the response to this dollarization statement
that Professor Hanke made?
Mr. Jasinowski. I think it makes general sense. I do not
know how far it can go in terms of dealing with the central
problem of the strong dollar policy being advocated by the
Treasury. But it does, I think, help on the demand side with
respect to dollars. And therefore, I think it is good in that
sense. It is also good in the sense of the dollar currency
being a more stable currency than most. So, I would initially
be positive toward that.
Chairman Sarbanes. As I understand it, the assertion is
that a good part of the Japanese trade is invoiced in dollars.
I take it you then draw from that the conclusion that the
exchange rate difference is not affecting the trade balance. Is
that right?
Mr. Bergsten. Mr. Chairman, let me take a stab at that.
In this context, dollarization is a narcotic because, with
most of the world's trade financed in dollars and with most of
the reserves in central banks held in dollars it is very easy
for us to finance these big deficits relative to other
countries whose currencies are not widely used in international
finance.
Charles de Gaulle 35 years ago said that the United States
ran deficits without tears. And the reason he said that was
because
he argued, and he was right then, and it is happening right
now--
that foreigners acquire dollars as they run their trade
surpluses,
tend to hold them in dollar terms, and that, ipso facto,
finances our
deficit.
So it is quite easy for us, relative to anybody else, to
finance these huge boxcar deficits, and there is no secret, in
fact, to why we have been able to run them. In part, it is
because the dollar is the world's currency.
The flip side of that, however, is that it is quite
difficult for the United States to change its exchange rate if
it decides it wants to do so because its exchange rate--our
dollar exchange rate--is essentially in the hands of other
countries.
As Hanke said, we float freely. So if Japan wants to
intervene and buy dollars for their reserves, they have the
perfect right to do that under the way the system works.
We then have to take an initiative to counter that and say,
quoting Ernie Preeg, but that is not consistent with the IMF
rules and with international equilibrium. But we are in a free-
floating system where the kind of debate we are having around
this table today is replicated in every G-7 and other meeting
where they address this, because there are really no rules of
the game and there is no notion of what is an equilibrium
exchange rate.
That is why for many years I have supported a target zone
exchange rate system. I do not agree with Hanke that there is a
consensus on the so-called two corners approach. The world has
been moving very rapidly away from that because it realizes the
shortcomings. But that is for a different day.
The point is when the United States decides that it needs
to do something about its current account and the exchange
rate, it has to take a major initiative.
John Connally did it in 1971 and brought down the Bretton
Woods system of fixed rates in order to get the dollar
depreciated.
Jim Baker did it at the Plaza Accord in 1985. To bring the
dollar down, he had to get G-7 agreement to bring the dollar
down. The United States could not do it by itself.
I am thinking now of Senator Gramm's comment about the
cheap shovel. The fact that the dollar is international
currency makes it much easier for us to buy the cheap shovel
and that has big consumer benefits. But the fact that it does
create deficits without tears and makes it easy to finance,
makes it easy for the dollar to get overvalued and to cause the
problems that we are talking about today.
One other historical example that proves the point is the
U.K. All through the period of the sterling's dominance as the
world's currency, in the 19th century, and into the early 20th
century, the exchange rate of the sterling was vastly
overvalued.
The British manufacturing sector ran into the ground and
here they are 100 years later without much. I hope we do not go
that way. It is a slow process. It is more like termites in the
woodwork than it is a crashing crisis, although every once in a
while the sterling and the dollar had a crisis.
But the role of the dollar is actually, in this context,
rather insidious, and it sets us up for the kind of competitive
problems we have and the occasional crash in the exchange rate,
which I repeat, we have experienced once a decade now
throughout the modern post-war period.
Chairman Sarbanes. Mr. Preeg.
Mr. Preeg. Mr. Chairman, in response to your question about
when should countries dollarize, it is their choice. This goes
back to the optimum currency area discussions and analysis of
40 or 50 years ago.
My own assessment, and it is widely shared, is that smaller
economies that are very open to trade investment, and that are
predominantly dependent on one major trading partner like the
United States, are the most apt to be net beneficiaries of
dollar-
ization. There are pluses and minuses that have be considered,
and this is a net assessment.
In my judgment, the countries of the Caribbean Basin, and I
believe also Canada and Mexico, based on the numbers, plus and
minus, would thus benefit from dollarization. Argentina is not
in that category and has paid a heavy price.
The second point, trade is invoiced in dollars, but that is
not, in my judgment, relevant because it is the dollar prices
that count.
Toyota car exports to the United States may be invoiced in
dollars, but at what dollar price? And if Japan keeps the
exchange rate down, Toyota can maintain lower dollar prices.
Chairman Sarbanes. That is the point I was trying to make.
The fact that you are invoicing in dollars does not take out of
the
picture the problem of a mismatch in the exchange rates. Is
that
correct?
Mr. Jasinowski. I think that is right, Mr. Chairman, it
does not. I should have said that myself, and that is what
Ernie's saying.
Chairman Sarbanes. Yes. Did you want to add something?
Mr. Hanke. If I may. One thing you asked, is it desirable
to dollarize?
Chairman Sarbanes. Now, I wasn't really addressing that
question because I think that depends a lot on the countries
and the nature of the trade. I was trying to get to the
question, the assertion that the Japanese were invoicing in
dollars. You gave some figures of the percent of trade.
Mr. Hanke. Right.
Chairman Sarbanes. I was really trying to explore whether
that means that it renders the exchange rate discrepancy
irrelevant.
I think Mr. Preeg essentially answered that question
because it is still relevant in terms of what dollar level you
place on the invoice, so to speak. So that is affected by the
exchange rates.
Mr. Bergsten. The exchange rate would become irrelevant
only for a country that dollarized and adopted the dollar as
its official currency, not one that just invoices dollars. You
are right, the invoicing is a technical thing.
Chairman Sarbanes. Well, that is what I was trying to get
at.
Mr. Hanke. It gets a little bit tricky because, let's say
you are importing, one big import, and it is oil. And it is
priced in dollars. Well, that affects your cost structure
because that is an input that you are bringing into your
economy. It is purely priced in dollars.
Chairman Sarbanes. That is a reasonable point on oil. But
we do not have that in either the Japan or China trade where we
are running these extremely large deficits.
I am struck by how disproportionate the trading
relationship is. It is 5:1 in China and it is about 2:1, I
think, in Japan. With the Europeans, they are at about 45
percent, I guess, of the trade is our exports and 55. So that
is in a much narrower range. But this China and Japan trade,
particularly China now because that is a growing trade, the
disproportion, I do not know how long you can sustain that
disproportion.
Mr. Hanke. I have spoken at least to Under Secretary Taylor
privately about this, and he has an appreciation for the
bipolar view expressed by Rubin and Summers. If we adhere to
that, we should be putting a lot of pressure on the Chinese to
change their exchange rate set-up and get rid of capital
controls. Right?
Mr. Preeg. Right. Short of that, they should stop
intervening now and bring their currency down 10 or 20 percent.
Mr. Hanke. Now one thing I would like to ask Fred----
Mr. Preeg. Well----
Mr. Hanke. If I could ask Fred----
Chairman Sarbanes. Let me regain control here because, as
interesting as this is----
[Laughter.]
Time is passing us by and I want to make sure Senator Gramm
gets his shot.
Senator Gramm. Mr. Chairman, I appreciate that. I do not
want to miss my cheap lunch.
[Laughter.]
Let me first say that I never met anybody who said to me, I
want to have a strong dollar. If there is such a person out
there, I never met them. I have to believe that this strong
dollar business is a strawman. I represent 21 million people
and they have greatly diverse views. Some of them even oppose
me.
[Laughter.]
But I cannot help but believe that, out of 21 million
people, there would be some strong dollar guy and I would have
heard from him. So, I am just mystified by all this strong
dollar business. And I have to conclude that it is a strawman.
Second, we have not had a crisis in the dollar since we
went on flexible exchange rates. I remember I was an economist
and I took the world very seriously.
[Laughter.]
I remember when Nixon went on price controls. We got a
group of people together, my sweet wife, who is also an
economist, and several of our colleagues, and we decided, since
the world was going to hell, a Republican president had gone on
wage and price controls and they had not worked since
Diacletian, or the Code of Hammarabbi, that there was reason to
be disturbed.
So in 1971, we went out to eat, and we did note that one
thing about flexible exchange rates, and there was a debate
then that the dollarization debate then was the gold standard.
There was a little debate, should we be on a gold standard
flexible exchange rate? But nobody with any sense thought we
ought to have pegged exchange rates, because we were always
defending the dollar.
Though I would have to say, when I was a graduate student,
I thought, well, maybe I would want to defend the dollar. It
sounds exciting. You have your sword. You are defending it. We
have had no crisis in the dollar that I can see, and I have
been here. I have watched every day. My keen observations, I
have not seen it.
Now let me turn to this chart. I cannot afford one of these
big charts. But I see a lot of different things on this chart
than other people see.
First of all, let's just go 3 years on either side of 1985.
In 1982, 1983, 1984, and 1985, the economy was blowing and
going and the value of the dollar was just shooting right
through the roof. Did a crisis occur and the value of the
dollar just collapse in 1985? Well, if it did, I missed it, and
I was here.
In 1985, the value of the dollar falls right through the
floor and yet, I remember no crisis. And the economy was about
as good in 1986, 1987, and 1988 as it was in 1983, 1984, and
1985. Now what does that tell me? Well, it tells me that market
forces produced the high-value dollar and market forces
produced the low-value dollar and market forces generate what
market forces generate in terms of underlying economic forces.
In fact, I could have a theory based on these numbers that
elections determine the value of the dollar.
When Ronald Reagan was elected President and a Republican
Senate was elected, the value of the dollar went up like a
rocket. And when Republicans lost control of the Senate, the
value of the dollar collapsed.
[Laughter.]
And when Republicans won control of the House and Senate in
1995, the value of the dollar went up like a rocket.
Now do I really believe that there is an election theory of
currency values? Well, I believe it more than I believe that
there is manipulation of exchange rates. I think there is more
scientific basis to it because there is a logic to it.
Where would you get $50 billion a year to put into currency
manipulation, Mr. Preeg?
Mr. Preeg. What they do to keep their currency down is you
buy dollars.
Senator Gramm. Yes, but where do you get the money to buy
it?
Mr. Preeg. With the Chinese printing press.
Senator Gramm. Fifty billion dollars--printing? They do not
print dollars.
Mr. Preeg. No, yuan. They are buying dollars, paying out
their currency in order to take those dollars off the market
and keep the exchange rate down.
It is the opposite of what Argentina went through. China is
simply taking those dollars off the market because people have
all these dollars from the trade surplus and the FDI. The
dollar holders want to convert them into yuan. And the capital
account is constricted.
So what the Chinese central bank does is to print yuan, $50
billion last year, and give it to these people who give the
central bank in return the $50 billion. The dollars are thus
taken off the market and there is less upward pressure on the
exchange rate in formal and informal markets.
That is the great asymmetry, as I said before. There is an
entirely different situation when you are trying to defend an
over-
valued currency and you only have so many dollars to sell. But
when you are buying dollars that people are willing to sell, as
has
been happening in Japan and China, there is no limit to the
official purchases.
Senator Gramm. Why does it work in China and fail in Japan?
Mr. Preeg. It has been working in Japan the last 5 years,
too.
Senator Gramm. Well, the economy has gone to hell. How is
it working? Why haven't they protected all these manufacturing
jobs that we are exporting?
Mr. Preeg. No, they haven't. The objective is simply to
keep a big trade surplus. We economists call it mercantilist.
Senator Gramm. Is that your objective?
Mr. Preeg. No, that is the Japanese objective.
Senator Gramm. But our objective is prosperity. Right?
Mr. Preeg. Well----
Senator Gramm. It is mine. Is that yours?
Mr. Preeg. My objective is to have market-oriented exchange
rates.
For the Japanese, it may be a foolish policy, but they have
kept the largest trade surplus in the world over the past 5
years, to a large extent because they have manipulated their
currency below market-determined levels.
You may say that they shouldn't do that. I would say that
they shouldn't do that. You shouldn't make your economy
dependent on a large trade surplus as they have. They should do
the structural reforms that everybody advises them to do.
Senator Gramm. I am running out of time and I am not going
to get into an argument with you. But let me tell you what I
think is happening.
Chairman Sarbanes. Actually, the Japanese now are looking
for the trade to pull their economy up.
Senator Gramm. I would say that Japan has had a huge net
capital outflow because people are not investing there and
people there that are able are investing here, and that has
been the determining factor.
Mr. Bergsten. Except, Senator, that, as he said, part of
their, ``capital outflow,'' has been a huge build-up in the
official reserves of the Bank of Japan, which now exceed $400
billion. It has----
Senator Gramm. I am glad they have it. The policy in China
under your thesis would be it would be just as good to not sell
us the goods, but take them out to sea and throw them
overboard.
Mr. Bergsten. No. In their case----
Senator Gramm. And print the money to pay for them, and
just go right on.
Mr. Bergsten. Just to elaborate on what Ernie said, in the
Chinese case, because of exchange controls, they require the
export earnings of a Chinese exporter to be sold to the central
bank for local currency.
Senator Gramm. I understand they do that. Their economy
would be better if they did not. Are you proposing that we do
it?
Mr. Preeg. No.
Mr. Bergsten. I am proposing that we suggest they not do
it.
Mr. Preeg. Right.
Senator Gramm. I do not mind suggesting they not do it.
Mr. Bergsten. That is what we are saying.
Senator Gramm. If you are in China, do not do it. It is
stupid.
Mr. Bergsten. That is what we are saying.
[Laughter.]
But the implication would then be an appreciation of the
renminbi and some modest depreciation of the dollar, which
would help solve the problem that we are talking about here.
But it would be through their change in that case, and
likewise, with Japan.
Chairman Sarbanes. Jerry, did you want to add something?
Mr. Jasinowski. Since Senator Gramm liked the chart, and
certainly saw a number of things in it beyond what I saw, I
wanted to just say, Senator, the chart always reflected the
fact that there are a number of variables that influence trade,
as you know better than anyone, from growth to interest rates
to the performance of the economy--and the chart reflects that.
And therefore, your comments are correct.
We are not here to say that the exchange rate is the only
determinant of trade, I should say. We are here to say, though,
that anybody who says that the exchange rate does not affect
trade--that is our position--is dead wrong.
Senator Gramm. Oh, of course it does. But what affects
exchange rates? That is where we differ.
Mr. Jasinowski. Okay. But then I want to go on to repeat
the point that I said earlier. If you have a Treasury policy,
and we certainly have heard it and we would be happy to
document it for the Committee, about a strong dollar, and the
rhetoric----
Senator Gramm. The Secretary never uttered strong dollar
when he was here. And he was belligerent and he would have said
it had he meant it.
Mr. Jasinowski. Well, I also can tell you if you go back to
the Reagan Administration, I was involved with the Plaza
Accord. I was involved with Secretary Baker and others and
there were comments that came out of that Administration about
a strong dollar and how wonderful it was. If you have any
Administration that is shouting from the rooftop, even if they
do not use the term, ``strong dollar'' about how unmitigated
higher and higher exchange rates for the dollar are desirable
you are going to affect trade flows. That is the only point
that I would make.
Senator Gramm. Well, the only thing I would say is that, of
all the times that I met with President Reagan, and of all the
conversations that I listened to, I never heard him mention
strong dollar. I never heard him mention it.
Mr. Bergsten. Mr. Chairman, could I say one other thing to
Senator Gramm because you said, ``Senator, you had not
experienced any crises under floating exchange rates?''
Senator Gramm. I did not see one in 1985.
Mr. Bergsten. I want to give you two examples.
Senator Gramm. Okay.
Mr. Bergsten. If the chart went back a couple of years
earlier--and I have scars on my back because I was in the
Carter treasury--there was a dollar crisis in the late 1970's
under floating rates. The dollar collapsed----
Senator Gramm. Because of inflation.
Mr. Bergsten. Because of inflation and it added, then, to
the inflation and it pushed up interest rates, and we had to do
a huge intervention in the exchange markets in addition to
doing things on the domestic front.
Paul Volcker finally came to the Fed.
That was a real crisis under floating rates. But I want to
make a more subtle point. There was a crisis in 1985 with that
strong dollar, even aside from jobs and all that. The crisis
was in trade policy.
You may remember, friends of mine in the House--I cannot
quote any Senators--said, if the Smoot-Hawley tariff itself had
come to the floor at that time, it would have passed, because
of the huge decline in our competitive position.
You remember, there were Gephardt amendments----
Senator Gramm. Listen, I remember the automobile industry
came to me and said, we are going to have to go out of
business. General Motors could go broke. We were producing
crappy cars. We were producing crappy trucks. The guys on
Monday were thinking about the weekend. The guys on Friday were
thinking about the weekend to come. They were having--what is
the country song--daydreams about night things in the middle of
the afternoon.
[Laughter.]
We got the hell kicked out of us. They came here and said
to Reagan, protect us. And Reagan, in essence, said, compete or
die.
Mr. Bergsten. No.
Senator Gramm. And now we make the best trucks in the world
and our cars are as good as anybody's in the world. Why?
Because we had to.
Mr. Bergsten. No, but Senator----
Senator Gramm. You all created the crisis in the Carter
Administration.
Mr. Bergsten. No. President Reagan put import controls on
cars. He had the Japanese do the so-called voluntary export
restraints that limited car exports here for 10 years. He did
it on steel.
Senator Gramm. He did it absolutely as little as he could
get away with. He jawboned.
Chairman Sarbanes. How much did the Plaza----
Mr. Bergsten. It was because of the overvalued dollar.
Chairman Sarbanes. By how much did the Plaza Accord, done
during the Reagan Administration by Secretary Baker, affect
this relationship of currencies?
Mr. Bergsten. The dollar came down 50 percent on average
over the next 2 years.
Chairman Sarbanes. Fifty percent.
Mr. Bergsten. Fifty percent, having gone up 50 percent from
1980 to 1985. I am not criticizing President Reagan. I am----
Senator Gramm. Cause, or did it just happen?
Mr. Bergsten. It was a response to the policy mix of the
huge budget deficits and very high interest rates that brought
in huge amounts of capital, drove the dollar sky high, and I
actually had sympathy with the Reagan Administration when they
went for import controls on autos, steel, machine tools, all
those things. But it was because the exchange rate had driven
the firms into an uncompetitive position. My point is simply,
that is what we are confronting again today.
Chairman Sarbanes. Mr. Preeg, you wanted to add something?
Mr. Preeg. Just a technical correction. I believe it was
closer to 40 percent. But it had already come down 10 percent
before the Plaza meeting. The Plaza participants agreed that
the dollar should go another 12 percent, which is an awfully
precise projection. And there was a very modest intervention.
They were very small numbers compared with today. And then the
dollar overshot and went down another 30 percent.
So my judgment is that the market forces were already in
play because the dollar had already come down 10 percent, and
we may be starting that way today. Very heavy market forces
were in play, although the official intervention did help.
Also, politically, calling for G-7 intervention is
something I would advocate today. Rather, we should say that it
is in our mutual interest to gradually bring down the U.S.
trade deficit. If we once said that and let the market forces
respond, I believe that the dollar would begin to move down
somewhat.
Senator Gramm. Mr. Chairman, I am going to lunch. But I
want to thank you. It was an excellent hearing.
Chairman Sarbanes. Yes. We are going to draw it to a close.
I want to read into the record an interview that Secretary
O'Neill had with the AFX News Limited Service. These are
quotes. Of course, the Secretary is not here and I guess he
could argue that he has been misquoted, but anyhow, this is
what people read and this is what they take their message or
signals from. This was on March 15, so it was not that long
ago:
We have a so-called strong dollar policy and it is
consistent and constant and there is no change, he said,
suggesting he is immune to U.S. industry complaints. I do not
feel pressured to change the strong dollar policy, he stressed.
That is because, earlier, they asked him about whether he
was experiencing a lot of pressure. Actually, he said, O'Neill
would not comment on whether he expects the rebound in U.S.
manufacturing to help ease the pressure manufacturers have put
on the Bush Administration to change the strong dollar policy.
I hadn't noticed, he facetiously said of the repeated lobbying
attempts by manufacturing associations and U.S. automakers to
get the Administration to abandon his policy. And then he went
on with this quote about a strong dollar and not feeling
pressure.
The Treasury Secretary also said he does not regard the
current account deficit to be a risk to the economy because it
is irrelevant. I just think it is a meaningless concept in a
globalized economy, he said, despite some forecasts that the
deficit could reach 6 percent of GDP within the next 3 years.
Economic policymakers should not pay attention to the deficit,
he said, explaining that the only reason that I pay attention
to it at all is because there are so many people who mistakenly
do so.
I think today was more or less consistent with these
statements.
