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INTERVIEW OF L. RANDALL WRAY, PROFESSOR OF ECONOMICS, UNIVERSITY OF MISSOURI—KANSAS CITY, 17 April 2003

Interviewed by Rama Krishna Neti, The ANALYST, a monthly finance magazine published by the Institute of Chartered Financial Analysts of India (ICFAI), Icfaipress.org.

Q 1.    The US dollar has been losing ground steadily over the last few years to its competitors like the Euro on the world market. What do you think might be the reasons for this downfall of the dollar?

Wray: In recent months there has been much talk about the “weakness” of the US dollar, with some predicting a coming “collapse”. I think this is all very much overstated. While it is true that the dollar has fallen somewhat against a number of other currencies, it has remained “strong” versus “traded goods” given deflationary trends around the globe. Hence, there is certainly no significant effect within the US of this currency depreciation. That is to say, there are no inflationary pressures resulting, nor are consumers forced to cut-back their spending on imports. Further, it must be recalled that over the Clinton boom, the dollar rose significantly against most of these same currencies, hence, what we see now is mostly a reversion to pre-bubble exchange rates. I think some of this fall of the dollar might be due to lackluster performance on Wall Street. However, much of it is due to the domestic policies of other nations, which are pursuing strongly deflationary fiscal policy. In any case, it is quite incorrect to presume that the goal of economic policy ought to be directed to appreciation of the domestic currency. Certainly Japan’s yen has remained “strong” throughout its decade-long recession, but it is difficult to see how this has benefited the Japanese economy. A more stimulative fiscal policy aimed at raising employment would have been far better. As Euroland economic growth slips ever-closer to negative territory, it is difficult to see why the strength of the euro ought to be taken as a sign of good economic performance.

Q 2.    Do you think the trade-deficit policies being followed by the US government are further adding to the dollar’s woes? If so what measures can be taken up to right the situation?

It must be remembered that imports are a benefit, and exports are a cost. A trade deficit means that Americans get to consume goods and services that they did not have to produce. The trade deficit results primarily from restrictive fiscal policies in the rest of the world that keep those populations from being able to consume what they produce. Hence, the products of the rest of the world are sent to American consumers because governments all over the world refuse to let domestic demand expand sufficiently. Obviously, this is not a situation that the US can or should correct. If the US were to follow the example of Euroland and tighten the fiscal stance even as unemployment rose, this might succeed in reducing our trade deficit, but it would lower demand for the exports of other nations. This would only compound the unemployment problems of East Asia and Europe. A nearly world-wide relaxation of fiscal stances would be the best solution—but this is not something the US can control.

3.    Is the “Strong Dollar” policy initiated by the Bush government losing its grip to a “Weaker Dollar” policy? What would be the implications of such a shift on US trade and the Dollar?

It is far from clear that the US can or should do anything. History shows that interest rates have little impact on exchange rates—there are many examples in which nations have raised overnight interest rates to 100% and beyond without halting a depreciation. Japan has overnight rates equal to zero, without initiating depreciation of the Yen. Tight fiscal policy can often place upward pressure on a currency, but with negative impacts on employment and growth. Fiscal policy in the US is still too tight even with the tax cuts and (fairly small) increase of defence spending. It would be highly counterproductive to try to increase the value of the dollar by tightening the fiscal stance. Further, as I mentioned earlier, there is no inflationary impact to date from the depreciation of the dollar because of the strong deflationary forces around the world. There are two reasons I do not expect much further depreciation of the dollar. First, given that there are only four major currencies around the world (dollar, euro, sterling, yen), the major players will not allow large relative movements of any of these. If the dollar were to fall by a third relative to the other three currencies, this would represent a huge appreciation of those currencies that would place exporters with costs in these currencies at an insurmountable competitive disadvantage (and especially with respect to producers in those nations that peg to the dollar). Hence, they will pressure their governments to respond (for example, by direct intervention into foreign exchange markets). The second reason I doubt that depreciation of the dollar will accelerate is that dollar-denominated assets remain (and will remain) in demand. As the world-wide recession gathers momentum, wealth holders will seek a safe haven. The US trade deficit provides dollar income and dollar assets that will be increasingly demanded as domestic markets in Euroland and elsewhere worsen.

Q 4.    What would be the impact of the war with Iraq on the US economy, especially on its trade and the Dollar?

To date, the impact is fairly small. According to recent press reports, the US military spent about $20 billion on the war, with expected further costs running about $2 billion per month to maintain troops in the region. The demand gap in the US is probably close to $600 billion annually. Hence, the increased defence spending is just a drop in the bucket. There was some disruption of oil markets, but to date this has not had any significant impact.


Q 5.    Any other issues which you would like to comment upon?

A trade deficit is mostly the result of nonresident desires to accumulate US dollar-denominated financial assets.  It is this desire that drives US ability to net import. Most of the concern about the dollar results from the misconception that the US “needs” to borrow in order to run a trade deficit. This has got the direction of causation exactly backwards. The rest of the world uses its trade surplus to obtain the financial wherewithal to take positions in dollar assets. Thus, in an important sense, we can argue that the US trade deficit “finances” the rest of the world’s net saving in dollar assets. So long as governments around the world misperceive exports as a benefit and imports as a cost, they will maintain overly tight fiscal policy in an effort to run trade surpluses. If they correctly recognized that imports are a benefit, they could relax fiscal policy, increase domestic employment, and consume their output rather than sending it to US consumers.

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