FORBES GLOBAL March 06, 2000
Hidden strength
By David Roche
Based on conventional international financial analysis, the U.S. dollar is heading for big trouble. The U.S. current-account deficit looks ready to jump this year to well over $400 billion, from about $320 billion in 1999, driven by the continuing strength of the U.S. economy. Any slowdown in domestic demand during 2000 will come too late to make things better.
Current-account deficits are financed through voluntary net capital inflows. Here, too, the picture is dim for the dollar. I anticipate a big increase in U.S. corporate acquisitions overseas as opportunities to invest in both Europe and Japan take off. At the same time, net portfolio inflows to the U.S. are likely to tail off. Foreign investors are already fully invested in U.S. equities. U.S. investors may find overseas prospects in Europe a tempting alternative.
So I reckon that, whereas voluntary capital flows more than covered the U.S. current-account deficit last year, this year there will be a yawning financing deficit after voluntary capital flows of $250 billion, 2.6% of GDP.
Conventional wisdom says that these deteriorating fundamentals will exert huge downward pressure on the dollar. This is where I part company with the traditional analysis. I think the dollar's strength this year will surprise the conventional thinkers.
First, let's consider central bank funding. It's true that the dollar may not be used as the currency of international reserves as much as before because of the gradual internationalization of the yen and the advent of the single European currency. Even so, the dollar remains the world's reserve currency, accounting for around 70% of global central bank foreign-exchange reserves, a percentage that's hardly changed in the last decade. That suggests that central banks may not want to diversify much into other currencies, particularly while the euro continues to be weak. So central banks will continue to give powerful support to the dollar.
But official inflows alone will not be enough to cover the financing gap. That leaves banking system dollar liabilities to fill the void. This is where the increasing irrelevance of national trade accounts in an interdependent global economy comes in.
Conventional wisdom says that deteriorating fundamentals will exert huge downward pressure on the dollar. Ithink the dollar's strength this year will surprise the conventional thinkers.
An increase in the foreign liabilities of the U.S. financial system means that someone offshore is making a dollar deposit. Sure, these deposits may be hot money that will flee as soon as returns are better on other currencies. But that's not the whole story, and it won't be in 2000. Here's why.
The U.S. domestic economy may run a huge current account deficit, as well-paid Americans exchange their paychecks for BMW cars, Samsung TVs, Nokia cell phones. But U.S. business is global and getting more so. U.S. corporations produce 24% of their output abroad, compared with 18% for Europe and 14% for Japan. To a large extent, the international activities of U.S. companies fall outside the U.S. national accounts.
Think, for example, about the technology sector. U.S. trade figures show that the U.S. runs a deficit of $75 billion a year in high-tech and IT goods. That's what the trade figures show. Yet everyone knows that the U.S. is the world's greatest IT success story. The answer is that U.S. high-tech firms don't make many of the products they sell around the world in the U.S., simply because it's more profitable to make hardware in Asia and employ programmers in India.
This brings me to the impact of globalization on the dollar. A U.S. corporation producing computer widgets in an overseas location and selling them back to the U.S. or in international markets, gets dollars for its pains. It may well keep these dollars rather than sell them for yen or euros, because much of its business is conducted in dollars anyway.
These dollar earnings stay parked in the local banking system, so there's a hidden demand for dollars that never shows up in the U.S. external accounts. This represents a very stable, voluntary and long-term demand for dollars that will continue as long as U.S. business is successful at globalization.
The bottom line is that a substantial part of the U.S.' external financing requirement is met by the propensity of U.S. corporations to hold dollars. I reckon that this hidden demand for dollars (dollars as part of U.S. corporations' overseas production chain) is worth from $200 billion to $250 billion. That's real support for the U.S.' current account financing gap.
The dollar will weaken against the euro. But it will strengthen against the yen and hold its own against most other currencies.
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