Let me ask this question. Do you think that the exchange
rates, that a Plaza-like effort, or a major effort--has the
economy developed in such a way worldwide that your ability to
have an impact has been diminished or undercut? Or if you
prepared to move ahead with an active policy, could you have an
impact?
Mr. Jasinowski. Mr. Chairman, let me just start the
response by saying that most of us have stressed a several part
policy correction. The first part of the correction is for the
Secretary of the Treasury to acknowledge the problem, to stop
talking about a strong dollar, and to allow markets to make
some judgment--apart from the Treasury putting a floor under
the dollar.
Words do make a difference. Rhetoric affects the markets.
That is policy step number one. And that will clearly work.
There is wide consensus on that. In fact, there is a quote in
my testimony about how much the market-makers believe the
dollar would adjust by that alone.
The second step, which Fred has emphasized, is that if we
proceeded with an effort to get agreement among our major
trading partners and have them support a new set of policies
that would stress fundamental factors, and intervention, yes,
it could have an effect.
Mr. Bergsten. Just to echo what I said earlier, Mr.
Chairman, I actually think the prospects for intervention
working now are at least as good as in the past at the time of
the Plaza Accord.
I noted that the Rubin-Summers Treasury tried it only three
times in 5 years. I think it worked just like a textbook would
say, on all three cases. The fact that they have not intervened
much actually means that, if they were to do it now, it would
clearly have more effect. If intervention is done every day
routinely----
Chairman Sarbanes. It would require a joint effort, I take
it, by the G-7.
Mr. Bergsten. There are several criteria. It has to be
sustained, cooperative, well-coordinated. The rhetoric has to
be consistent.
Chairman Sarbanes. Do you think it is likely we would get a
cooperative, well-coordinated effort on the part of the others?
Mr. Bergsten. I think the Europeans clearly would agree to
intervene to strengthen the Euro. There would be difficulty
with them on how much. The Europeans would agree to move the
Euro back at least to 1:1 against the dollar. They might begin
to get hesitant beyond that, even though more than that is
clearly necessary, but I think they would clearly agree to
start it.
Japan, given the weakness of its economy that we have
talked about, and the fact that it is scrambling for any scrap
of positive news, would be reluctant right now. But they have
the world's biggest trade surplus. It is soaring again because
of the recent decline in the yen. We would simply have to
insist that they cooperated, which, incidentally, would then
put more pressure on them to make the kind of domestic
structural reforms they need, anyway, and I think would be
beneficial in the broader sense as well.
Chairman Sarbanes. Mr. Preeg.
Mr. Preeg. I think the interventions that Fred mentioned
earlier are really token interventions of a few billion, $5 or
$10 billion.
Mr. Bergsten. Which is so amazing why they work.
Mr. Preeg. They give a political signal, and it is not the
economics. And the comparison of figures, again back to China.
China intervened with $50 billion last year, while China has
one-fifth the trade that we do. So for a comparable impact on
our trade or our exchange rate, we would need $250 billion of
U.S. intervention per year. And we are talking about $2 or $3
billion during the decade of the 1990's.
The orders of magnitude compared with what Japan and China
are doing, comparing their trade levels and ours, indicates
token U.S. intervention in economic terms. But even token
intervention can have political significance in that markets
would sense that the dollar is going to go down.
Chairman Sarbanes. At any rate, I take it it is your view
that even just the rhetoric that we are using is helping to
skew this thing in the wrong direction.
Mr. Bergsten. That is clear, and the market people say that
repeatedly. One question another time to ask the Secretary is,
what would be the downside of changing your rhetoric? Why does
he not want to change his rhetoric?
The reason is he fears he would drive the dollar down too
far, too fast. Now, I think that is not a realistic fear, but
that is the reason. That is the only argument he and his
predecessors could make for not changing the rhetoric when they
were implored to do so. They clearly think it would have an
impact, or else they would accept to do it.
Ernie made also a very important point. The three cases I
mentioned, the amounts of intervention were very modest. And to
me, that makes it all the more clear how effective the tool is.
You do not have to spend a lot of money. It is the signaling
effect. It is indicating with your money where your mouth is.
You want to see a change. You want to correct the current
account problem.
Mr. Jasinowski. Mr. Chairman.
Chairman Sarbanes. We have to draw this to a close.
Mr. Jasinowski. One suggestion to make along these lines,
going back to a point that Steve made, is to seek a precise
written statement from the Treasury as to what our policy or
nonpolicy is, which is what I have been arguing in part for
that would help clarify where we are.
Here we have one of the most important policy issues before
the country and nobody is quite sure what the Treasury policy
is. And it does seem to me greater clarity is essential.
Chairman Sarbanes. The Secretary says there is no problem.
Mr. Jasinowski. Well, I think there is.
Chairman Sarbanes. I am going to have to draw to a close.
Did you want to add anything?
Mr. Hanke. I would like to briefly make a remark on this
last round of things.
Chairman Sarbanes. If you could keep it brief.
Mr. Hanke. Yes. I think if we have an exchange rate policy
that is a floating exchange rate policy, the Secretary should
refrain from all open-mouth operations in all respects and just
keep quiet--say absolutely nothing on it.
The second point, Mr. Chairman, is, I think I detect in
your view, and the views of my colleagues here, that, well,
somehow, the balance of payments is getting a little bit out of
whack and extreme values are showing up and we have to do
something about it.
My own view on that is a little bit different. That is, a
little bit more like the Secretary's. We have a floating
exchange rate policy, which acts automatically. And therefore,
these balance of payments adjustments just take care of
themselves, Fred.
Mr. Bergsten. Yes, but they do not.
Chairman Sarbanes. They won't take care of themselves if
the currencies are being overvalued for one reason or another,
either because we are making these pronouncements about the
strong dollar and/or because China and Japan are sort of
working against the way the market forces work in order to make
the purchases. My perception is that the market is not working
pure and simple as a market. It is being impinged upon in a lot
of ways.
Mr. Hanke. Fred, let me make my third point because it fits
into this. We agree on this thing.
Chairman Sarbanes. Yes.
Mr. Hanke. My view is we should become neutral and
sanitized on the whole exchange rate comment thing. Let the
balance of payments accounts adjust naturally and over time,
market forces will take care of that, too.
Back to your question, Mr. Chairman, about whether some
kind of policy change now, intervention, three-part thing like
Jerry says, would work. My view is that the market is set up to
be taken down.
So right now, I am Chairman of the Friedberg Mercantile
Group. Our business is trading currencies. And we are short the
dollar against 10 very peripheral currencies. And the reason it
is a great trade is because we pick up the carry and make
interest carrying a short position against the so-called strong
dollar.
The war on terrorism has changed things enormously. And the
perception that people have in the world about the United
States and how great the prospects might be in the future for
the U.S. economy--cranking up a big war machine against an
enemy that even our Secretary of Defense says is elusive--is
that we are in a war of indeterminate duration that is going to
start eating up real resources in the economy and start
whacking away at productivity in the economy.
The story we are getting about the economy has been very
rosy and that is why there have been deficits without tears,
Fred.
But this thing, I think, is a little bit on a pivot now. So
even though I disagree with Fred and Jerry in terms of an
activist policy to correct the balance of payments imbalances,
I would have to agree that, if you were going to do it, I think
now is a great time to do it, in a technical sense.
Chairman Sarbanes. Well, this has been a very helpful
panel, obviously.
Mr. Trumka and Mr. Stallman, I just want to say to you,
when we were talking about the cheap shovel, I was thinking to
myself, if we do away with these jobs, who is going to have a
paycheck that will enable them to buy the shovel, whether it is
a worker or a farmer? So, we have to keep that in mind as well.
Thank you all very much. It has been a very good panel. The
hearing is adjourned.
[Whereupon, at 12:58 p.m., the hearing was adjourned.]
[Prepared statements, response to written questions, and
additional material supplied for the record follow:]
PREPARED STATEMENT OF SENATOR DEBBIE STABENOW
Thank you, Mr. Chairman. I welcome the opportunity to discuss
exchange rate policy and I appreciate that the Treasury Secretary and
our other witnesses have come to testify before us today.
The issue of exchange rates and, in particular, currency
manipulation is one that has a profound impact on my home State of
Michigan, especially as it relates to the automotive sector. I am
concerned that the Administration does not seem to be aggressively
addressing this issue.
It is not a coincidence that the on-going weakening of the yen has
occurred at the same time that Japanese automakers are experiencing
record profits and American automakers are facing significant losses.
Indeed, recently, the weakened yen has effectively given Japanese
automakers up to a 30 percent cost advantage over U.S. manufacturers.
On the floor of the Senate, we are beginning a discussion on
promoting trade. Free and fair trade can be good for our country, but
we must be outspoken about anticompetitive tools in the global
marketplace. Currency manipulation is one of those anticompetitive
tools.
Japan intervened in the currency market a staggering 11 times last
September alone. This resulted in an 11 percent decline in the value of
the yen against the dollar. I understand that the Japanese face
difficult economic challenges that create incentives for them to
devalue their currency, but our Government cannot stand idly by and
watch our domestic manufacturers lose out.
It is not fair to our domestic auto manufacturers who deserve to
compete on a fair and level playing field. It is not fair to our auto
workers who will lose jobs due to this invisible tariff caused by
currency manipulation. Indeed, Mr. Chairman, it is not fair to a whole
number of industries who suffer unfairly.
I look forward to hearing from the Treasury Secretary today about
what the Bush Administration is going to do about this problem and I
also look forward to hearing the perspectives of our other witnesses.
----------
PREPARED STATEMENT OF SENATOR CHUCK HAGEL
Thank you, Mr. Chairman, for holding this hearing today to explore
concerns about the value of the dollar against other currencies.
I know there are sectors of the economy that have been hit hard
over the last year by the recession and September 11. Farmers, textile
workers, manufacturers, and all exporters have especially been
impacted.
There are several factors that have helped create this situation,
including the trade barriers of other countries, production subsidies
that distort markets both here and abroad, technological advances that
have lowered the prices of production, and lower demand in other
countries that are going through recessions. Some will also say the
blame lies with the strong dollar. I am not persuaded that the strong
dollar is a primary factor attributing to the difficulties in our
economy. There are down sides to a strong dollar. However, an
appreciating dollar can be compatible with a rising value of exports, a
falling value of imports, a growing trade surplus, and increased
employment.
Given the degree in which traders around the world value the
dollar, can one say that the dollar is overvalued? It is true that the
dollar is at a stronger level relative to other currencies, but this
reflects the productivity, creativity, and value of American labor and
resources.
I am concerned about the unintended consequences of intervention in
the value of the dollar. For instance, how will our interest rates,
Government expenditures, and capital inflow be impacted?
There are many benefits to having a strong dollar. Most
importantly, a strong
dollar attracts investment which provides new capital resulting in new
jobs and
increased productivity in the United States.
One reason for the current strength of the dollar is that foreign
investors desire to purchase American assets. In large part, this is
due to the increase in national productivity that has raised the rate
of return on American capital.
I am looking forward to hearing Secretary O'Neill and our other
panelists discuss these issues today.
Because the strength of the economy is based on many different
factors, attempting to manage one of those factors will have an impact
on all of the others. We need to be cautious when we talk about
intervening in the market when there is no way to be even relatively
certain of how other pieces of the market will move as a result of any
action taken.
----------
PREPARED STATEMENT OF PAUL H. O'NEILL
Secretary, U.S. Department of the Treasury
May 1, 2002
Chairman Sarbanes, Ranking Member Gramm, Members of the Banking
Committee, I thank you for this opportunity to appear before you this
morning to discuss our International Economic and Exchange Rate Policy.
The April 2002 Report reviews global economic developments in the
second half of 2001. This interval and the most recent months encompass
a turbulent period in which the events of September 11 and their
aftermath shook the United States and world economies, and a period
when the underlying strength in the U.S. economy showed itself
forcefully, leading the world back to recovery. I have said before that
creating economic growth and jobs in the U.S. economy is our overriding
concern and that getting our economic policies right at home is one of
the best contributions we can make to global economic growth.
Increasing economic growth and reducing economic instability are
vital interests of the United States. For this reason, I would like to
touch on several of the Administration's broad policy initiatives for
facilitating growth and stability.
Reducing Barriers to International Trade
The global economic slowdown, from which we are recovering, brings
into sharp focus the importance of international trade. Total U.S.
trade in goods and services amounts to about one quarter of GDP. It now
touches almost all parts of our economy and is a vital ingredient in
its health, creating millions of jobs that pay above-average wages.
President Bush achieved a key objective in his trade agenda with
the WTO Ministerial decision in Doha to launch multilateral trade
negotiations. Negotiations are already underway for a Free Trade Area
of the Americas (FTAA) and for Free Trade Agreements (FTA's) with Chile
and Singapore. In January 2002, the United States announced that it
will explore an FTA with the countries of Central America. An FTAA,
when combined with existing free trade agreements, and bilateral FTA's
with Chile and Singapore, will fully open market access overseas for
nearly 50 percent of U.S. exports.
The Treasury has a special interest in promoting further
liberalization of trade in financial services. The growth potential in
many countries is being held back by a lack of deep and liquid capital
markets. The swift removal of barriers in key markets will help
strengthen financial systems internationally. It will also mean more
American jobs in a sector with above-average wages.
In sum, both to help bolster growth and create new export and job
opportunities for America, it is vital for the Senate to pass, and the
Congress to expeditiously enact, Trade Promotion Authority.
Reform of the International Monetary Fund
The primary role of the International Monetary Fund is to foster
conditions in the international economic and financial system that
support growth. First and foremost, the IMF must seek to prevent crises
that undermine and reverse growth. The IMF is making progress in
enhancing crisis prevention, including through increased transparency.
For example, nearly all countries borrowing from the IMF now release
the details of their reform programs, but more steps are needed to
release information and encourage policymakers to take quick action to
avert potential crises. Indeed, no matter how good the IMF's analysis
and policy advice are, their impact will be limited if they do not
serve to inform the public and markets. We look forward to further
progress on transparency in coming months.
To help prevent financial crises and better resolve them when they
occur, we are working with others in the official sector to implement a
market-oriented approach to the sovereign debt restructuring process.
This contractual approach would incorporate new clauses, which would
describe as precisely as possible what would happen in the event of a
sovereign debt restructuring process, into debt contracts. We have
proposed three clauses: Super majority decisionmaking by creditors; a
process by which a sovereign would initiate a restructuring or
rescheduling--including a cooling-off, or standstill, period; and a
description of how creditors would engage with borrowers. While we
believe it is important to move forward with this contractual approach
as expeditiously as possible, we also support continued work on the
IMF's statutory approach to sovereign debt restructuring. We believe
that the two approaches are complementary.
Reform of the Multilateral Development Banks
Rising productivity is the driving force behind increases in
economic growth and rising per capita income. The multilateral
development banks (MDB's) can deliver better results by being
rigorously selective in their lending, focusing their activities on a
discrete set of high-impact, productivity-enhancing activities that
diversify the sources of growth, foster competitive and open markets,
promote accountable governance, raise human productivity, and expand
access of the poor to physical infrastructure, new productive
technologies and social services.
Education and private sector development in particular need to
feature more prominently as a critical element in lifting people out of
poverty.
Private capital flows now dwarf official development assistance;
the challenge is to deploy development assistance in areas where we
know it will unleash the entrepreneurial and creative capacities of
people living in the poorest countries and to encourage individual
investment. Investment climate reforms and capacity-building at the
Government and enterprise level should be at the front and center of
development policies. The scale of global poverty and unrealized human
potential underscores the importance of the MDB's (and all other
donors) focusing much greater attention on improving the effectiveness
of their assistance. Delivering results means insisting on rigorous
quantifiable measures of each aid project and accountability from each
aid institution's impact in improving living standards. An incentive
structure must exist where performance will be rewarded and
nonperformance will not. The United States has proposed such a
structure for the IDA-13 replenishment in which the U.S. base-case
annual contribution to IDA can be increased if specified input and
output triggers are met in priority growth and poverty-reduction areas
such as private sector development, primary education and health.
President Bush proposed that up to 50 percent of the World Bank and
other MDB funds for the poorest countries be provided as grants rather
than as loans. Investments in crucial social sectors (e.g., health,
education, water supply and sanitation) do not directly or sufficiently
generate the revenue needed to service new debt. Grants are the best
way to help poor countries make such productive investments without
saddling them with ever-larger debt burdens.
Millennium Challenge Account
Effective assistance means delivering against a set of priority
objectives that is measurable. It requires a solid partnership between
donors and client countries on priority reforms that drive growth and
poverty reduction, while underscoring the need to measure the impact
and accountability of those reforms.
On March 14, President Bush outlined a major new vision for
development based on the shared interests of developed nations alike in
peace, security, and prosperity.
The President's compact for global development proposes a truly
historic, shared commitment to stop the cycle of poverty in the
developing world and is defined by a new partnership between developed
and developing countries to achieve measurable development results.
The compact creates a separate development assistance account
called the Millennium Challenge Account. It will be funded by
substantial increases over and above the approximately $10 billion in
existing U.S. development assistance (better known as Official
Development Assistance or ODA).
To take advantage of Millennium Challenge Account funds, developing
countries must be committed to sound policies that promote growth and
development, including the need to fight poverty. We will channel these
funds only to developing countries that demonstrate a strong commitment
to:
Governing justly (e.g., rule of law, anticorruption measures,
upholding human rights).
Investing in people (e.g., investment in education and
healthcare).
Economic freedom (e.g., more open markets, sustainable budget
policies, strong support for development, policies promoting
enterprise).
Experience has shown that policies that are effective in promoting
these goals
underpin successful growth, productivity increases, and poverty
reduction. Further, these goals are mutually reinforcing.
Over the coming months we will be asking for ideas from our
development partners--donors, developing countries, academics, NGO's--
on developing a set of clear, concrete, and objective criteria for
measuring progress in these areas.
Combatting Financing of Terrorism
Depriving terrorists of financial resources is critical to the war
on terrorism. The President has directed me to take all measures
necessary to pursue this goal.
On September 23, 2001, President Bush issued an Executive Order
listing 27 terrorist organizations and individuals and directing the
blocking of their property. This Executive Order has now been extended
to a total of 202 individuals and entities. To date, all but a handful
of countries have committed to join this effort. There are now 161
countries and jurisdictions that have blocking orders on terrorist
assets in force and over $104 million in terrorist assets has been
frozen globally since September 11--some $34 million here in the United
States, and another $70 million by other countries or jurisdictions. A
portion of that amount linked to the Taliban has recently been
unblocked for use by the new Afghan Interim Authority.
On April 19, I announced with my counterparts from the Group of
Seven an unprecedented joint listing of terrorist targets. In March,
the United States and Saudi Arabia designated jointly the Bosnia and
Somalia offices of the Saudi-based charity Al-Haramain. These joint
designations mark a new level of coordination in the fight against
international terrorism.
Cooperation on International Tax Matters
International cooperation and coordination on tax matters are
critically important for reducing investment distortions and for
promoting the proper functioning of
financial markets and systems. Tax rules should not serve as an
artificial barrier to cross-border investment.
The United States has bilateral income tax treaties with
approximately 60 countries. The purpose of those treaties is to
coordinate our respective income tax systems so as to avoid double
taxation and to reduce or eliminate tax ``toll charges'' on cross-
border investment. We are working to update and modernize existing tax
treaties and to expand our treaty network.
As I have said many times, we have an absolute obligation to
enforce the tax laws of the United States, because failing to do so
undermines the confidence of honest taxpayers in the fairness of our
tax system. This can be done more efficiently, given the increasingly
global nature of economic activities, with the cooperation of other
countries. Currently, we have effective tax information exchange
arrangements with many of the world's financial centers. We are working
to extend and deepen this network.
International Economic Conditions
I would like to turn now to global economic conditions.
As you know, the U.S. economy began slowing in the summer of 2000
and this weakness extended through the first half of 2001. Then, the
terrorist attacks of September 11 set off disruptions that quickly
swept through our economy. The events battered consumption as consumers
stayed at home, and with our passenger transport system significantly
impacted, many associated industries such as tourism and hotels were
badly hit. Activity fell at a 1.3 percent annual rate in the third
quarter.
Prior to September 11, I had been optimistic about the prospects
for U.S. recovery. My optimism now appears to have been well justified.
The fourth quarter showed a healthy rebound at a 1.7 percent annual
rate. Economic indicators for 2002 already paint a hopeful picture of
an economy bouncing back. I believe that the data will show in the
final analysis that last year's downturn in real GDP will be the
shortest, shallowest on record.
Why was the optimistic view well founded? Even before September 11,
the economy appeared to be moving forward at a slow, but positive rate.
The inventory overhang was being reduced. The Administration and
Congress had responded with timely relief action. The tax rebates and
rate cuts from the Economic Growth and Tax Relief Reconciliation Act of
2001 had put money in people's pockets and increased incentives in the
economy to work, save, and invest. The Federal Reserve had aggressively
lowered interest rates and energy prices were then coming down.
Most importantly, the fundamental strengths of our economic system
remain well intact--the American people are hard working; our markets
are the most flexible and dynamic in the world; and our macroeconomic
policies are sound. Our economy is the most advanced in the world
because our economic structures are predicated on the recognition that
the private sector drives growth, and that the role of Government is to
provide a framework that promotes competition and encourages individual
decisionmaking. This has produced, among other things, financial
markets that are the deepest and most liquid in the world.
The confluence of these factors is reflected in the remarkable
productivity growth of our economy. Unlike in past recessions,
productivity continued to rise last year and posted an extraordinary
5.2 percent gain at an annual rate in the fourth quarter. Meanwhile,
trend productivity growth remains around 2\1/2\ percent, sharply higher
than the 1\1/2\ percent trend rate from 1973 through 1995, keeping
inflation pressures well at bay.
I am convinced that the United States has regained its economic
footing. In fact, the figures released just last week showed real GDP
rising at an exceptionally strong 5.8 percent annual rate. This
performance is a testimony to the inherent resilience of our economy
that over the past 6 months has continually surprised on the upside.
So far, I have focused on the United States. The world economy,
while beginning to recover from the recent slowdown, is still in the
early stage of recovery. Last year, global growth was highly anemic, at
roughly 2\1/2\ percent. Prospects for 2002 are somewhat better but
strong growth may not be fully visible until the second half of the
year.
Before becoming the Secretary of the Treasury, I had the pleasure
of gaining a special appreciation for the strength of the Japanese
economy and its people. Over the last decade, however, Japan's economic
performance has been well below its potential. The resulting cost has
been high not only for Japan, but also for the world economy. Restoring
strong Japanese growth is one of the keys to unlocking strong global
growth.
President Bush has expressed support for Prime Minister Koizumi's
commitment to reform. The United States also shares his view that it is
important for Japan to increase price competition through deregulation
and structural reform and to vigorously tackle its banking sector
problems. We in the United States learned from the S&L crisis the
importance of comprehensively addressing banking sector problems and
returning distressed assets to private hands by selling loan claims and
underlying collateral rapidly in the market.
We also learned that these reforms can take place only in a
supportive macroeconomic environment. For the last 7 years, except for
1997 in response to a one-time tax increase, Japan's economy has been
mired in deflation. Last March, the Bank of Japan committed to expand
the money supply until the CPI was either stable or increased slightly
on a year on year basis. Since then, a welcome and sharp expansion in
monetary aggregates has indeed taken place. So far, however, deflation
remains entrenched.
The Euro-zone recorded its best growth in a decade in 2000. Going
into 2001, there was substantial optimism that the foundations for
sustained growth were well in place. But despite these expectations,
Euro-zone growth slowed markedly and was negative in the fourth
quarter. While Europe too was affected by the events of September 11,
Europe's slowdown in 2001 underscored the fact that the interactions
and transmission mechanisms among our economies run deep and extend
well beyond the realm of trade.
The Euro-zone is poised to begin growing anew. However, the
consensus outlook is that the recovery will lag and be slower than the
U.S. upturn. That said, it is in many respects difficult to speak about
the Euro-area as a single entity. Indeed, there are many very
successful pockets of reform, such as Ireland, Spain, and the
Netherlands. But European policymakers recognize the need more
generally to implement tax reforms within the context of efforts aimed
at achieving medium-term fiscal stability and to undertake structural
reforms targeted especially at increasing employment and raising
potential growth.
On April 19-20, I hosted a meeting of the G-7 Finance Ministers and
Central Bank Governors. We recognized that a recovery is already
underway in our economies, influenced by macroeconomic policies put in
place last year. Nonetheless, while confident about our collective
prospects, we also agreed that downside risks remain, especially those
arising from oil markets. In this spirit, we agreed that each of our
countries has a responsibility to implement sound macroeconomic
policies and structural reforms to sustain recovery and support
strengthened productivity growth in our own economies and in the global
economy.
The U.S. current account deficit was around 1\1/2\ percent GDP in
the mid-1990's. It rose to 4\1/2\ percent in 2000 before falling,
during last year's global slowdown, to just over 4 percent in 2001. We
have all heard the view that this is a threat to America's economic
fortunes and global financial stability. I believe that this view
ignores forces that are working in the market. The current account
represents the gap between domestic savings and investment and has
grown in the face of a productivity-fed U.S. investment boom for the
past decade. It is financed by international capital inflows that have
risen over this period due to strong foreign interest in investing in
the United States.
In the last 2 years, these capital inflows were sustained despite a
slowing of U.S. economic activity, a fall in U.S. interest rates, and a
decline in equity prices. This is a clear demonstration that foreigners
regard investment in the United States as continuing to offer extremely
attractive rates of return. These inflows are attracted by the long-
term soundness and relative strength of our economy's fundamentals: Our
underlying productivity growth, our low inflation and sound
macroeconomic policies, our flexible labor markets, and our financial
markets which are the deepest and most liquid of any in the world. As I
often say, these investments in our economy's future are not a gift.
They are made because of the prospect of a sound return.
Emerging market and developing economies also felt the effects of
the slowdown in the major economies in 2001, and their prospects were
also set back by the uncertainties stemming from the events of
September 11. However, I am hopeful that their prospects will brighten
over the course of this year. The truth is that many emerging markets
have not performed well in recent years and investment flows going to
these markets have declined sharply. On the positive side, though, many
emerging market economies are now better able to withstand external
shocks, having reduced short-term external liabilities and built up
reserves. Many countries, such as Brazil, Indonesia, and South Korea,
have moved to more flexible exchange rates regimes, which allow their
exchange rates to absorb the brunt of external shocks. I think there is
a much greater appreciation throughout these countries on the need to
run sound policies. And there has been very little contagion from
recent events in Argentina.
I would also like to submit for the record the Report to Congress
on International Economic and Exchange Rate Policies as mandated by
Section 3004 of the Omnibus Trade and Competitiveness Act of 1988.
In conclusion, I thank you again for this opportunity to testify
before you. I would be delighted to answer any questions you may have.
PREPARED STATEMENT OF RICHARD L. TRUMKA
Secretary-Treasurer
American Federation of Labor and
Congress of Industrial Organizations
May 1, 2002
Chairman Sarbanes, Members of the Committee, I am glad to have the
opportunity to talk with you today on behalf of the 13 million working
men and women of the AFL-CIO about the economic impacts of the
overvalued dollar.
As we struggle to escape the grip of recession, the overvalued
dollar represents a serious problem. It is also causing long-term
damage by destroying our manufacturing base. If we fail to redress the
problem there is a danger that our fragile
recovery will be short-lived, pushing us into a double-dip recession.
Manufacturing is ground-zero of the recession, and its troubles are
intimately connected to the dollar. Since March 2001, we have lost 1.4
million jobs, of which 1.3 million have been manufacturing jobs.
Manufacturing has therefore accounted for 93 percent of all job losses
despite being only 14 percent of total employment. Today, manufacturing
employment is at its lowest level since March 1962.
Business has slammed the brake on investment spending, but
fortunately the American consumer has kept the recession milder than
anticipated. However, a strong recovery that restores full employment
needs a pick-up in investment spending. And that will not happen as
long as currency markets give a 30 percent subsidy to our international
competition.
Over the last 5 years our goods trade deficit has exploded from
$198 billion to $427 billion, costing good jobs across a wide array of
industries.
Last year, in the paper industry there were mill and machine
closures at 52 locations. All are considered permanent, indefinite
or long-term.
In the textile industry two mills per week closed in 2001, and
closures have continued this year.
The weakening of the yen has given Japanese car companies a
huge price advantage. The result has been loss of market share by
our Big Three automakers that threatens some of the best jobs in
America.
Boeing, which operates at the cutting edge of technology, is
losing market share to Europe's Airbus. And losses today mean
future losses because airlines work on a fleet principle. They will
therefore order Airbus aircraft 5 years from now when they expand
their fleets.
Moreover, job losses are not restricted to manufacturing.
Tourism and hotels are hurt by the strong dollar, and film
production is moving offshore to cheaper destinations such as
Canada, Australia, and New Zealand.
Many of these jobs will never come back. These are higher paying
jobs that have been the ladder to the American Dream for millions of
Americans. But now we are kicking away that ladder.
Manufacturing has faster productivity growth, and productivity
growth is the engine of rising living standards. But now we are
shrinking our manufacturing base, and that is bad for future living
standards.
The Administration has shown blind indifference to these problems.
Arguments for a ``strong dollar'' do not wash.
Inflation is not a problem, and there is no evidence that a lower
dollar will lower the stock market or raise interest rates. Those who
say we need a strong dollar to finance the trade deficit have the
reasoning back-to-front. We need to finance the trade deficit because
we have an overvalued dollar.
It is time for a new policy that puts American jobs and American
workers first.
It is unacceptable that Japan depreciate its currency. This will
not solve Japan's problems, and will only export them to its neighbors
and us.
China exemplifies all that is wrong with currency markets. It has a
massive trade surplus and vast inflows of foreign direct investment. In
a free market, China's currency should appreciate, but it does not
because of government manipulation. This is a problem that appears in
different shades in many countries.
American workers are paying the price of currency manipulation.
Trade cannot be ``fair'' when we allow countries to manipulate exchange
rates to win illegitimate competitive advantage.
Those who argue we can do nothing about exchange rates abdicate the
national interest. The historical record and the 1985 Plaza Accord
intervention show we can. Academic research shows the same. Just as we
manage interest rates, so too we can manage exchange rates.
Currency markets are speculative and respond to policy signals. The
Treasury and the Federal Reserve must take immediate action with their
international partners. The upcoming G-7 summit provides an appropriate
moment to do so.
Beyond intervention today, we must avoid a repeat of today's
overvalued dollar, just as today's problems are a repeat of mistakes
made in the 1980's. The dollar must be a permanent focus of policy, and
the Treasury and the Federal Reserve must be made explicitly
accountable.
And every trade agreement must include strong specific language
that rules out sudden currency depreciations that more than nullify the
benefits of any tariff reductions. We have been NAFTA-ed once, and that
is more than enough.
The Senate Banking Committee has a vital oversight role to play in
ensuring that the Treasury and the Federal Reserve live up to these
obligations.
I thank you for the opportunity to testify before you, and I will
be happy to answer any questions you may have.
PREPARED STATEMENT OF JERRY J. JASINOWSKI
President, National Association of Manufacturers
May 1, 2002
Mr. Chairman, Members of the Committee, I am pleased to be here
this morning on behalf of America's manufacturers to participate in
this discussion of U.S. International Economic and Exchange Rate
Policy. U.S. manufacturing is suffering very strong negative effects
from current U.S. exchange rate policy, and we appreciate the
opportunity to state our views on the value of the U.S. dollar and the
impact it is having on American industry.
The National Association of Manufacturers represents 14,000
American firms--10,000 of which are small- and medium-sized companies.
Manufacturing is vital to America. It comprises one-fifth of all the
goods and services produced by the U.S. economy and directly supports
56 million Americans--the nearly 18 million American men and woman who
make things in America and their families.
I am pleased to join the other members of this panel today, and am
particularly pleased to be testifying along with Richard Trumka, the
Secretary-Treasurer of the AFL-CIO. The National Association of
Manufacturers and the AFL-CIO differ on many things, but we are united
in lock-step in our need to have the dollar begin reflecting economic
fundamentals.
The Dollar is Overvalued, and Everybody Knows It
Mr. Chairman, I would like to make three points today: First, the
U.S. dollar is very overvalued; second, this overvaluation is having a
devastating effect on U.S. manufacturing and on jobs; and third, the
overvaluation is fixable--for it is the result of market imperfections
that are preventing the dollar from adjusting to a more normal level.
How do we know the dollar is overvalued?
To begin with, NAM members are on the cutting edge of U.S. trade;
and our members have been telling us that after years of being highly
competitive in world markets, their customers are now saying the
foreign currency price of made-in-the-USA products have become 25-30
percent more expensive than foreign products. This did not happen
because U.S. producers became less productive or efficient. And it did
not happen because they raised their dollar prices. It happened only
because the price of the dollar rose in terms of foreign currencies.
About two-thirds of the companies represented at the recent NAM
Board of Directors meeting said that the dollar is having serious
effects on their firms, and this is an important reason why the NAM
Board passed a resolution calling on the Administration to act to
correct the dollar's overvaluation. A copy is attached to my statement.
The dollar is now at its highest level in 16 years. After remaining
fairly stable for the better part of a decade, the dollar began a sharp
climb starting in January 1997. It has now appreciated about 30 percent
against major currencies, as measured by the Federal Reserve Board's
widely-used price-adjusted index of major currencies. The sharp rise in
the dollar is clearly evident in Figure 1, appended to my statement.
This graph makes it plain that the dollar is not in any sense in
``normal territory.'' In fact, the extent of the post-1997 climb of the
dollar has been exceeded only once before--the severe overvaluation of
the dollar in 1982-1985 that put U.S. trade into a tailspin.
Unfortunately, a close look at Figure 1 shows an uncomfortable parallel
to the path followed by the dollar in the early 1980's.
The dollar's rise has exactly the same effect as the sudden
imposition of a new 30 percent tariff against U.S.-made goods. Congress
and the Administration would howl with anger if Europe, Japan, Canada,
and others were to slap such huge new tariffs on United States
products--yet there has so far been little concern for an overvalued
dollar that is doing the same thing. Worse, the dollar is also making
many foreign products artificially cheap in the U.S. market. The Bureau
of Labor Statistics' capital goods import price index, for example, has
fallen nearly 20 percent in the last few years.
The NAM may have been the first in saying that the dollar was
overvalued, but we are now in growing company. We are joined by over
50 trade associations representing manufacturing and agriculture, who
have come together in the Coalition for a Sound Dollar--advocating a
dollar that is consistent with economic fundamentals.
We are also joined by the International Monetary Fund, whose just-
released Global Economic Outlook says that one of the principal risks
to the sustainability and durability of the upturn in the United States
and elsewhere is the overvaluation of the dollar. The European Central
Bank concurs in saying the Euro is ``very undervalued'' and the dollar
is ``very overvalued.'' The Chairman of the Bank of England and of the G-
10 Group of Central Bankers also said the dollar is overvalued.
U.S. Government officials have also commented. New York Fed
President McDonough has said the dollar is overvalued. The Chairman of
the President's Council of Economic Advisors, Glenn Hubbard, told the
press that the strong dollar is bad for U.S. manufacturers.
The President's Trade Representative, Ambassador Zoellick, has said
the strong dollar is leading to a flood of imports and providing
export-led growth to other countries. Former Federal Reserve Board
Chairman Paul Volcker testified last year that maintaining a stable
U.S. economy might require ``strengthening of the Euro and the yen
relative to the dollar.'' And Keith Collins, Chief Economist, U.S.
Department of Agriculture, said ``The high value of the dollar is
expected to continue to impair the U.S. competitive position in world
markets. . . . The strong dollar not only makes U.S. products more
expensive, it insulates foreign competitors from market price declines
. . .''
Additionally, we are joined by the financial community. For
example, Larry Kantor, Global Head of Currency Strategy for J.P. Morgan
Chase told National Public Radio that, ``We judge the dollar to be high
relative to its fundamentals, something on the order of 20 percent at
most . . .'' And Morgan Stanley currency expert Joachim Fels, stated
flatly to Fortune Magazine that, ``The dollar is overvalued, and
everybody knows it.''
Then, finally, there is the Big Mac Index. Don't laugh, The
Economist Magazine's Big Mac Index, comparing Big Mac prices around the
world, has consistently been among the most accurate indicators of
currency valuation and future currency changes. The current issue of
the Economist says, ``Overall, the dollar now looks more overvalued
against the average of the other big currencies than at any time in the
life of the Big Mac Index.''
Even Paul O'Neill has commented on dollar overvaluation, and has in
the past agreed that the dollar can become overvalued and depart from
its normal level--harming U.S. industry. Of course, he wasn't Secretary
of the Treasury when he said so. Nevertheless, his words from 1985 are
surely indicative of his belief. When the dollar became badly
overvalued in 1985, he said the strong dollar ``. . . has turned the
world on its head. We have suffered a major loss in competitive
position because of exchange rates.'' He went on to say, ``Exchange
rates moving back to normal
levels would be very good news for our industry. We would recoup most
if not all of our export volume.''
Mr. O'Neill's words were good advice then, and are just as relevant
today.
The Overvalued Dollar is Having a Huge Effect
The overvaluation of the dollar is one of the most serious economic
problems--perhaps the single most serious economic problem--now facing
manufacturing in this country. It is decimating U.S. manufactured goods
exports, artificially stimulating imports, and putting hundreds of
thousands of American workers out of work. It is leading to plant
closures and to the offshore movement of production away from the
United States, with harmful long-term consequences for future U.S.
economic leadership.
This is a matter to be taken seriously not only because of the cost
in terms of jobs that have been lost, but also because manufactured
goods comprise over 85 percent of all U.S. goods exports--and two-
thirds of all exports of goods and services. America's ability to pay
its international bills depends on America's manufacturing industry.
Effect on Trade and Jobs
The effect on U.S. manufacturing has been huge, as is detailed in
the NAM analysis titled, ``Overvalued U.S. Dollar Puts Hundreds of
Thousands Out of Work,'' which I ask be made part of the record of this
hearing. That report shows the dollar's overvaluation has had a major
impact on exports, imports, the trade balance, and jobs.
Exports of U.S. manufactured goods have plunged $140 billion in the
last 18 months, at an annual rate--the largest such fall in U.S.
history (Figure 2). This fall, which is more than a 20 percent drop, is
so huge that it accounts for close to two-fifths of the entire fall in
U.S. manufacturing output and jobs in the current manufacturing
recession--over 500,000 lost factory jobs.
The recession from which we are beginning to emerge was, to a
remarkable degree, a manufacturing recession. Comprising 14 percent of
the American workforce, the manufacturing sector accounted for 80
percent of the job loss in the entire U.S. economy. Manufacturing lost
about 1,500,000 jobs--and over 500,000 of them were directly due to the
unprecedented fall in American exports. The export losses, principally
due to the overvalued dollar, are a key factor explaining why the
manufacturing sector has fared so much more poorly than the rest of the
economy in this recession.
To put the $140 billion export drop in a different perspective, it
is instructive to realize that the NAM estimates a successful Free
Trade Area of the Americas agreement (FTAA) could triple U.S. exports
to South America from $60 billion to $200 billion within 10 years of
implementation--which is scheduled to begin in 2006. Thus over the next
14 years, the FTAA may result in a $140 billion increase in U.S.
exports. American exports have fallen by that much in just the last 18
months!
Additional hundreds of thousands of jobs have been lost on the
import-competing side as well, though this is more difficult to
measure. From the beginning of 1997 through the first quarter of 2002,
U.S. manufacturing output rose 12 percent, while the volume of goods
imports soared 45 percent--almost four times as fast. Much of this is
due to the fact that import prices fell 10 percent relative to domestic
manufacturer's prices. Import prices fell even more rapidly in some
sectors--such as in imported capital goods, where they fell 17 percent,
reflecting the rising dollar.
This is evident in what has happened to some individual industries.
For example, prior to 1997 the U.S. paper industry routinely supplied
about 80 percent of the growth in the U.S. market for paper. Since
1997, however, 90 percent of the growth in demand for paper in the
United States has been met by imports. The U.S. paper industry has
closed 60 plants since 1998.
The U.S. textile industry, through large investments and
productivity improvements, and generally stable prices for Asian
imports, had been able to hold its own until 1997. Since the dollar
began to rise in that year, dollar import prices for textile products
fell 23 percent, imports from Asia soared, and 177,000 U.S. textile
jobs were lost.
The Treasury Department's periodic examinations of exchange rates
and trade
curiously have not mentioned any effect of exchange rates on trade.
Instead the Treasury attributes all the U.S. trade changes solely to
faster economic growth in the United States than abroad. While slower
economic growth abroad certainly has contributed to the U.S. export
slowdown, it has been a subordinate cause, and the principal cause has
been the huge shift in relative prices brought about by the rise of the
dollar.
For example, U.S. exports to the European Union dropped 20 percent
over the last year and a half. European industrial production declined
only about 4 percent during that time period. While this slowdown
certainly had some influence on declining U.S. exports, typically each
1 percent change in European industrial production
results in a little less than a 2 percent shift in U.S. exports. Thus,
the decline in European industrial production should have cut U.S.
exports by about 7 percent--leaving a 13 percent residual that can only
be explained by the dollar's overvaluation.
A much stronger relationship exists between currency misalignment
and trade shifts, as is depicted in Figure 3, attached to my statement,
which clearly shows how dollar overvaluation affects trade flows. The
graph shows two economic series: (1) the ratio of U.S. imports to U.S.
exports--i.e., how much larger imports are than exports; and (2) the
Federal Reserve Board index of the value of the dollar. Even a cursory
examination of the graph shows the close relationship. The time lag
between a change in exchange rates and a change in trade patterns is
visible as well, particularly in the exchange rate peak in 1985 that
resulted in imports cresting at being 80 percent larger than exports in
1987.
Largely as a result of the import and export effects of the
overvalued dollar, the manufactured goods trade deficit has grown so
much that it has reached a record 21 percent of U.S. manufacturing GDP
(gross value added in manufacturing)--more than double what it was in
1997.
Treasury Secretary O'Neill was quoted recently in the press as
saying that he thought the trade deficit was of no consequence because
capital inflows are strong. We differ sharply with this statement, as
does the International Monetary Fund and the vast preponderance of
economic evidence. The current account deficit has three very
significant consequences. The first is that the continuing deficit
generates an ever-increasing load of foreign debt that one day will
have to be paid, and at large cost. Federal Reserve Chairman Greenspan
and many others, including a worried International Monetary Fund, have
pointed out that there could be serious consequences on the United
States and global economies.
The second aspect is its damage to U.S. industry--particularly to
manufacturing. Perhaps one of the most worrisome aspects of the dollar-
induced shift in the U.S. trade balance is what has happened to U.S.
trade in technology-intensive products. This is America's most
competitive sector, and is based on the best of American research and
development, productivity, and innovation. It is always a sector we
have taken for granted in trade.
Indeed, as recently as 1997 it generated a $40 billion trade
surplus for the United States. That surplus has been declining at an
accelerating rate, and has now, for the first time in our history,
moved into a substantial deficit, running at an annual rate of $20
billion. If the United States cannot compete in knowledge-intensive,
technology-intensive trade, where can it compete?
The third aspect is that dollar overvaluation and the consequent
huge trade and current account deficits erode support for free trade
policies and contribute to rising protectionist sentiments. When
industries and displaced workers see their sales and jobs disappearing
because of falling exports and rising imports despite their best
efforts to be competitive, their natural reaction is to urge that trade
policies be changed. America's historic support for free trade policies
was threatened in the 1980's overvaluation, and the current
overvaluation and trade deficits are the principal reasons why public
support for further trade liberalization is weak.
Effect on Small- and Medium-Sized Firms
While manufactured goods exports are widely assumed to be
associated with large firms, in truth more than 95 percent of all
exporters are small- or medium-sized firms. Exporting has been a major
source of growth for small-manufacturers. For example, according to the
NAM's surveys of small- and medium-sized member companies, the
proportion of these companies that generated at least 25 percent of
their total business from exports grew from 5 percent in 1993 to almost
10 percent in 1998--nearly doubling. With 95 percent of the world's
consumers outside our country's borders, small manufacturers have found
world markets to be a major source of growth and jobs.
Unfortunately, the sharp rise in the dollar over the last few years
has led to a major reversal. Based on the most recent NAM survey of its
small and medium membership, all the export gains since 1993 have been
erased. Last year the proportion of smaller companies exporting at
least 25 percent of their production fell to only 4.2 percent. And for
this year, only 3.8 percent anticipate exports to be at least 25
percent of their business.
Effect on Earnings
Finally, American firms' profits have been strongly affected,
including from the fact that profits from overseas operations have been
reduced sharply as earnings from abroad are converted back into
dollars. After recovering from a drop due to the Asian financial crisis
in 1997, manufacturing after-tax earnings peaked at $76 billion in the
first quarter of 2000. By the first quarter of 2001, earnings had
collapsed to $-1.7 billion, a level not seen since the 1st quarter of
1992. Reduced
exports, heightened import competition, and the conversion into dollars
from operations abroad have had a major impact. Foreign operations,
especially in Europe, represent a sizable proportion of global sales
and profits for many large American firms. As foreign earnings are
converted into dollars and have had to be marked down 30 percent or
more because of the shift in currency values, the impact on total
corporate profits has been huge. Corporate releases in recent weeks
have been
replete with reports of reduced earnings because of the overvalued
dollar.
How Individual Companies Have Been Affected
To understand the real extent of the injury being caused to U.S.
manufacturers it is necessary to look at the effect dollar
overvaluation is actually having on individual companies and their
employees. Many NAM member companies have written to the Treasury
Department urging action to bring relief from the overvalued dollar.
Typically they relate that after having been competitive in world
markets for years, they are now losing their foreign business. Many
tell of export decreases of 25 percent, and some have lost almost all
their export business.
Some letters are from large companies that are world industry
leaders. Others are from small companies, many of them family-owned.
They tell a story of being unable to compete not because of a decline
in product quality or productivity and not because of any price
increases in dollar terms--but only because of the rise in the dollar's
value relative to other currencies. All of them are losing sales
overseas or find they can no longer compete against imports into the
U.S. market. Many of them are having to reduce their workforces. Others
say they have no choice but to close their U.S. plant and start
production overseas. This is the cost of having an overvalued currency.
These are not poorly-managed companies. They are not ``whiners.''
They are among the best U.S. manufacturers, and many had built large
export markets, won Government export awards, installed the latest
machinery and technology, and proudly sold their American-made products
around the world. I have appended about a dozen of these stories to my
testimony.
Correcting the Currency Misalignment
Currency values should--and over the longer term do--reflect
economic funda-
mentals. However, the normal market adjustment mechanisms appear to
have been thwarted in the case of the dollar's recent rise. While about
one-fourth of the dollar appreciation since 1997 took place during
1997-1998 as capital fled to the safety of the U.S. economy in the wake
of the Asian financial crisis, three-quarters of the rise in the dollar
took place after 1998 in spite of, not because of, the economic
fundamentals of the United States. In the face of slowing economic
growth, declining interest rates, and rising manufacturing
unemployment, the dollar has remained high.
Interest rate differentials are one of the key factors normally
expected to affect exchange rates. In June 1999, the U.S. Federal Funds
rate stood at 5 percent, roughly 2 percentage points above the European
Central Bank's key lending rate. This was certainly a factor
contributing to dollar strength. However, repeated interest rate cuts
have now put the Federal Funds rate fully 1\1/2\ percentage points
below European rates. Why hasn't the dollar fallen relative to the
Euro?
Economic growth differentials are another important factor. In the
late 1990's, U.S. economic growth averaged more than 4 percent,
outpacing our major trading partners. However, U.S. economic growth
slowed substantially beginning in the second half of 2000. By
comparison, while economic growth in Europe and the Pacific Rim has
also slowed, most analysts now expect economic growth to favor our
trad-
ing partners overseas after the 1st quarter of 2002. Clearly, the
impressive growth
disparity between the United States and economies abroad in the late
1990's has
shifted. Why hasn't this been reflected in exchange rates?
Trade and current account balances are important as well. The U.S.
trade deficit now stands at more than $400 billion, or 4.4 percent of
real GDP--up significantly from just 1.4 percent in 1997. During the
late 1990's the outflow of U.S. dollars, which is the flip side of a
large trade deficit, was largely used to acquire U.S. assets--primarily
U.S. plant and equipment in the form of direct investment. However,
business investment demand in the United States has been negative for 5
quarters running. Combined with continuing large trade deficits, this
translates into an oversupply of dollars in the world financial system
which should put downward pressure on the value of the dollar. Why
hasn't that happened?
Unless economic theory is to be rewritten, clearly there are market
imperfections at work. By far the most important factor interfering
with the market is the Treasury's maintenance of a ``strong dollar no
matter what'' policy, a carryover from the Clinton Administration. This
rhetoric is artificially propping up the dollar--and causing severe
economic dislocation especially for manufacturing.
The Treasury's statements are inherently contradictory. On the one
hand it says that a strong dollar policy is necessary in order to
continue to attract the capital needed to finance the trade deficit
(which is caused by the strong dollar). On the other hand, its says
that the dollar is strong because the United States is the best place
to invest, and rapid foreign capital inflows are driving up the dollar
through the free operation of the marketplace.
But if the latter were true--that the dollar remains strong because
of market forces--then it wouldn't matter if the Treasury said the
United States had a strong dollar policy, a weak dollar policy, or even
no dollar policy at all. Markets would only care about the economic
fundamentals of U.S. growth, productivity, and returns to capital.
But what would really happen if the Treasury announced it no longer
had a strong dollar policy and was adopting a policy of benign
neglect--letting the markets set the dollar wherever they thought it
should be?
Larry Kantor, Global Head of Currency Strategy for J.P. Morgan
Chase, answered that on National Public Radio recently, when he said
that if markets, ``hear even a slight change in the rhetoric, it does
risk a pretty sharp fall in the dollar.'' Why? Because the dollar is
very high compared to its economic fundamentals. It should have been
adjusting for some time now, but has not.
If markets no longer believed the Treasury would keep the dollar at
its present levels, market expectations would change overnight, realism
would take hold, and the dollar's correction would begin immediately.
As Morgan Stanley told Fortune Magazine, ``the dollar is overvalued,
and everybody knows it.'' Thus, we believe the Treasury's policy is in
effect distorting the market and preventing market forces from working.
It is time to end this policy and to allow the market to correct the
valuation of the dollar.
Accordingly, we believe the Administration should stop and take the
following steps:
1. Announce clearly that exchange rates are not reflecting economic
fundamentals, that the Treasury is adopting a sound dollar policy of
benign neglect, and that the United States will not intervene in
exchange markets to maintain the value of the dollar.
2. Seek cooperation with other major economies in obtaining common
agreement and public statements that their currencies need to
appreciate against the dollar.
3. Make clear that the United States will resist, and take
offsetting action as necessary, foreign country interventions designed
to retard movement of currencies toward equilibrium.
4. Seek agreement that the G-8 countries should state their
intention to work together, as they stated in 1985 when the dollar was
badly overvalued, and to make a clear and unambiguous announcement at
their next meeting, in June, that:
external imbalances have become too great and are contributing
to protectionist pressures which, if not resisted, could lead to
serious damage to the world economy; and
exchange rates should play a role in adjusting external
imbalances and in order to do this exchange rates should better
reflect fundamental economic conditions than has been the case.
Should currencies begin adjusting too rapidly, coordinated
intervention in the market can assure an orderly movement. When
countries coordinate intervention and clearly state their intentions,
markets react. The experience of the 1985 Plaza Accord is instructive.
This Accord restored currency stability and broke the back of the
rising protectionism. The preponderance of economic research,
meticulously reviewed in the September 2001 issue of the American
Economic Association's highly respected Review of Economic Literature,
makes it plain that highly visible coordinated action, including
intervention, does work.
The Treasury's Report on Exchange Rate Policy
In concluding my remarks, Mr. Chairman, I would like to offer some
views on the Treasury's Annual Report on International Economic and
Exchange Rate Policy. Section 3005 of the Omnibus Trade and
Competitiveness Act of 1988 requires the Secretary of the Treasury to
provide Congress with periodic reports on exchange rates and economic
policies.
Of particular interest to the NAM is the requirement (Section
3005(b)(4)) that the Treasury's report include an assessment of the
impact of the exchange rate of the dollar on production and employment
in the United States and on the international competitive performance
of U.S. industries. We have been disappointed consistently that the
Treasury's reports have not, and do not, contain such an assessment.
The reports have contained no discussion at all of the effect the
appreciation of the dollar has had on trade in U.S. manufactured goods
or in farm commodities.
More transparency and visibility is desirable here, both for
policymakers and for the public. The NAM, therefore, recommends that
the Commerce Department and the Agriculture Department be required by
the Congress to begin preparing semiannual reports directly analyzing
the effect of exchange rates on U.S. trade, pro-
duction, and employment. These reports would be separate from the
Treasury's
macroeconomic reports, and would be produced independently by the
Commerce and Agriculture Departments. Moreover, as part of their
reports, they should be required to survey what private sector
economists are saying about the effect of exchange rates on trade and
production.
Mr. Chairman, I appreciate the opportunity of appearing before this
Committee; and we look forward to working with you to persuade the
Administration to drop its pegging of the dollar through its ``strong
dollar'' policy and to adopt a ``sound dollar'' policy in which markets
set currency rates based on economic fundamentals. The longer this
change is delayed, the worse matters will get.
Thank you, Mr. Chairman.
PREPARED STATEMENT OF BOB STALLMAN
President, American Farm Bureau Federation
May 1, 2002
Mr. Chairman, Members of the Committee, I am Bob Stallman,
President of the American Farm Bureau Federation and a rice and cattle
producer from Columbus, Texas. AFBF represents more than 5.1 million
member families in all 50 States and Puerto Rico. Our members produce
nearly every type of farm commodity grown in America and depend on
access to foreign markets for our economic viability.
We appreciate the opportunity to testify on the importance of the
exchange rate to U.S. agriculture. Over-valuation of the dollar is one
of the most pressing international economic problems facing America's
agriculture and manufacturing sectors. U.S. farmers and ranchers have
been losing export sales for the past 3 years because the dollar is
pricing our products out of the market--both at home and abroad. In
addition, the higher exchange rate of the U.S. dollar has resulted in
rising agricultural imports due to increased purchasing power. The
purchasing power of the dollar grew 21 percent from 1995 to 2000 in
comparison to the exchange rate value of those nations that supply food
to our country.
Agriculture is one of the most trade dependent sectors of our
economy. Our sector has maintained a trade surplus for over two
decades, but that surplus is shrinking. One of the primary factors
affecting our declining trade balance is the strong value of the
dollar.
In addition, the value of the dollar has significantly impacted
agricultural employment. According to a recent USDA study, agricultural
employment lost 87,000 jobs between fiscal years 1997 and 2000, a
period in which the real agricultural exchange rate was rising rapidly
and U.S. agricultural exports were stagnant.
The sharp rise of the dollar since 1995 has reduced our ability to
compete in foreign markets. In 1996, U.S. agricultural exports reached
a record $60 billion, but declined sharply to a low of $49 billion in
1999. This decline came as the U.S. dollar strengthened. USDA estimates
that 14,300 jobs are lost for every $1 billion decline in agricultural
exports. The short-term outlook for agricultural exports is not
expected to improve significantly. Slow United States and global
economic growth in 2001-2002 and a strong U.S. dollar will result in
weak prices for the agricultural sector, according to USDA. The
continued strength of the U.S. dollar will be a primary constraint on
agricultural export growth.
We are deeply concerned about countries that engage in currency
devaluations in order to gain an export advantage for their producers.
The real trade-weighted exchange rates for agricultural exports from
all of the major competitor countries, including Canada, Australia,
Argentina, China, and Malaysia, have exhibited a long-term trend of
depreciation against the dollar, contrary to market fundamentals. This
trend has persisted over several decades, leaving it hard to conclude
that this is not a deliberate monetary policy of these and other
governments.
U.S. agriculture relies on exports for one-quarter of its income.
In addition, about 25 percent of agricultural production in the United
States is destined for a foreign market. A number of our commodities
are highly dependent on trade for a sizable portion of their
production. Some crops, like walnuts and wheat, about one out of two
acres is exported. Exports now account for nearly one-quarter of our
apple, beef and corn production and more than one-third of grapefruit
and soybean production.
As productivity growth of U.S. farms and ranches continues to
exceed the growth in U.S. population, our dependence on trade will
increase. Only 4 percent of the world's consumers live in the United
States. It is estimated that 99 percent of the growth in the global
demand for food over the next 25 years will be in foreign
markets.
Our country is also a major importer of food and fiber. The
aggregate import share of U.S. food consumption has been rising
steadily, along with the strength of the U.S. dollar. For nearly 20
years, imports accounted for 7.5 percent of total U.S. food
consumption. The share of imports climbed to 8.6 percent in 1996 and
9.3 percent in 1999. These jumps in import share coincided with the
strong value of the dollar and U.S. economic growth.
With a strong dollar, we have the double challenge of our products
being less competitive in other markets while products from other
countries are more competitive in U.S. markets.
In addition, there is a strong relationship between the value of
the dollar and the domestic price of our commodities. As the value of
the dollar rises, foreign buyers must spend more of their currency to
purchase our exports. This causes foreign buyers to decrease their
consumption of U.S. commodities or buy from our competitors instead.
The resulting drop in consumption drives U.S. commodity prices down
even further.
Net farm income is not directly tied to the rise and fall of the
U.S. exchange rate; rather it is the exchange rate that affects the
price competitiveness of our exports. The resulting change in the
volume of trade--increased exports when exchange rates are low and
decreased exports when exchange rates are high--directly impacts farm
income. As you know, U.S. agricultural commodity prices are the lowest
they have been in over two decades. Further price depressions stemming
from the strong value of the dollar are exacerbating an already dire
situation.
The exchange rate is the single most important determinant of the
competitiveness of our exports. Other important determinants of U.S.
agricultural export values include income growth rates in developing
countries, the growth and productivity of the foreign agricultural
sectors against which we compete, export subsidies use by our
competitors and weather conditions.
USDA's Economic Research Service estimates that movements in
exchange rates have historically accounted for 25 percent of the change
in U.S. agricultural exports. The elasticity of export demand for all
agricultural products with respect to the value of the dollar is 1.38.
This means that a 1 percent increase in the value of the dollar is
associated with a 1.38 percent reduction in the value of U.S.
agricultural exports.
The elasticity of export demand for individual agricultural
commodities is 1.77, thus resulting in a 1.77 percent decline in the
export value of specific commodities when the U.S. dollar appreciates 1
percent. The export dependency of U.S. agriculture, combined with the
highly elastic response of U.S. agricultural export values to changes
in the exchange rate underscore the need to maintain a stable exchange
rate policy without overstating the value of the dollar.
The increasing strength of the dollar, and steady depreciation of
the currencies of our major export competitors, has had a profound
impact on our ability to export. In fact, the rising appreciation of
the dollar is one of the primary reasons why the agricultural economy
did not experience the economic prosperity that most other sectors of
the U.S. economy enjoyed between 1995 and 1999. The dollar's increased
purchasing power, and rising U.S. disposable income encouraged
Americans to buy more imported products, while high prices of U.S. food
and agricultural exports, in foreign currency terms, discouraged demand
for our goods. As a result of the rapidly appreciating dollar, our
competitors gained an advantage in third-country markets over our
exports without even adjusting their sales price.
It is abundantly clear that the strong dollar is severely
handicapping our ability to compete. Agricultural analysts note that
macroeconomic fundamentals point to continued weak export performance
in the near future.
For some commodities, the rising value of the dollar has directly
contributed to the export competitiveness of our foreign rivals.
Sharply depreciating currencies such as the Canadian and Australian
dollars, the European Euro, the Brazilian real and the Korean won have
enabled our competitors to out-compete us in a number of third-country
markets.
The strong dollar is enabling our competitors to expand their
production and gain market share at our expense. Recent USDA estimates
note that U.S. corn export sales have fallen 3 percent and wheat
shipments 10.5 percent as a result of the appreciation of the dollar.
Meats
Since 1995, the dollar has appreciated 42 percent against the
currencies of beef producing countries. The rise in red meat imports
from 6.4 percent in 1996 to 8.9 percent in 2000 is explained in part by
the strength of the dollar. In addition, the recent announcement by
McDonald's to buy imported beef was largely driven by the price
advantage it faced vis-a-vis its competitors, other U.S. fast food
chains that have historically used imported beef trimmings. Imported
trimmings are cheaper than U.S. trimmings due to the strong U.S.
dollar.
Horticultural Products
During the period 1995-2000, U.S. imports of fruits and nuts jumped
33 percent, largely due to the dollar's 18 percent gain with respect to
the currencies of foreign suppliers of these commodities to the United
States. The dollar rose only 3 percent against currencies of foreign
vegetable importers to the United States. The appreciation of the
Mexican peso in price adjusted terms helped to mitigate the strength of
the dollar against the currency of Mexico, the country that supplies
the majority of U.S. vegetable imports.
A Farm Bureau-commissioned study documented the impact of the
exchange rate on corn, wheat, soybeans, and melons.
Corn
United States corn prices in Japan have been affected by adverse
exchange rate movements. The U.S. landed corn price decreased from
$3.64/bu in 1995 to $3.31/bu in 1998. The United States dollar
appreciated 39 percent relative to the Japanese yen, from 94.23/$
to 130.81/$. The yen price of U.S. corn increased from 343/bu
to 4331bu, an increase of 26 percent even though the U.S. dollar
price had declined 9.1 percent. United States exports of corn to Japan
fell 11.3 percent, from 16 mmt to 14.2 mmt.
Wheat
Exchange rates had similar impacts on the Mexican wheat market.
Between 1995 and 1999, the price of United States wheat delivered to
Mexico declined from $3.95/bu to $3.20/bu. The United States dollar
appreciated 48 percent relative to the Mexican peso (NP) during this
period from NP6.45/$ to NP9.58/$. This appreciation led to a 20 percent
increase in the peso price of U.S. wheat from NP25.46/bu to NP30.64/bu,
though the U.S. dollar price of wheat declined 19 percent. However,
even with higher prices in peso terms, the volume of United States
wheat exports to Mexico rose significantly during this time, from
791,000 mt to 1.8 mmt (130 percent). This contrasts with the Japanese
results for two main reasons. First, Japan is a mature market with an
established demand, extremely sensitive to price and geographically
distant from major grain suppliers. Second, the growth of the Mexican
market, coupled with its proximity to United States suppliers, has more
than compensated for the increase in peso wheat prices.
Soybeans
Between 1996 and 1998 the U.S. average annual farm price for
soybeans declined from $7.27/bushel (bu) to $5.93/bu, an 18.5 percent
drop. Over the same period, the United States dollar appreciated 20
percent relative to the Japanese yen, going from 108.81/$ to
130.82/$. When the yen price of United States soybeans landed in
Japan is compared over this period of time it is important to note that
the price of U.S. soybeans in dollars fell from $9.09/bu to $8.16/bu,
but in yen the landed price actually increased from 989/bu to
1,068/bu, an increase of 8 percent. The cost of United States
soybeans to Japanese buyers increased primarily due to the appreciation
of the United States dollar even though United States prices had fallen
significantly. The result was higher priced United States soybeans in
Japan when compared to soybeans from Brazil, which fell from 986/
bu to 958/bu, allowing Brazilian soybeans to be sold in Japan for
about $1.00/bu less than United States soybeans. United States soybean
exports to Japan declined during this period from 3.9 million metric
tons (mmt) to 3.7 mmt (200,000 mt, or 5 percent), while exports from
Brazil increased from 379,000 mt to 524,000 mt (145,000 mt, or 38
percent).
Poultry
Recent empirical evidence supports the strong relationship between
exchange rates and agricultural trade. Kapombe and Colyer \1\ found
that a 1 percent increase in the Japanese yen-United States dollar
exchange rate led to a .96 reduction in Japanese demand for United
States broilers. In addition, they also found that a
1 percent increase in the Hong Kong-United States exchange rate
resulted in a .56 percent decline in Hong Kong demand for United States
broilers, while a similar change in the Mexican peso--United States
dollar exchange rate led to a .58 drop in Mexican demand.
---------------------------------------------------------------------------
\1\ Kapombe, C.M. and D. Coyler. ``A Structural Time Series
Analysis of U.S. Broiler Exports.'' American Journal of Agricultural
Economics, 21 (December 1999): 295-307.
---------------------------------------------------------------------------
Melons
Other empirical studies have also documented the importance of the
Mexican peso-United States dollar exchange rate in influencing United
States imports of melons (Espinosa-Arellano, Fuller, and Malaga).\2\
Their results suggest that the 1994-1995 Mexican peso devaluation
increased United States imports of watermelon, honeydew, and cantaloupe
by 36, 18 and 4 percent, respectively in the short run. In fact, a
survey of historical empirical literature since the early 1970's has
revealed that in 32 separate studies of the role of exchange rates on
U.S. agricultural trade, the exchange rate was found to be an important
explanatory variable in 24 of the studies (Kristinek).\3\
---------------------------------------------------------------------------
\2\ Espinosa-Arellano, J.J., S. Fuller and J. Malaga. ``Analysis of
Forces Affecting Competitiveness of Mexico in Supplying U.S. Winter
Melon Market.'' International Food and Agribusiness Management Review
1, No. 4 (1998): 495-507.
\3\ Kristinek, Jennifer. ``The Impact of Exchange Rates of Beef and
Cattle Trade in North America.'' Texas A&M University, 2001.
---------------------------------------------------------------------------
Conclusion
American farmers are the most productive in the world. However, the
comparative advantages that our producers generally enjoy, abundant,
fertile natural resources, access to high-quality inputs and
technology, for example, are mitigated by the rising appreciation of
the dollar. The strong value of the dollar has, in many instances, shut
our exports out of foreign markets and increased import competition in
the U.S. market.
In short, U.S. agriculture is part of a worldwide food production
system. We do not advocate isolation as a means to shield our sector
from the economic forces that shape world trade. However, we cannot
effectively plan our farming and ranching enterprises in a world where
exchange rates suddenly depreciate by 50 percent, as happened with the
Mexican peso in late 1994, or shift more slowly, such as the 50 percent
decline in the Brazilian real from 1995 to 2000.
Exchange rate issues are certain to increase in importance as U.S.
agriculture produces more for export markets and U.S. food and fiber
markets become more open to imports. If these issues are not resolved
by macroeconomic policies, there will be continued pressure to find
solutions in traditional farm policies.
Effective long-range financial planning at the farm and ranch level
and the overall economic health of U.S. agriculture depends on more
stable exchange rates that do not overvalue the U.S. dollar against our
competitors' currencies.
PREPARED STATEMENT OF C. FRED BERGSTEN
Director, Institute of International Economics
May 1, 2002
The Rise of the Dollar
Since hitting its all-time lows in early 1995, the dollar has risen
by a trade-weighted average of 40-50 percent in real terms against
larger and smaller baskets of currencies of its trading partners. It
has climbed by well over 50 percent against the yen and the European
currencies. It could rise considerably further over the next year if
the United States continues to recover more quickly and more robustly
than Europe and Japan (or anybody else) from last year's worldwide
slowdown, as is quite likely.
Every rise of 1 percent in the trade-weighted dollar produces a
rise of at least $10 billion in the U.S. current account deficit.\1\
Hence the currency's appreciation over the past 7 years accounts for a
large share of the total external imbalance, which will probably
approximate $500 billion this year and be close to 5 percent of GDP,
entering the traditional ``danger zone'' where the United States and
other OECD countries have traditionally experienced correction of their
external deficits.\2\ The deficits rose at an average rate of $100
billion (or over 50 percent) per year during the late 1990's, an
explosive and obviously unsustainable path that may now have resumed.
They dropped back to annual rates closer to $400 billion during 2001,
with the drop in U.S. economic growth and hence import levels, but rose
again sharply in the first quarter of this year (and in fact subtracted
1.2 percentage points from our economic growth in that period).
---------------------------------------------------------------------------
\1\ William R. Cline, American Trade Adjustment: The Global Impact,
Policy Analyses in International Economics 26, Washington: Institute
for International Economics, 1989.
\2\ See Catherine L. Mann, Is the U.S. Trade Deficit Sustainable?,
Washington: Institute for International Economics, September 1999,
especially pp. 156-57, and Caroline Freund ``Current Account Adjustment
in Industrial Countries'' International Finance Discussion Papers 692:
Federal Reserve Board of Governors, December 2001.
---------------------------------------------------------------------------
Our latest projections at the Institute for International Economics
suggest that, absent any corrective action, the U.S. current account
deficit will rise to 7 percent of GDP by 2006 (about $800 billion).\3\
The previous sharp falls in the dollar, which have occurred about once
per decade since the early 1970's, were triggered by external
imbalances that never even reached 4 percent of GDP. Our latest
calculation is that the dollar is overvalued in trade terms by 20-25
percent, i.e., a depreciation of that magnitude would reduce the
current account deficit to the level of around 2-2\1/2\ percent of GDP
that is likely to prove sustainable over the longer run.\4\
---------------------------------------------------------------------------
\3\ Catherine L. Mann, ``How Long the Strong Dollar?'' Institute
for International Economics, March 2002.
\4\ Simon Wren-Lewis, Exchange Rates for the Dollar, Yen and Euro,
International Economics Policy Brief 98-3, Institute for International
Economics, Washington, July 1998. The International Monetary Fund has
publicly expressed a similar view, e.g., in its World Economic Outlook
of May 2001.
---------------------------------------------------------------------------
These annual imbalances add to the negative net international
investment position of the United States, which reached $2.2 trillion
at the end of 2000 as a cumulative result of the deficits of the past
20 years. As recently as 1980, the United States was the world's
largest creditor country. It has now been the world's largest debtor
for some time. Its negative international investment position is rising
by 20-25 percent per year. This trajectory too is clearly
unsustainable.
The Impact of the Strong Dollar
These external deficits and debts levy several significant costs on
the United States:
Over the longer run, they mean that we will pay rising annual
amounts of debt service to the rest of the world with a consequent
decline in our national income. These payouts are surprisingly
small so far, amounting to only about $14 billion in 2001, because
foreign investment by Americans yields a substantially higher
return than foreigners' investments here. However, the numbers are
clearly negative and will become substantially larger over time.
In the short run, any increases in the deficit subtract from
our gross domestic product. Export output falls and domestic demand
that could be met by domestic output is instead satisfied by higher
imports. U.S. output and employment suffer as a result and must be
of concern unless the economy is at full employment because of
booming domestic demand, as in the late 1990's (on which, see more
below) but not now. Since most of our goods trade is in
manufactured products, the deterioration of the trade balance has
contributed substantially to the large, and perhaps permanent, loss
of employment in that high-paying sector--whose wages average 13
percent higher and benefits average close to 40 percent higher than
for the manufacturing sector as a whole.\5\
---------------------------------------------------------------------------
\5\ Howard Lewis, III and J. David Richardson, Why Global
Commitment Really Matters! Institute for International Economics,
October 2001.
---------------------------------------------------------------------------
At almost any time, markets could decide that the deficits and
debt are unsustainable and reduce their new investments in dollars
sufficiently to drive the exchange rate down sharply. The United
States must attract about $2 billion of net capital inflow every
working day to finance the deficits at their current level. Since
gross U.S. capital outflows have been running about as large as the
current account deficit, our gross capital inflows must average
about $4 billion per working day--and totaled about $1 trillion in
2000. Any decline in the level of these inflows, let alone their
reversal via a selloff from the $10 trillion of outstanding dollar
holdings of foreigners, would produce increases in the U.S. price
level and higher interest rates (and almost certainly a fall in the
stock market as well). This ``triple whammy'' would severely hurt
the U.S. economy.\6\
---------------------------------------------------------------------------
\6\ For a more optimistic view, see Richard N. Cooper, Is the U.S.
Current Account Deficit Sustainable? Will It Be Sustained? Brookings
Papers on Economic Activity 2001:1, pp. 217-26.
---------------------------------------------------------------------------
In terms of domestic policy, large external deficits and the
overvalued dollar that produces them have been the most accurate
leading indicator of resistance to trade liberalization throughout
the postwar period. Paul Volcker has recently noted, for example,
the correlation between the roughly 30 percent tariffs on steel
just imposed by President Bush and the decline of roughly 30
percent in the value of the Euro since its creation in 1999. The
deficits generated relatively little concern in the late 1990's,
because growth was so strong and unemployment so low, but are
clearly doing so now as indicated by the other statements to the
Committee this morning. Antitrade pressures will almost certainly
rise again if the economy fails to resume rapid growth on a
sustained basis and especially if unemployment fails to fall much
from its current levels.
It should also be noted that a disorderly correction of the
dollar's overvaluation would produce major foreign policy problems,
especially with Europe. A decline of 20-25 percent in the average
value of the dollar would require a much larger decline against the
Euro because the currencies of many of our closest trading partners
(such as Canada and Mexico) would fall at least part of the way
with the dollar itself. A complete dollar correction would in fact
require the Euro to rise well beyond its initial starting point in
1999 and more than 30 percent above current levels. This would
sharply reduce Europe's competitive position and trigger major
complaints there, deeply exacerbating the transatlantic trade
conflict that is already so severe.\7\
---------------------------------------------------------------------------
\7\ C. Fred Bergsten, ``The Need for A TransAtlantic G-2,'' The
Washington Post, April 2002.
At the same time, it must be recognized that the external deficits
and dollar appreciation provided important benefits to the U.S. economy
during the boom period of the late 1990's. With growth at 5-6 percent
in those years, and unemployment falling to a 30 year low of 4 percent,
the sharp rise in net imports and the climb in the dollar itself helped
to dampen inflationary pressures. The capital inflows that financed the
deficit funded part of our investment boom and held interest rates in
check, permitting monetary policy to accommodate the rapid growth.
Under such circumstances, the ``strong dollar'' policy enunciated by
the Clinton Administration (though never defined nor made operational)
was defensible.\8\
---------------------------------------------------------------------------
\8\ C. Fred Bergsten, ``Strong Dollar, Weak Policy,'' The
International Economy, July/August 2001 and ``Ducking a Dollar
Crisis,'' The International Economy, September/October 2001.
---------------------------------------------------------------------------
No such defense is possible under current circumstances, however.
The economic slowdown and rise in unemployment in 2000-2001 underlined
the costs of the external deficit. The absence of inflationary pressure
obviates the chief benefit of large net imports. The sharp reduction in
interest rates over the past year reduces the need for large capital
inflows. Investment is now limited by excess capacity and lagging
demand, rather than by any shortage of capital, so that particular
benefit of the earlier inflows has largely disappeared.
It is thus stunning that Secretary O'Neill, in an interview
published on March 15, suggested that the current account deficit is
``a meaningless concept'' and that ``the only reason I pay attention to
it at all is because there are so many people who mistakenly do''--a
very different view that he expressed as CEO of International Paper in
the middle 1980's when the dollar was also hugely overvalued and he
could observe its impact directly. Similar statements of ``benign
neglect'' by his predecessor Secretary Donald Regan (and especially
Under Secretary Beryl Sprinkle) in the first Reagan Administration
turned out to be so wrong, and so costly for the economy, that they had
to be totally reversed by the second Reagan Administration via the
Plaza Accord in 1985 to drive the dollar down by 50 percent over the
succeeding 2 years.
A New Dollar Policy
It is thus time for a change in the dollar policy of the United
States. There is no basis for maintaining the ``strong dollar'' mantra
of the prior boom period. At a minimum, the United States and its G-7
partners should ``lean against the wind'' of any renewed dollar
appreciation to keep the problem from getting worse. Indeed, they
should now begin easing the dollar down toward its long-run equilibrium
level through a combination of altered rhetoric and direct intervention
to support other currencies, especially the Euro.
The new policy should also make clear to other countries that the
United States will not accept any efforts to competitively depreciate
their currencies against the dollar. This dimension is particularly
needed because Japan intervened massively last fall, once again, to
keep the yen from rising as documented in the Treasury's latest Report
to Congress on International Economic and Exchange Rate Policy. After
halting the yen's rise, at about 116:1 against the dollar, the Japanese
then actively talked it down to about 135:1. This latest episode of
competitive depreciation of the yen apparently ended in January but it
clearly had a major impact in the currency's level that persists today.
The Japanese characterized this intervention as part of an effort
to combat deflation by pumping more yen into their economy. However,
there are many other assets that the Bank of Japan could buy to expand
domestic liquidity--even if one thought that doing so could be
effective when demand for money is so low due to the depressed state of
the Japanese economy. Moreover, it appears that the Bank of Japan
sterilized the monetary effects of the currency intervention (as usual)
so it made little or no contribution toward easing monetary conditions
anyway.
The more plausible explanation of the intervention is that Japan
was once again seeking to export its domestic economic problems to the
rest of the world, as it has done on numerous occasions in the past.
One can readily sympathize with Japan's plight, in light of its
economy's ``decade of decline'' and the failure of so many of its
efforts to use traditional monetary and fiscal instruments to restore
growth.\9\ One might even countenance a temporary decline in the yen
that resulted from
implementation of needed reforms in Japan, as suggested by the
Administration
during its early days.
---------------------------------------------------------------------------
\9\ Adam Posen, Restoring Japan's Economic Growth, Washington:
Institute for International Economics, 1998.
---------------------------------------------------------------------------
But the renewed rise of Japan's trade surplus that is already
evident will ease pressure on the country to take the decisive steps
needed to deal with the huge problems of its banking system--the
fundamental requirement to get its economy back on track--and cannot be
accepted as an alternative to such reforms. Moreover, especially in the
context of last year's global economic slowdown, any such exporting of
Japan's problems to other countries is highly inappropriate and must be
resisted--through all the relevant multilateral forums, notably the IMF
and G-7, as well as bilaterally by the United States.\10\ It is thus
disturbing that the new Treasury Report ignores the problem even after
identifying and acknowledging the existence of the massive intervention
last fall, and indeed implies that it was somehow related to the
terrorist attacks of September 11 and thus excusable.
---------------------------------------------------------------------------
\10\ C. Fred Bergsten, Marcus Noland and Takatoshi Ito, No More
Bashing: Building a New Japan--United States Economic Relationship,
Washington: Institute for International Economics, 2001.
---------------------------------------------------------------------------
On the broader issue of U.S. currency policy, it is encouraging
that neither Secretary O'Neill nor any other Administration official
has repeated the ``strong dollar'' rhetoric since September 11, or even
for some time before. Though the Treasury denies that there has been
any change in policy, the absence of ``strong dollar'' language is
promising. The Administration should now substitute advocacy of a
``sound dollar,'' or some equivalent, to signal a substantive change in
attitude.
The presumed reason for the Administration's reluctance to embrace
such a shift is a fear that the dollar could then shift course abruptly
and go into a sharp decline that would trigger some of the deleterious
consequences cited above. There is little risk of any such ``free
fall'' for the foreseeable future, however, in light of the far
stronger fundamentals of the United States economy (vis-a-vis both
Europe and Japan) that have in fact held the dollar so high for so
long. The dollar in fact remained quite strong during 2000-2001 despite
the sharp falls in U.S. economic growth, interest rates, and equity
prices--all of which would have traditionally been expected to produce
a depreciation of the exchange rate. At the same time, there are no
foreseeable sharp pickups in Europe or Japan (or anywhere else) that
would pull large amounts of investment away from the United States.
Hence this is an excellent time to start easing the dollar down toward
its sustainable equilibrium level, especially as it has already fallen
by 3-4 percent over the past few months and that ``leaning with the
wind'' is most likely to be effective.
The worst policy course is to wait until the inevitable change in
economic fortunes, whenever it comes, triggers a shift in market
sentiment against the dollar. Coming on top of the huge underlying
imbalance, such an alteration of investor views could indeed trigger a
very sharp fall in our currency and a ``hard landing'' for the economy.
There is in fact a third factor that could then also kick in and make
the ensuing adjustment even nastier: The likely structural portfolio
shift into Euros that will almost certainly occur at some point due to
the likelihood that that currency, based on an economy as large as the
United States and with even greater trade, will move up alongside the
dollar as a global key currency.\11\
---------------------------------------------------------------------------
\11\ C. Fred Bergsten, ``The Dollar and the Euro,'' Foreign
Affairs, July/August 1997.
---------------------------------------------------------------------------
The risk of maintaining the Administration's policy of ``benign
neglect'' would be substantially increased if the likely strong
recovery of our economy over the next year or so were to trigger a
renewed appreciation of the currency that, in combination with the
growth pickup itself, would send our external deficits soaring even
further.\12\ Under such circumstances, continuation of the ``strong
dollar'' rhetoric would be particularly inappropriate because it would
encourage an even greater rise in the currency's overvaluation. It
would be a huge mistake to let the dollar rise to levels from which it
would be even more certain to come crashing down.
---------------------------------------------------------------------------
\12\ The sharp reduction in the U.S. budget surplus, resulting from
the tax cuts of early 2001 and the post-September 11 stimulus package,
further enhances the prospect of larger trade deficits via a strong
dollar. The fall in the surplus means that Government saving will
decline sharply, by perhaps 2-3 percent of GDP, and that an equivalent
amount of additional foreign capital will have to be imported--implying
a similar jump in the trade deficit--unless private saving were to rise
by a like amount, which is not only unlikely but also undesirable since
the goal of the stimulus efforts is to promote increased consumer
demand and thus a restoration of rapid economic growth. See C. Fred
Bergsten, ``Can the United States Afford the Tax Cuts of 2001?''
American Economic Association, January 5, 2002.
---------------------------------------------------------------------------
Such a situation would be reminiscent of what actually occurred in
1984-1985. Even after the ``Reagan dollar'' had risen by about 25
percent in 1981-1983, and already shifted the U.S. current account from
balance in 1980 toward a deficit of over $100 billion, the dollar rose
by another 25 percent or so in what all subsequent analysts have
characterized as a purely ``speculative bubble.'' The Reagan
Administration itself was then forced to engineer the Plaza Accord in
September 1985 to drive the dollar down by more than 50 percent against
the other main currencies by the end of 1987.
There are of course those who doubt the effectiveness of sterilized
intervention in the currency markets. Such a view ignores the fact that
all three cases of intervention by the Rubin-Summers Treasury worked in
textbook fashion. Joint United States-Japan intervention stopped and
reversed the excessive strengthening of the yen in 1995. Similar
intervention stopped and sharply reversed the excessive weakening of
the yen in 1998. Joint U.S.-EU intervention in late 2000 stopped the
slide of the Euro and prompted a 10 percent rebound. But the best
evidence comes from the Administration itself: Why is it so afraid to
alter the ``strong dollar'' mantra if it believes there would be no
impact from doing so? Does anyone really think that the dollar would
fail to decline toward a more desirable level if Secretary O'Neill and
his G-7 colleagues were to start calling for such a correction? An
effective alternative policy is clearly available.
We also know that currency depreciation, supported by sound
domestic policies, produces the desired changes in current account
balances with a lag of 2 or 3 years. The large dollar decline of 1985-
1987, for example, led to virtual elimination of the U.S. current
account deficit in the early 1990's. The sharp appreciation of the yen
produced a similar correction in the Japanese surplus.
Hence there is a strong case for a new U.S. policy toward the
dollar. Virtually every sector of the economy is now calling for such a
change, as indicated at this hearing: The business community through
the National Association of Manufacturers, labor through the AFL-CIO,
agriculture through the American Farm Bureau. Important parts of Wall
Street, including former Fed Chairman Paul Volcker and the chief
economist of Goldman Sachs, have issued similar calls. It is time for
the Administration to change its policy toward the dollar, to improve
the prospects for the U.S. economy and U.S. trade policy, and to reduce
the risks of the much more severe adjustment that will inevitably
hammer us later if it continues to ignore the problem.
PREPARED STATEMENT OF ERNEST H. PREEG
Senior Fellow in Trade and Productivity
Manufacturers Alliance / MAPI, Inc.
May 1, 2002
Thank you, Mr. Chairman, for this opportunity to appear before your
Committee to address the impact of the dollar on the U.S. balance of
trade, economic growth, and long-term economic stability. I will focus
my presentation heavily on one particularly disturbing aspect of the
trade deficit, namely currency manipulation to commercial advantage by
some trading partners, and in particular by China, the nation with whom
we have the largest and most lopsided trade deficit. To put this issue
in broader context, however, I begin with brief comments on three basic
concerns I have about the chronic and very large overall U.S. trade
deficit.
Three Basic Concerns About the Trade Deficit
The first, most immediate concern, is the impact of a larger trade
deficit on U.S. economic recovery this year and next. The U.S. trade
deficit was $345 billion in 2001, and could rise sharply to $400
billion or more this year, as a result of a faster initial rate of
economic recovery in the United States compared with our major trading
partners and the time-lagged adverse trade impact of the strengthening
of the dollar over the past 2 years. More than 80 percent of the
deficit--in the order of $350 billion this year--will fall on the
manufacturing sector, which has been hardest hit by the economic slump
of the past 18 months. U.S. manufacturing industry, through new product
innovation and capital investment, is the engine for overall growth in
the U.S. economy, and a major increase in the trade deficit for
manufactures could be the Achilles' heel for the hoped-for strong
rebound in such productivity-enhancing investment and sustained overall
growth.
The second, somewhat longer term concern, is that the longer we
maintain a trade deficit--or more precisely current account deficit--in
the prospective order of 5-6 percent of GDP, the larger becomes the
U.S. international debtor position, and the greater becomes the
likelihood of a more disruptive ``hard landing'' for the dollar and the
U.S. economy when the inevitable downward adjustment on trade account
finally occurs. The chronic trade deficit has transformed the United
States from the largest net creditor nation in the mid-1980's to the
unprecedented largest net debtor nation approaching $3 trillion of net
foreign debt today, projected to $5 trillion by mid-decade. There is
near consensus that this foreign debt accumulation course is
unsustainable and the question is rather how and when we will confront
the point of unsustainability. I believe an earlier downward adjustment
in the trade deficit--which would entail a depreciation of the dollar
exchange rate by perhaps 10-20 percent--would be less disruptive and
better for longer term economic stability, in the United States and for
the world economy, than a prolonged further debt buildup until
financial markets finally react against the dollar under the cloud of a
$5 trillion U.S. foreign debt.
My third and even longer term--but no less important--concern about
the trade deficit and the consequent buildup of foreign debt is the
social inequity we are imposing on our children and grandchildren. A
current account deficit of $500 billion per year means we are living
beyond our means by roughly 5 percent of GDP, mostly for immediate
personal consumption and to a lesser extent for investment.\1\ This
consumer binge is being paid for through foreign borrowing comparable
to the current account deficit, and the resulting $3-$5 trillion
buildup of foreign debt is being left to our children
and grandchildren to service indefinitely or to pay off fully in
principal. With a younger generation of Americans already concerned
about paying rising Social Security and Medicare commitments to the
current older generation, the foreign debt buildup is one more
intergenerational income transfer being undertaken essentially by
stealth.
---------------------------------------------------------------------------
\1\ Actually, about 80 percent consumption and 20 percent
investment. For a full explanation of this important yet often
misunderstood relationship, see Ernest H. Preeg, The Trade Deficit, the
Dollar, and the U.S. National Interest (Hudson Institute, 2000),
Chapter 4; a briefer explanation by the author is in ``A rose-tinted
view of the deficit,'' Financial Times, June 22, 2000.
---------------------------------------------------------------------------
These are my three principal concerns about the trade deficit. As
to what we can or should do to reduce the deficit, there are two
principal remedies. The first is to increase domestic savings, thereby
reducing the need to borrow abroad, about which there is more in the
concluding section of this presentation. The second and more immediate
way to reduce the trade deficit is to restrain others from
``manipulating'' their exchange rates to commercial advantage.
U.S. Benign Neglect of Currency Manipulation by Others
We currently have a predominantly floating exchange rate
international financial system. The United States has a basically free
float policy, with official market intervention rare and in only token
amounts. The EU, Canada, and Mexico have similarly followed a free
float during the past several years. Others, however,
particularly in East Asia, implement a heavily managed float through
large scale official purchases of foreign exchange, principally dollars,
in order to keep their exchange rates lower than they would be subject
to market forces alone, and consequently to push the dollar higher.
This managed approach is ``mercantilist'' in that the objective is to
maintain a large trade surplus as a matter of national policy, and the
result for the United States is a trade deficit larger than it would
be based on market forces alone.
Article IV of the IMF Articles of Agreement states that members
shall, ``avoid manipulating exchange rates to gain an unfair
competitive advantage,'' and, under IMF surveillance procedures, a
principal indicator of such manipulation is ``protracted large scale
intervention in one direction in the exchange market.'' Protracted
purchases of dollars by certain East Asian central banks would thus
clearly qualify as currency manipulation, under the IMF definition, but
the U.S. Treasury has rarely raised the issue, preferring a policy of
benign neglect.
Japan, the largest trade surplus nation in the world, is an
outstanding example of such currency manipulation, with $250 billion of
official foreign exchange purchases (almost all dollars) since 1995,
including $33 billion in September and October 2001 alone when market
forces were putting upward pressure on the yen. The yen, meanwhile,
declined by 15 percent vis-a-vis the dollar during 2001. South Korea is
another more recent example of such currency manipulation. The Korean
central bank bought $9 billion of foreign exchange during 2001 while
the nation recorded a $9 billion trade surplus. In effect, the central
bank purchases entirely offset any upward pressure on the won from the
trade surplus, and the Korean currency, in fact, depreciated 5 percent
against the dollar during the year.
This form of currency manipulation does not, of course, explain all
of the strengthening of the dollar vis-a-vis these currencies in recent
years, but currency traders know that the central banks involved will
not let their currencies strengthen significantly, and therefore they
hold back speculative purchases even when market conditions would
otherwise indicate a currency appreciation. It is also noteworthy that
the relevant indicators involved are net figures, whether for central
bank intervention, trade flows, or capital market transactions, and on
this basis the net purchases of foreign exchange by the Bank of Japan
in recent years have probably held the yen at a significantly lower
level than would have prevailed based on market forces alone. And
consequently, Japan has likewise maintained a significantly larger
trade surplus with the United States, especially in price-sensitive
industries such as the automotive sector.
The Uniquely Powerful Chinese Currency Manipulation
Chinese exchange rate policy is an important special case which
spells currency manipulation in a different way. The Chinese currency
has a fixed rate to the dollar but is nonconvertible on capital
account. Over the past year, there has been a $25 billion trade
surplus, a $45 billion net inflow of foreign direct investment--which
also puts upward market pressures on the exchange rate--and over $50
billion of central bank purchases of foreign exchange. In this case,
the central bank purchases offset almost three-quarters of market-
generated upward pressure on the yuan from the trade surplus and the
FDI inflow combined. Moreover, these official foreign
exchange purchases may have been even larger except for an unfolding
financial
scandal involving billions of dollars of missing reserves.\2\
---------------------------------------------------------------------------
\2\ See the Financial Times, January 16, 2002, ``Banker's fall
throws spotlight on China's missing billions.''
---------------------------------------------------------------------------
Based on the IMF definition, China has clearly been manipulating
its currency for mercantilist purposes. The Bank of China has made
protracted large scale purchases of foreign exchange--$150 billion
since 1995--in order to maintain a large trade surplus as an offset to
poor growth performance in the domestic economy. A direct measure of
the manipulation is not possible because of the nonconvertible fixed
exchange rate. There is no doubt, however, that if the central bank had
not purchased $50 billion in 2001, there would have been strong upward
pressures on the yuan in formal and informal markets. The bottom line
is that the Chinese yuan is substantially undervalued and should
certainly not be devalued as the Chinese government occasionally
threatens to do.
The Benefits and Costs of Chinese Currency Manipulation
The unique form of Chinese currency manipulation provides a mix of
benefits and costs for China and for the United States. The most direct
result is a larger trade surplus for China, which means more export-
oriented jobs in the Chinese economy. From the United States point of
view, of course, it means a larger trade deficit with China and the
loss of export-oriented and import-competing jobs. In 2001, United
States imports from China were $102 billion, or more than five times
larger than the $19 billion of United States exports to China.
One problem for China in implementing currency manipulation through
a fixed but nonconvertible exchange rate is that it creates
breathtaking opportunities for official corruption, as noted above. A
floating rate, however heavily managed, would do the manipulation job
more efficiently, as it does for Japan, and China will, for this and
other reasons, likely move in this direction as its economy becomes
progressively more open to international trade and investment.
Additional benefits to China from its cumulative purchase of
foreign exchange accrue in other areas of foreign policy. With $220
billion of ready cash in the central bank--far greater than any measure
of ``adequate'' reserves for commercial purposes \3\-- Chinese purchases
of weapons and other military equipment abroad, as regularly received
from Russia, in particular, can be made without financial constraint.
---------------------------------------------------------------------------
\3\ The World Bank rule of thumb for adequate reserves is 25
percent of annual imports; China and Japan now have foreign exchange
reserves of approximately 100 percent of annual imports.
---------------------------------------------------------------------------
A similar conclusion can and should be drawn about China as an
economic aid ``graduate.'' There is no longer any justification for
China to receive several billion dollars per year in long-term loans on
favorable terms from the World Bank, the Asian Development Bank, and
some bilateral donors, when there are $220 billion of unutilized funds
stashed away in the Central Bank. And yet the development banks
continue to lend large sums to China!
Another geo-economic advantage to China from its large reserves is
the ability to offer concessionary trade and investment finance to
other Asian nations, particularly in Southeast Asia, as a means of
strengthening Chinese economic engagement in the region at the expense
of the United States. Some first steps along these lines have been
taken together with Japan, to weaken ``United States economic
hegemony,'' and such trade-related incentives will likely be expanded
in support of the recent Chinese initiative for a free trade
arrangement with the Association of Southeast Asian Nations (ASEAN).
Finally, and more speculatively, China at some future point could
use its official dollar holdings as foreign policy leverage against the
United States by threatening to sell large quantities of dollars on the
market, or merely shift its reserves away from dollars and into Euros
and yen. This will not happen anytime soon because the result would be
a decline in the dollar and an adverse impact on Chinese
exports. At some future point, however, if China were to become less
dependent
on exports to the United States for economic growth, such a threat
could become
credible. For example, the threat of substantial Chinese sales of
dollars, with its implications for a disruptive decline in the dollar
and the U.S. stock market, especially during a downward phase in the
U.S. economy and/or an election year, could influence the course of
U.S. policy toward Taiwan. Chinese military officers, in fact, in their
studies of nonconventional defense strategies, include reference to
George Soros and his attack on the British pound in 1992 as a template
for disrupting a rival's (i.e., the United States) economic system.
Thus, the Chinese currency manipulation is very real and
substantial, with wide-ranging implications, and it deserves, as a
policy response, something more than the total official neglect it has
received up to this point.
A Long Overdue Policy Response
The United States should adopt a clear and forceful strategy for
reducing its chronically large external deficit. Indeed, such an
initiative is long overdue.
The first step in such a strategy would be to have frank
discussions with major trading partners as to why it is a mutual
interest to reduce current imbalances on current account. These
consultations could take place within the G-7 finance ministers'
framework and with key trading partners, including China, Mexico, and
South Korea.
The substance of the strategy should begin with a joint commitment
to a free or very lightly managed floating exchange rate relationship,
except for those nations engaged in full monetary union. Within this
international financial framework, the macroeconomic response would be
for the United States to take steps to increase its domestic savings
while other, large trade surplus countries would take corresponding
steps to increase domestic consumption. These domestic steps would
force adjustment in the trade imbalances, in large part through
downward movement of the dollar exchange rate.
The U.S. policy objective for the exchange rate would consequently
change from current categoric support for a strong dollar to a neutral
reliance on market forces to establish the rate, with the expectation
of some downward adjustment of the
dollar in parallel with a declining trade deficit. Such a United States
stated objective, in conjunction with complementary statements by major
trading partners, would, in itself, likely lead to some decline in the
dollar and the beginning of the trade adjustment process.
Another immediate objective should be to restrain others from
further currency manipulation to competitive advantage. This could be
done through G-7 and bilateral discussions and, in parallel, more
formal consultations within the IMF. The point of departure would be
that nations with persistently large trade surpluses--and even more so
if they have large FDI inflows as well--should cease official purchases
of foreign exchange or any other actions that would maintain their
currencies below market-determined levels. A joint announcement to this
effect should further influence financial market behavior, with upward
pressures on floating currencies that have recently been subject to
substantial manipulation, such as the yen and the Korean won, and
corresponding downward movement of the dollar.
China, once again, is an important special case in view of its
nonconvertible fixed rate to the dollar, and should thus be given a
very high priority for bilateral consultations. The mutual interest in
reducing the extremely lopsided bilateral trade account should be
assessed in detail, starting with the question as to why China has such
a large trade surplus with the United States and moderate trade
deficits with most other trading partners. A United States request to
China to cease official foreign exchange purchases and to adjust its
fixed rate upward would define the immediate United States objectives.
The longer term transition of China toward a fully convertible,
floating rate relationship with the dollar should also be examined
seriously, as a mutual interest, and as the best way to avoid trade
conflict resulting from further unjustified Chinese currency
manipulation.
----------
PREPARED STATEMENT OF STEVE H. HANKE
Professor of Applied Economics
Johns Hopkins University
May 1, 2002
Mr. Chairman, thank you for this opportunity to express my views on
exchange rate policies. Commentary about exchange rate policies often
originates in polemical, and more or less political, attempts at self-
justification. In consequence, the discourse is often confused and
confusing. In an attempt to bring some clarity to the topic, I will
begin by presenting some principles and characteristics of exchange
rate regimes.
Exchange Rate Regimes
There are three types of exchange rate regimes: Floating, fixed,
and pegged rates. Each type has different characteristics and generates
different results. Although floating and fixed rates appear to be
dissimilar, they are members of the same family. Both are ``automatic''
free-market mechanisms for international payments. With a ``clean''
floating rate, a monetary authority sets a monetary policy, but has no
exchange rate policy--the exchange rate is on autopilot. In
consequence, the monetary base is determined domestically by a monetary
authority. In other words, when a central bank purchases bonds or bills
and increases its net domestic assets, the monetary base increases and
vice versa. Whereas, with a fixed rate, a monetary
authority sets the exchange rate, but has no monetary policy--monetary
policy is on autopilot. In consequence, under a fixed-rate regime, the
monetary base is determined by the balance of payments. In other words,
when a country's official net foreign reserves increase, its monetary
base increases and vice versa. With both of these free-market exchange
rate mechanisms, there cannot be conflicts between
exchange rate and monetary policies, and balance-of-payments crises
cannot rear their ugly heads. Market forces automatically rebalance
financial flows and avert balance-of-payments crises.
Floating- and fixed-rate regimes are equally desirable in
principle. However, floating rates, unlike fixed rates, have rarely
performed well in developing countries
because these countries lack (in varying degrees) strong independent
institutions,
coherent and predictable systems of governance and the rule of law.
Accordingly, they cannot establish confidence in their currencies.
Indeed, they usually lack either a sound past performance or credible
guarantees for future monetary stability. In consequence, a floating
currency usually becomes a sinking currency in a developing country.
Fixed and pegged rates appear to be the same. However, they are
fundamentally different. Pegged rates are not free-market mechanisms
for international payments. Pegged rates (adjustable pegs, bands,
crawling pegs, managed floats, etc.), require the monetary authority to
manage the exchange rate and monetary policy simultaneously. With a
pegged rate, the monetary base contains both domestic (domestic assets)
and foreign (foreign reserves) components. Unlike floating and fixed
rates, pegged rates almost always result in conflicts between exchange
rate and monetary policies. For example, when capital inflows become
``excessive'' under a pegged system, a monetary authority often
attempts to sterilize the ensuing increase in the foreign component of
the monetary base by reducing the domestic component of the monetary
base. And when outflows become ``excessive,'' an authority attempts to
offset the decrease in the foreign component of the base with an
increase in the domestic component of the monetary base. Balance-of-
payments crises erupt as a monetary authority begins to offset more and
more of the reduction in the foreign component of the monetary base with
domestically created base money. When this occurs in a country with free
capital mobility, it is only a matter of time before market participants
spot the contradictions between exchange rate and monetary policies and
force a devaluation. Table 1 summarizes the main characteristics and
results anticipated with floating, fixed, and pegged exchange rates, when
free capital mobility is allowed.
The Evolution of U.S. Exchange Rate Regime Policies
If a country adopts a fixed exchange rate regime (either an
orthodox currency board \1\ or official ``dollarization'') and allows
free capital mobility, it must give up monetary autonomy.
Alternatively, if a country wants monetary autonomy and free capital
mobility, it must adopt a floating exchange rate. If a country has a
pegged exchange rate, it must restrict capital mobility to avoid
balance of payments and currency crises.
---------------------------------------------------------------------------
\1\ Contrary to the popular impression, Argentina's convertibility
system was not an orthodox currency board. Some students of currency
board systems pointed this out almost a decade ago. They anticipated
that Argentina's convertibility system would eventually degenerate into
a pegged exchange rate system and that it would blow up. See Steve H.
Hanke, Lars Jonung and Kurt Schuler, Russian Currency and Finance: A
Currency Board Approach to Reform. London: Routledge, 1993, pp. 72-77.
---------------------------------------------------------------------------
Over the past decade, the advantages of free capital mobility have
become clear, and restrictions of capital mobility have been
dramatically reduced. However, most developing countries have continued
to employ some variant of pegged exchange rates. And not surprisingly,
major balance of payments and currency crises have
occurred frequently in the 1990's.
In a world of increasing capital mobility, the U.S. Government had
no coherent policy on exchange rates until the late 1990's. Motivated
by criticism from a small group of economists (including myself ),
Former Senator Connie Mack's campaign for official dollarization in
countries with low quality currencies, and the fallout from the
currency crises that engulfed Mexico, Asia, and Russia, the U.S.
Treasury finally produced a clear policy statement on exchange rate
regimes. Given that the U.S. embraces free capital mobility, Treasury
Secretary Robert Rubin correctly concluded, in a speech made at The
Johns Hopkins University on April 21, 1999, that either floating or
fixed exchange rates were acceptable, but that pegged rates were not.
And shortly after Lawrence Summers became Treasury Secretary, he
presented the same policy conclusions at an address he delivered at
Yale University on September 22, 1999. Stanley Fischer, the Former
Deputy Managing Director of the International Monetary Fund, weighed in
with the same message, when he delivered the Distinguished Lecture on
Economics in Government at the annual meeting of the American Economic
Association in New Orleans on January 6, 2001.
With these policy pronouncements, the U.S. Treasury's (and the
IMF's) position on exchange rates became clear. In principle, the
position was correct. In practice, it was (and continues to be) applied
correctly in the case of the U.S. dollar, where a floating exchange
rate regime continues to be embraced. In developing countries, however,
the United States and the IMF have not adhered to the position with any
rigor. For example, Brazil and Turkey were both given the green light
to continue or establish pegged exchange rate regimes shortly after
U.S. officials indicated that these set-ups were, in principle,
unacceptable.
The Bush Administration has not yet articulated a clear policy on
exchange rate regimes. Secretary O'Neill would do well to clear the air
and make a statement along the same lines as Messrs. Rubin and Summers.
Indeed, since the United States espouses free capital mobility, the
only logical course is for U.S. policy to embrace floating rates or
fixed rates (orthodox currency boards or official dollarization), and
to reject pegged rates. With the departure of Stanley Fischer, the
IMF's position on exchange rate regimes has become fuzzy. Anne Krueger,
Fischer's successor, would do well to follow his lead and reaffirm
Fischer's conclusions.
The ``Strong'' Dollar Mantra
The exchange rate--the nominal exchange rate quoted in the market--
is a price. With a floating exchange rate policy, the price freely
adjusts to changes in individuals' and business' expectations about
conditions here and abroad. The dollar broadly strengthened against
other currencies after the mid-1990's because market participants
expected to receive higher rates of return on their investments in the
United States than abroad. For example, consider for a moment the fate
of the Euro versus the dollar since the Euro's launch on January 1,
1999. Then, the exchange rate was 1.17 dollars per Euro; today it's
about 0.90. The dollar strengthened by 30 percent against the Euro
primarily because market participants anticipated brighter prospects
and higher rates of return in the United States than in Euroland, and
capital flowed out of Euro-denominated assets into equities, bonds, and
other U.S. investments.
This brings me to the ``strong dollar'' mantra. This rhetorical
phrase, which was prompted by the dollar's broad strength in the
markets, is unfortunate and confusing, at best. The combination of a
floating exchange rate and the pursuit of low inflation, which the
United States has had for many years now, is a policy. The ``strong
dollar'' is not. Indeed, given a floating exchange rate regime, it is
impossible to know what a so-called strong dollar policy is because the
price of the dollar on foreign-exchange markets is on autopilot. The
price is (or should be) determined by buyers and sellers, and U.S.
Government officials should refrain from trying to influence it by
``open-mouth operations.'' As long as the United States embraces a
floating exchange rate policy, the Treasury Secretary should strike the
term ``strong dollar'' from his lexicon when engaging in discourses
about exchange rate policies. The phrase ``strong dollar'' is
meaningless and leads to no end of confusion.
The Dollar's Dominance
So under a floating-rate policy, one in which the dollar's price is
on autopilot, what can be said about the dollar? We can say that the
dollar is the world's dominant currency, more so with each passing
year.
Consider some facts about the U.S. dollar and its role in the
world's monetary affairs. Thanks to its stability, liquidity and low
transactions costs, the dollar occupies a commanding role. It is the
world's dominant international currency, a unique feature that gives
the United States an edge in attracting capital inflows to finance
current account deficits at a relatively low cost. This prompted
Charles de Gaulle, when he was President of France, to characterize the
benefits derived from the
dollar's dominant position as an ``exorbitant privilege.'' \2\
---------------------------------------------------------------------------
\2\ I thank Fred Bergsten for reminding me of de Gaulle's astute
observation.
Ninety percent of all internationally-traded commodities are
invoiced and priced in dollars.
The invoicing and pricing of manufactured goods in
international trade presents a much more complicated picture. The
dollar, however, dominates. For example, 37 percent of the United
Kingdom's exports to Germany are invoiced in dollars, not Euros or
Sterling.
The dollar is employed on one side of 90 percent of all
foreign exchange transactions.
Over 66 percent of all central bank reserves are denominated
in dollars, and that percentage has been steadily increasing since
1990.
The second most popular hand-to-hand currency used by
foreigners is the dollar, with their own domestic currencies in
first place. That explains why an estimated 50-70 percent of all
dollar notes circulate overseas.
The dollar is the second most popular denomination used by
foreigners for on-shore bank accounts, with their domestic unit of
account usually in first place.
According to the IMF, the average ratio of dollar-denominated bank
accounts to broad money in highly dollarized countries is 0.59, and
for moderated dollarized countries, the ratio is 0.18. Not
surprisingly, the dollar is the king of off-shore bank accounts.
Fifty percent of the internationally-traded bonds are
denominated in U.S. dollars.
The dollar also dominates the world's equity markets, with 60
percent of the capitalized value of all traded companies in the
world denominated in dollars. And that is not all. Capital markets
throughout the world are rapidly shifting into dollars. To lower
their cost of capital, foreign companies are beating a path to the
New York Stock Exchange and Nasdaq, which of course both trade in
dollars. Many traditional foreign companies now issue American
Depositary Receipts in New York. These ADR's, representing claims
on shares in foreign companies, are traded in dollars, and
dividends are paid in dollars. For example, 58.7 percent of the
total capitalization of all traded Latin American companies is
denominated in dollars, and for the two largest Latin economies,
Brazil and Mexico, the dollarized percentages are 69.9 percent and
42 percent, respectively.
All this boils down to a simple fact: The world is already highly
and unofficially dollarized. And unless the quality of the dollar
deteriorates, that is the way things will stay. If more countries with
low-quality currencies would officially replace their domestic currencies
with the dollar, the competitive devaluations that so many
fret about would come to an abrupt halt. And exchange rate crises that
frequently engulf countries with half-baked currencies would be a thing
of the past. After all, countries that are officially dollarized do not
have an exchange rate vis-a-vis the dollar.
The Dollar's Price
The dollar's strength against major currencies since 1995 and
particularly since the start of 2000 has persuaded many, particularly
the dollar bears, that the dollar's price is too ``high'' and
unsustainable. The dollar's ``high'' price has also generated
predictable howls from those who assert that the ``strong dollar'' has
made their businesses uncompetitive and squeezed their margins.
Just how ``high'' is the dollar's price? It depends on how you
measure it. If we use the Federal Reserve's broad dollar index or IMF's
dollar index, it appears that the dollar is at a ``high'' level and
perhaps not sustainable (see Chart 1). However, if we use ABN-AMRO's
trade-weighted dollar index, the dollar does not appear to be as
``strong'' as many believe. The weighting used by ABN-AMRO is more
representative of the realities (see Table 2). Indeed, ABN-AMRO's
dollar index more accurately reflects the dollar's trade weighted price
than do either the IMF's or the Fed's dollar indexes.\3\ Perhaps that
explains why the dollar bears have been disappointed so often in the
past few years: They have been looking at the wrong indexes.
\3\ The ABN-AMRO index is based on the Fed `broad' index weighting
system. To avoid creating an unwieldy index and to reduce
susceptibility to potential distortions from sharp fluctuations in
nominal values in developing economies, the ABN-AMRO index does not
explicitly include weights for minor U.S. trading partners. It does,
however, include weights for medium-sized trading partners such as the
UK, Mexico, China, Hong Kong, and Malaysia.
Yet another way to look at the dollar indexes, which are
constructed by a few
experts, is through the lens of the Austrian School of Economics. As
Friedrich von Hayek, a leader of the Austrian School, observed, the
most important function of a market is to process widely dispersed bits
of information from many market participants to generate an easily
understood metric--a price. Not surprisingly, the judgments of many
market participants, who are putting real money at risk, are deemed to
be more important, as they should be, than artificial constructs
produced by a small group of experts. Accordingly, the dollar's price
is where buyers and sellers agree it should be. To the extent that the
dollar's price is too ``high'' simply means that the consensus of the
many market participants differs from the few who are in the business
---------------------------------------------------------------------------
of constructing artificial indexes.
Under a floating exchange rate regime, the future course of the
dollar will be determined by expectations about prospective rates of
return in the United States and overseas, as well as the risks
involved. Judgments about future returns and risks are, of course,
difficult and highly dependent on, as Lord Keynes put it, the state of
confidence. In this respect, all we know is that the United States
engaged in a new, long war against an elusive enemy which will consume
meaningful real resources, eventually becoming a drag on productivity.
This suggests that capital flows to the United States (as evidenced by
recent data), might not be as forthcoming in the future as they were
during the past few years. If that is the case, the floating dollar
will weaken in the markets and market forces will automatically cause
those ``troubling'' U.S. current account deficits to shrink.
In closing, under floating rates, the less said in Washington, DC
about the level and course of the dollar's price, the better. After
all, under floating, the dollar's exchange rate is on autopilot. Alas,
this is probably asking for too much. When it comes to exchange rates
and adjustments in the balance of payments, many of the cognoscenti in
Washington have a distaste for automaticity. For them, the consequences
of a country's balance of payments should not spread themselves out
inconspicuously in time and scope. Instead, they should remain
concentrated and visible as a signal for policy changes and as a pivot
for expert consultations.
RESPONSE TO WRITTEN QUESTION OF SENATOR AKAKA
FROM PAUL H. O'NEILL
Q.1. This week the Associated Press reported that the Treasury
Department would borrow one billion dollars instead of retiring
$89 billion of the national debt, which had been projected in
January. This was the first time since 1995 that the Government
needed to borrow money in the April- June quarter. Three-
quarters of the increase in borrowing was due to lower-than-
expected tax revenue. In the fourth quarter of last year,
foreign investors purchased $33.3 billion in U.S. Treasury
Securities. This debt adds to the current account deficit. What
are the impacts of the Federal budget deficit and the tax cuts
enacted last year on the current account deficit?
A.1. There is no direct connection between the Federal budget
and current account deficits. The current account reflects the
balance between savings and investment in the economy. This
fiscal year's Federal deficit is related to the recent downturn
in the U.S. economy and the spending requirements of the war on
terrorism. The deficit is not large by international standards.
The decline in revenue that naturally occurs during cyclical
downturns, and the
Administration's tax cuts, were critical in stimulating the
timely
recovery of the U.S. economy, and ensuring that the recent
recession was among the mildest and shortest on record.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING
FROM RICHARD L. TRUMKA
Q.1. What happens if the Secretary decides to ``talk down'' the
dollar, but foreign investors still look at our economy as the
strongest in the world and the best return for their
investment? Won't the foreign investors still send their money
here, and keep the dollar at a high rate against other
currencies?
A.1. That foreigners view the U.S. economy as the strongest in
the world is a strength and advantage to us. That said, it is
still possible for the dollar to get out of alignment owing to
speculative pressures, and there are many empirical measures
that show the dollar is overvalued today.
Foreign investor attitudes toward the United States are one
reason for the high value of the dollar. But equally important
is Treasury's policy toward the dollar. By constantly talking
about a ``strong dollar,'' and by failing to speak out against
the many countries who intervene to keep their currencies low
in order to gain competitive advantage, the Treasury has
encouraged speculators to think that they face a ``one way
bet.'' That is, the dollar will remain strong and other
currencies will remain weak. This policy must end, and ending
it is fully consistent with the United States
remaining an attractive place for foreign investment.
Q.2. If the Treasury went to an aggressive policy to lower the
dollar, it would raise import prices for the consumer. Would we
not risk increased inflation under such a scenario?
A.2. There are three reasons to discount the ``inflation risk''
scenario:
First, a lower dollar will cause import prices to rise
slightly because foreign firms pass through part of the
exchange rate change. But that need not translate into damaging
generalized price inflation. Most U.S. manufacturing firms have
massive excess capacity and stand ready to step into the breach
and fill the gap left by importing firms. As a result of this
substitution, the net impact on inflation and consumers stands
to be quite moderate. Moreover, any increase in import prices
will be a one-off increase, and therefore will not generate
continuing inflation.
Second, the current environment is one of very low
inflation, bordering on deflation. At these levels, even if a
small increase in inflation were to materialize it might
actually be a good thing by pushing the economy away from a
deflation--which is economically disastrous in an environment
where business and firms are heavily indebted.
Finally, an important consideration is that the real issue
is ``dollar adjustment now'' versus ``dollar adjustment
later.'' It is widely agreed that the dollar and the trade
deficit are unsustainable at current levels. Doing nothing
risks a damaging and painful adjustment down the road, and in
the meantime the overvalued dollar will have hollowed out our
manufacturing sector, destroyed good manufacturing jobs, and
undermined our economic recovery. A better strategy is to
manage the adjustment, avoid the damaging economic effects of
delay, and avoid a possible financial crash that might occur
when markets ultimately decide to correct.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING
FROM JERRY J. JASINOWSKI
Q.1. What happens if the Secretary decides to ``talk down'' the
dollar, but foreign investors still look at our economy as the
strongest in the world and the best return for their
investment? Won't the foreign investors still send their money
here, and keep the dollar at a high rate against other
currencies?
A.1. The fundamental force which drives investment flows is
access to developed and thriving markets. And with the
expectation that productivity growth (the main driver behind a
sustainable growth and increased living standards) will
continue to be robust in coming years, there is no doubt that
the United States will continue to be an attractive market for
worldwide investment. While this outlook does not support a
weak dollar, it also does not support a dollar 30 percent above
its level in 1997--a level reach in February 2002. The record
actually shows that investment inflows do not react to changes
in the dollar--but rather to changes in the outlook for the
economy.
Capital will continue to flow into the United States as the
dollar returns to normal, and, in fact, direct investment
inflows may actually increase. That is what happened after the
1985 correction of the dollar. During 1985 -1987 the dollar
fell 40 percent--returning to normal levels prevailing prior to
1985. During the time the dollar was appreciating--up until
mid-1985--foreign direct investment into the United States
averaged $4.5 billion per quarter. But after the dollar started
to fall, direct investment inflows nearly tripled, to $12.3
billion per quarter. Why? Because the dollar's return to
normalcy made the United States a better place to invest.
Q.2. If the Treasury went to an aggressive policy to lower the
dollar, it would raise import prices for the consumer. Would we
not risk increased inflation under such a scenario?
A.2. Certainly a declining dollar will put some upward pressure
on prices, for we have been having a free ride for several
years while the dollar became increasingly overvalued. The
adjustment, however, will be mild. According to NAM estimates
based on the widely-used Washington University Macro Model, a
15 percent dollar devaluation over the next year and a half
would only result in a one-time increase in the GDP deflator
(the widest measure of prices in the U.S. economy) of less than
1 percent.
This is because inflation has been held down principally by
the high productivity growth of U.S. industry--especially
manufacturing. Declining import prices for consumer goods have
actually not had that much of an inflation-restraining impact.
Bureau of Labor Statistics data show that despite the 30
percent rise in the dollar since 1997, consumer goods import
prices have fallen only 6 percent. Part of the explanation for
this is in the fact that a significant proportion of consumer
goods imports come from China, whose currency has remained
pegged to the dollar. Additionally, a significant part of the
consumer price index is related to energy imports, and these
are denominated in dollars--thus being impervious to
fluctuations in the value of the dollar.
Import prices for capital goods, however, have fallen 25
percent, which has put U.S. capital goods industries at an
enormous disadvantage. As the prices of these imports rise, we
would anticipate a shift back to U.S. production and a reduced
rate of import growth. Inflation will also be restrained by the
huge capacity overhang in the U.S. economy. Federal Reserve
Board data shows capacity utilization to be extremely low--less
than 75 percent. This makes it very difficult to raise prices,
showing that this is actually a good time for the dollar to
decline to more normal levels. The worst time for the dollar to
decline would be during a period of overheated boom.
A mild inflationary response to a dollar devaluation is
supported not only by econometric modeling, but also by
history. After a sharp appreciation in the early 1980's, the
dollar fell by 40 percent in 2 years starting in mid-1985.
While a strengthening dollar played a role in bringing down
inflation, which was running near double digits in the early
1980's to a more moderate 3.1 percent by 1985, no significant
pickup in inflation accompanied the 1985-1987 correction. In
fact, between 1986 and 1988, the inflation rate actually
averaged 0.3 percentage points lower than the inflation rate at
the height of the dollar's peak in 1985.
Thus, while a weak or devaluing dollar falling to
abnormally low levels may cause inflation, the evidence
indicates that a dollar declining to normal levels has little
inflationary impact.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING
FROM BOB STALLMAN
Q.1. What happens if the Secretary decides to ``talk down'' the
dollar, but foreign investors still look at our economy as the
strongest in the world and the best return for their
investment? Won't the foreign investors still send their money
here and keep the dollar at a high rate against other
currencies?
A.1. The American Farm Bureau Federation (AFBF) does not favor
the Secretary either ``talking up'' or ``talking down'' the
value of the dollar. We also recognize the importance of
maintaining a vibrant economy, one that attracts ample foreign
investment. It is equally important to ensure that all sectors
of the U.S. economy have the opportunity to thrive in a manner
that is not impaired by an overvalued dollar.
The strong dollar is severely affecting sectors, like
agriculture, that are highly dependent on exports. For this
reason, we support a Congressionally mandated study of the
impact of the value of the dollar on the U.S. economy. Such a
study should take into account the ability of the United States
to attract foreign investment and not only maintain, but also
increase, exports.
Q.2. If the Treasury went to an aggressive policy to lower the
dollar, it would raise import prices for the consumer. Would we
not risk increased inflation under such a scenario?
A.2. AFBF does not support pursuing an aggressive policy to
lower the dollar. Such a policy is not likely to be effective
in today's technology-based global economy wherein massive
intervention would be required, but would not have long lasting
effects. We remain concerned, however, with the actions taken
by some U.S. trading partners to intervene repeatedly in
international exchange markets in a concerted attempt to
devalue their currencies vis-a-vis the dollar and believe that
the United States should respond to these currency manipulation
attempts by other countries.
AFBF believes that the value of the dollar should be set by
the market without interference by either our Government or a
foreign government trying to manage the dollars value it to
achieve a certain economic outcome.
Thank you very much for the opportunity to clarify our
position on this issue.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING
FROM ERNEST H. PREEG
Q.1. What happens if the Secretary decides to ``talk down'' the
dollar, but foreign investors still look at our economy as the
strongest in the world and the best return for their
investment? Won't the foreign investors still send their money
here, and keep the dollar at a high rate against other
currencies?
A.1. The phrase ``talk down'' is ambiguous. If it implies
follow-up actions, such as large and persistent United States
official financial market intervention to bring the dollar rate
down below a market-based rate (as do Japan and China, for
example), such a statement would make foreign investors
hesitate in anticipation of such a ``manipulated'' lower
dollar. I oppose such a talk down/intervention strategy, and I
do not believe Secretary O'Neill has any intention of doing so.
If, in contrast, ``talk down'' simply means a personal
assessment by the Secretary that market forces are likely to
lead to a lower dollar, related to the unsustainability of the
record trade deficit, investors would likely maintain their
existing assessment as to whether the U.S. economy offered the
best rate of return on their investments.
Q.2. If the Treasury went to an aggressive policy to lower the
dollar, it would raise import prices for the consumer. Would we
not risk increased inflation under such a scenario?
A.2. If the dollar declined for any reason, import prices would
rise for the consumer, and there would be some corresponding
rise in the overall rate of inflation. In the context of a 10-
20 percent decline in the dollar, however, it would be a
relatively small, one-time upward blip in the inflation trend.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING
FROM STEVE H. HANKE
Q.1. What happens if the Secretary decides to ``talk down'' the
dollar, but foreign investors still look at our economy as the
strongest in the world and the best return for their
investment? Won't the foreign investors still send their money
here, and keep the dollar at a high rate against other
currencies?
A.1. If the Secretary decides to ``talk down'' the dollar,
which I believe would be imprudent, net financial flows that
favor the United States would be disrupted temporarily and the
dollar would probably weaken temporarily. But if rates of
return on capital, adjusted for risk, are anticipated to be
superior in the United States, net financial flows will
continue to favor the United States. Given that the United
States has a floating exchange rate regime, the value of the
dollar is determined in the market. It is on autopilot.
Accordingly, under the scenario sketched above, the current
account deficit as a percent of GDP will continue to increase
and so will the dollar's nominal exchange rate. This should not
be cause for alarm. It would simply be a reflection of the
superior underlying economic fundamentals in the United States
vis-a-vis those in the rest of the world.
Q.2. If the Treasury went to an aggressive policy to lower the
dollar, it would raise import prices for the consumer. Would we
not risk increased inflation under such a scenario?
A.2. On the assumption that the U.S. Treasury possesses the
policy levers to aggressively lower the value of the dollar--a
highly questionable assumption--and that these bear fruit, the
dollar would weaken and import prices would rise for the
consumer. And, yes, inflation would be higher than would
otherwise be the case. This set of events would tend to
motivate the Federal Reserve to attempt to fight inflation with
higher short-term interest rates. This would bring forth howls
of protest from those who advocate an aggressive Treasury
policy to lower the value of the dollar because many of the
``weak dollar'' advocates also tend to embrace ``low''
interest rate policies.
PREPARED STATEMENT OF THE
AMERICAN FOREST & PAPER ASSOCIATION
May 1, 2002
The American Forest & Paper Association (AF&PA) appreciates the
opportunity to comment on how U.S. exchange rate policies are
negatively impacting the forest products industry. The wood and paper
products business is highly sensitive to exchange rate fluctuations.
The Committee's long-term engagement on this issue has been helpful in
focusing attention on trade and exchange rate linkages and their
effect on the global competitiveness of the U.S. economy. Our statement
today will recommend additional measures which, we believe are
necessary to correct unsustainable trade and exchange rate imbalances--
and restore the ability of American manufacturing to fuel U.S. economic
growth.
AF&PA is the national trade association representing the forestry,
pulp, paper, paperboard and wood products industry in the United
States. This industry accounts for approximately 7 percent of total
U.S. manufacturing output and employs approximately 1.5 million people
in 42 States, with an annual estimated payroll of $64 billion. Industry
sales exceed $250 billion annually in the United States and
export markets. AF&PA's membership encompasses the full spectrum of
U.S. businesses ranging from small family owned manufacturing and tree
farm businesses to large integrated companies.
Many of the leading economists, including several represented at
today's hearing, believe the U.S. dollar is currently overvalued
relative to a basket of major currencies--and that the extent of the
imbalance is somewhere around 25-30 percent. We agree that it is
substantial.
At these levels, U.S. industry is, in effect, paying a 30 percent
``overvalued dollar tax'' on all shipments--whether they are going to
foreign or domestic customers. Few U.S.-based producers can compete for
long under those circumstances. Just a few of the devastating effects
of this ``tax'' are described in the following examples:
Our companies have had to exit export markets they have served
for decades. For example, United States kraft linerboard exports to
Europe have plunged by 48 percent in the 1997-2001 period, to
$207.6 million. At the same time, U.S. hardwood exporters have lost
key European markets based solely on the price differential caused
by the value of the dollar. The U.S. product is of a higher quality
and its delivery is more reliable than other competitors who are
now taking market share based on price alone. And, new Eastern
European production facilities are now being constructed to ensure
that U.S. manufacturers do not retake that market share when the
Euro-dollar exchange rate returns to balance.
Simultaneously, competitors have been taking advantage of
their relatively cheap currencies to capture an ever-widening share
of the U.S. domestic market. Over the period 1997-2001, United
States imports of European coated printing paper soared by 50
percent, to $730.6 million. In the 1997-2000 period, imports took
more than 90 percent of the growth in the U.S. paper market.
(Exhibit 1)
Similarly, the wood products sector has also been battered by
cheap imports, which has resulted in a ripple effect across
manufacturing interests. The domestic furniture industry, one of
the largest traditional users of hardwood lumber and veneer, has
been contracting rapidly as a result of substantial lower priced
furniture imports. (Exhibit 2)
As a result, the U.S. net imports of paper and of wood
products have more than
doubled from a negative $6 billion in 1997 to a negative $13.6
billion last year.
(Exhibit 3)
During this period, none of the factors which shape the underlying
competitiveness of the U.S. forest products industry have changed--
except the value of the
dollar. On the contrary, our companies have scrapped uneconomic
capacity and
upgraded technology to significantly improve competitive performance.
Nevertheless, a report by Salomon-Smith-Barney states that the exchange
rate is robbing U.S. paper companies of their long-held competitive
advantage vis-a-vis European producers. (Exhibit 4) The report further
states that companies will not return to profitability unless and until
exchange rates are adjusted to more appropriate levels.
The combined effect of weakening export markets and surging imports
has put unprecedented downward pressure on paper and wood product
prices. Faced with this kind of challenge, the only option available to
many of our companies is to close mills. Since 1997, American paper
companies have had to close 72 mills or an average of 14 mills per
year-- compared to an average of less than four in the early 1990's.
(Exhibit 5) Employment at paper industry mills has declined by 32,000
jobs since 1997. (Exhibit 6) In the last year alone, more than 20 wood
processing facilities with a capacity of 1.7 billion board feet were
shutdown permanently. In the last 3 years, the wood sector has lost
51,000 jobs. (Exhibit 7) These were high paying jobs in rural
communities where wood and paper manufacturing mills serve as the
backbone of small-town economies.
Data prepared by the National Association of Manufacturers (NAM)
shows an estimated 500,000 jobs lost since mid-2000 as a result of the
drop in manufactured goods exports. This job loss was principally due
to the overvalued dollar and makes clear that this pattern is not
unique to the forest products industry but is repeated in sectors as
diverse as automobiles, aerospace, steel, textiles, and machine tools
to name a few.
Looking ahead, there are no signs of future improvement. U.S.
producers of wood and paper products are closing capacity here in the
United States while foreign competitors--especially in Europe and East
Asia--are rapidly building more, often with their government's
financial support.
The real long-term danger is a hollowing out of American industry
as a result of the persistence of an overvalued dollar. This is what
adds a compelling urgency to our call for action today.
The American Forest & Paper Association supports policies that
encourage exchange rates to be set by market fundamentals. But, when
other countries are
purposely taking action to keep their currencies artificially low, the
United States must step in to ensure that the dollar is not overvalued
as a result of these nonmarket actions by foreign governments. We
believe U.S. exchange rate policy must address two major sources of
dysfunction in currency markets:
A widespread perception in exchange rate markets that there is
no upper boundary to United States support for the dollar.
Manipulation of currencies by U.S. trading partners for
competitive advantage.
In currency markets, rhetoric matters. The statements by U.S.
Treasury officials
indicating a totally hands off attitude toward the value of the dollar
have resulted
in a widespread belief that there is no point at which the U.S.
Government will
consider taking any action to stop the rise. Signals from the U.S.
Treasury that it
supports a sound dollar consistent with the competitive fundamentals of
the U.S. economy would go a long way toward erasing the current
expectation that the dollar will continue to rise in value.
Currency Manipulation
Ambassador Ernest Preeg has provided solid empirical evidence of
currency manipulation by U.S. trading partners--and its effect on the
U.S. economy. In a recent 12 month period, East Asian economies had a
cumulative current account surplus of $218 billion, while their central
banks together added an aggregate $165 billion in foreign exchange
reserves. Japan alone has accumulated $95 billion in foreign
reserves. This means that about three-quarters of the net foreign
exchange inflow
resulting from Asian current account surpluses was taken off the market
through central bank purchases, with the result of lower exchange rates
and larger trade surpluses than otherwise would have been the case. The
dollar share of the aggregate foreign reserve accumulation was
estimated at 80 to 90 percent.
Japanese officials also have been actively talking down the yen. In
recent months, China has become more outspoken in calling attention to
the effect Japanese policies could have on the global economy, by
triggering a race to the bottom among key Asian countries that compete
with Japan for export markets.
Provisions in the Trade Act of 1988 requiring surveillance of
exchange rate policies by U.S. trading partners have undoubtedly had a
positive effect in addressing more egregious practices. However, the
data cited above make it clear that further action is needed. The
Senate version of Trade Promotion Authority recognizes that significant
or unanticipated changes in exchange rates can negate U.S. market
access gains in trade agreements. The legislation provides for the
establishment of consultative mechanisms among parties to trade
agreements to protect against currency manipulation by foreign
governments. We believe this step is necessary to ensure that, in
future trade agreements, the balance of benefits USTR negotiates--and
the U.S. Congress approves--cannot be upset by subsequent exchange
rate manipulation. We strongly support this provision of the bill.
G-8 Collaboration
Concerted action by major economies worked in 1985 with the Plaza
Accord and we believe it can work again today. The G-8 meeting in
Canada next month offers an opportunity for action to address the twin
imbalances--the overvalued U.S. dollar and the U.S. trade deficit--
which are widely recognized as posing a major threat to global economic
stability. Indeed, the just released IMF World Economic Outlook
concluded that the overvaluation of the U.S. dollar and the large U.S.
current account deficit pose significant risk to the sustainability and
durability of the incipient economic upturn, both in the United States
and globally. There are also mounting indications that some of our
trading partners share this concern about trade and currency
imbalances, and might be prepared to work with us to ensure a ``soft
landing'' which minimizes the real economic pain associated with an
unmanaged or ``hard landing'' adjustment.
Such a concerted approach, combined with enhanced Trade Promotion
Authority provisions, would improve the prospects for long-term market-
sustainable exchange market rate equilibrium.
Agreement on a joint plan of action would represent a substantial,
positive G-8 outcome. Alternatively, failure to deal with the issue at
the G-8, in the face of the clear warning signals, risks exposing the
still fragile United States and the global economic recovery to an
unpredictable and potentially unmanageable market adjustment.
The Time for Action is Now
There is a striking similarity between the situation in 1985 and
today in terms of the impact of the overvalued dollar on the U.S.
economy and the forest products industry's trade balance. But there is
also an important difference: Today, the U.S. economy is more dependent
on trade than ever before. An indication of this is that U.S. trade
exposure (i.e., total imports and exports) was 17 percent of GDP in
1985, while today it accounts for 24 percent. The forest products
industry reflects this trend as well. In 1985, the trade exposure for
paper was 23 percent, but reached 33 percent in 2001. (Exhibit 8)
Notwithstanding the challenges of the past year, the American
economy is sound. There are increasing signs that the economy is coming
out of recession. The incipient recovery will not thrive without a
robust and sustainable rebound in U.S. manufacturing. For the U.S.
forest products and other manufacturing industries, this will require
exchange rate policies which ensure that the value of the dollar is
consistent with the underlying economic fundamentals. It will also
call for action to prevent future currency misalignment, which rob our
companies of the competitiveness they and their workers have built.
We appreciate the opportunity to present these views and look
forward to working with the Committee and the Administration in
reaching solutions that will ensure a strong and vibrant U.S. forest
products industry.
PREPARED STATEMENT OF THE
AMERICAN TEXTILE MANUFACTURERS INSTITUTE (ATMI)
May 1, 2002
The American Textile Manufacturers Institute (ATMI) submits this
statement to the Senate Committee on Banking in regards to the May 1
hearing on the release of the Treasury Department's Foreign Exchange
Report. ATMI is the national trade association of the U.S. textile
industry, one of the largest manufacturing sectors in the United
States.
ATMI is writing to describe the devastating impact that the
overvalued dollar, now at a 16 year high, is having on the U.S. textile
sector and to urge the Committee and the Administration to take
immediate steps to bring the dollar back down to normal, historic
levels.
The U.S. textile industry is suffering its worst economic crisis
since the Great Depression. Since the dollar began to surge in value in
1997, over 175,000 textile workers have lost their jobs and over 215
textile plants in the United States have closed.
The Asian currency devaluation in 1997-1998 and the ``strong U.S.
dollar'' policy instituted at that time are the root cause for this
devastation. As of last year, the dollar had increased in value by an
average of 40 percent against the leading Asian textile exporting
countries. Prior to the dollar's surge, the U.S. textile industry was
enjoying some of its best years in history and recording new highs for
shipments, profits, and exports.
Since that time, the strength of the dollar has allowed Asian
exporters to cut their prices by an average of 23 percent and caused
Asian textile and apparel exports to the United States to increase by
an astonishing 6 billion square meters, an increase of 65 percent.
As a result, U.S. textile profits have virtually disappeared,
shipments have declined by 25 percent or $12 billion, exports have
fallen by $2 billion and a swath of misery has spread across the
Southeast.\1\
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\1\ We have attached a one-pager on the impact of the dollar on
textiles for your review.
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This impact has hit not only domestic textile manufacturers but
U.S. cotton and wool growers, textile machinery suppliers and man-made
fiber manufacturers. It has also devastated small towns across the
Southeast that have depended for generations on domestic textile
manufacturing.
In addition, the problem of the overvalued dollar impacts virtually
every manufacturing and agriculture sector in the United States. The
National Association of Manufacturers estimates that half a million
manufacturing jobs have been lost in the last 18 months just from lost
export orders. That figure does not include hundreds of thousands of
jobs lost because of a surge in artificially low-priced imports.
We also note that the International Monetary Fund (IMF), the
Organization for Economic Development (OECD), the European and Canadian
Central Banks and even members of the Federal Reserve in the United
States have all expressed alarm over the continuing rise in the
dollar's value.
In February, despite stagnant economic activity, rising imports and
a dramatic jump in the current accounts deficit, the Federal Reserve
reported that the dollar had hit a new high, with a 31 percent increase
in value against the world's major currencies since 1997.
It is clear that economic fundamentals are being overridden by a
belief in the market that the U.S. Treasury will act to support a
``strong dollar.'' This policy is now having a devastating impact on
the textile sector.
The last time the dollar surged to such heights was in the mid-
1980's during the Reagan Administration. At that time, Treasury
Secretary Jim Baker took strong
action, in concert with other major trading nations, to restore the
dollar to sound,
stable levels. That action set the stage for a decade of dollar
stability and U.S. export growth.
ATMI firmly believes that for the textile crisis to end and for the
industry to return to health, the U.S. Government must act to return
the dollar to its normal, historic range. We strongly urge the
Committee and the Administration to act quickly to accomplish this.
PREPARED STATEMENT OF THE COALITION FOR A SOUND DOLLAR
May 1, 2002
Mr. Chairman, we the undersigned organizations comprising the
Coalition for a Sound Dollar appreciate the opportunity to submit a
statement for the record for the Committee's May 1, 2002 hearing on the
release of the Treasury Department's Foreign Exchange Report.
The Coalition represents a broad array of manufacturing and
agricultural interests which employ millions of U.S. workers and which
have been deeply impacted by the overvaluation of the U.S. dollar over
the past 5 years. As of this date, job losses from the overvalued
dollar are almost certainly in excess of three-quarters of a million
U.S. workers.
Indeed, the damage caused by the dollar's prolonged surge has
become so great that U.S. manufacturing and agriculture, two
fundamental legs of the U.S. economy, are unlikely to rebound as a
result of the economic recovery. Recent statistics show that despite a
surge in first quarter GDP, durable goods orders and business
investment remain down and that the bump up caused by inventory
restocking was a one time event. In addition, despite increased
economic growth overseas, both manufacturing and agricultural exports
have continued to decline.
The Coalition members believe that a sound dollar is a fundamental
prerequisite for maintaining a healthy United States and global
economy. A sound dollar is one whose value relative to other major
currencies is determined by market forces that reflect fundamental
economic trends, such as trade balances, interest rates, GDP growth,
and other objective indicators of a country's performance.
The disturbing reality is that for several years the dollar has not
been reflecting economic fundamentals. In 1997, after 8 years of
stability, the dollar began to appreciate sharply against other major
currencies. The appreciation has continued despite a U.S. economic
downturn, a yawning current accounts deficit and, in many cases, higher
comparable GDP growth overseas. Today, the dollar stands 30 percent
higher than in 1997--its highest level in 16 years. The dollar is now
approaching the calamitous levels last seen in 1985, which provoked
intervention on an international scale.
As a result of the 30 percent dollar ``tax,'' many U.S. made goods
have been literally priced out of markets at home and abroad. For
example, U.S. manufacturing exports have dropped by an annual rate of
more than $140 billion over the past 18 months. The National
Association of Manufacturers estimates that half a million
manufacturing jobs have disappeared simply as a result of the export
decline, principally due to the fact that the dollar has taxed U.S.
exporters, rightly proclaimed by the U.S. Government as the most
productive in the world, out of market after market.
Indeed, the conventional wisdom that the U.S. advantage in high-
technology products is a key to future U.S. economic growth has been
gutted by the dollar's impact. U.S. Government statistics show that
over the past 5 years, a healthy U.S. surplus in these products has
vanished into a deficit of $20 billion.
Winners of the President's vaunted ``E-awards'' given to top U.S.
exporters have not been spared either. In letters sent to Secretary
O'Neill, these E-award winners, among many other top exporters, said:
``The value of the U.S. dollar now makes us uncompetitive in
almost all world markets . . . The 30 percent change in currency
value is making us uncompetitive even in our own home market. We
are a small business with our only manufacturing facility in South
Dakota. We have been forced to make substantial layoffs of
production and support personnel to adjust to this catastrophic
problem.''
``The strength of the dollar has had a profound effect upon
our business, especially in the area of employment. A year ago at
this time we employed 1,625 people in the Green Bay area. Today
that number is down by over 500 people . . . As this environment of
a strong dollar has continued, we have been forced to consider
relocating our manufacturing capabilities offshore.''
U.S. agriculture, which suffers from the same ``Made in the
U.S.A.'' dollar tax, estimates that nearly 100,000 agricultural workers
have been displaced because of the overvalued dollar. From cotton to
rice to wheat, the U.S. breadbasket is seeing its major export markets
dwindle and imports increase because of the dollar's sustained rise.
The damage extends to industries where there have been significant
import surges with the overvalued dollar acting as an enormous import
subsidy. Sectors such as textiles, paper and forest products,
automobiles, nonferrous castings, steel and furniture have, in total,
lost hundreds of thousands of workers as imports have ridden the
currency wave by cutting prices or increasing incentives. Many of these
jobs have been lost in rural communities that often depend on local
manufacturing or agricultural as their major source of employment.
In particular, textiles have seen Asian prices drop by an average
of 23 percent since 1997--prior to 1997, Asian prices were showing
moderate growth. Since the dollar's rise, job losses in the textile
sector have totaled more than 175,000.
U.S. automakers are being forced by the dollar penalty to pay out
billions of dollars in incentives in an expensive effort to slow a
sharp decline in market share. At the same time, they are being treated
to reports of record profits by Japanese automakers who have tacked
billions of dollars in currency-generated profits to their bottom
lines.
Paper mills, many with state-of-the-art equipment, have been closed
by the dozen as dollar-cheapened imports now take 90 percent of the
growth in the U.S. paper market.
The truth is that the overvalued dollar is increasingly forcing
manufacturing permanently off-shore as well as displacing increasing
numbers of farmers. Jobs, not goods, are now being exported as a result
of the dollar tax.
Long term, a 30 percent dollar tax on goods produced in this
country is simply not by the majority of U.S. companies and farmers. A
key policy question for this Committee and the Government is whether
shrinkage of the U.S. manufacturing and agriculture base is an
acceptable cost for supporting the out-of-kilter dollar.
The Coalition contends that the U.S. Treasury's policy of a
``strong dollar'' regardless of economic fundamentals or the dollar's
cost to U.S. workers and their families is not good or sound policy.
Indeed, this policy has already led to an increase in the current
accounts deficit to new record highs, now almost 4.5 percent of U.S.
real GDP, more than triple the deficit's level before the dollar began
to rise in 1997.
The Coalition notes that Secretary O'Neill, in his previous
incarnation as President of International Paper during the 1980's run-
up in the dollar's value, complained that the dollar ``had turned the
world on its head.'' Today, when the dollar is now reaching the very
heights it did during 1980's, the Secretary calls U.S. manufacturers
``whiners,'' expressing ``no sympathy'' for the burdens the overvalued
dollar policy has created. This is not the message that hard-working
American families should be hearing.
We firmly believe that sound currency values can be restored and
that manufacturing and agriculture can again thrive in this country. To
do this, the Treasury should:
State publicly that the dollar is out of line with economic
fundamentals.
Firmly state that its policy is to seek a market-determined
dollar that is consistent with underlying global economic
fundamentals, including the competitiveness of America's farms and
industries.
Seek cooperation with other major economies in obtaining
common agreement and public statements that their currencies need
to appreciate against the dollar.
Make clear that the United States will resist, and take
offsetting action as necessary, foreign country interventions
designed to retard movement of currencies toward equilibrium.
The Coalition notes that when the Treasury faced a similar
situation more than 15 years ago, it took decisive and successful
action. In crafting the ``Plaza Accord'' of 1985, Treasury Secretary
James Baker was able to restore currency equilibrium and launched
renewed global growth. It was possible then, and is possible now.
Sincerely,
Aerospace Industries Association
American Brush Manufacturers Association
American Cotton Shippers Association
American Fiber Manufacturers Association
American Forest & Paper Association
American Furniture Manufacturers Association
American Hardware Manufacturers Association
American Iron and Steel Institute
American Paper Machinery Association
American Pipe Fittings Association
American Textile Machinery Association
American Textile Manufacturers Institute
Associated Industries of Florida
The Association for Manufacturing Technology
Automotive Trade Policy Council
Business and Industry Association of New Hampshire
The Business Council of New York State
The Business Roundtable
The Carpet and Rug Institute
Composite Can and Tube Institute
Copper and Brass Fabricators Council
Fiber Box Association
Industrial Fabrics Association International
IPC--Association Connecting Electronics Industries
Mississippi Manufacturers Association
Motor and Equipment Manufacturers Association
National Association of Manufacturers
National Cotton Council of America
National Marine Manufacturers Association
New Jersey Business and Industry Association
Non-ferrous Founders' Society
North Carolina Citizens for Business and Industry
North Carolina Manufacturers Association
Ohio Manufacturers Association
Packaging Machinery Manufacturers Institute
Paperboard Packaging Council
Precision Machined Products Association
Process Equipment Manufacturers' Association
Secondary Materials and Recycled Textiles Association
Southern Forest Products Association
Steel Manufacturers Association
Textile Distributors Association
Tooling and Manufacturing Association
USA Rice Federation
Utah Manufacturers Association
Virginia Manufacturers Association
Waste Treatment Technology Association
Wheat Export Trade Education Committee
Wood Component Manufacturers Association
Wood Machinery Manufacturers of America
For more information about the Coalition for a Sound Dollar,
contact Frank Vargo at 202-637-3182 or visit the Coalition's website at
www.sounddollar. org.