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The U.S. remains in a sustainable, piece-by-piece recovery from the Great Deflation of 1997-2001. And the strength of the recovery in 2003 and beyond depends on currency stability — the confidence that governments will avoid both deflationary mistakes (as was the case in the 1990s) and inflationary mistakes (the 1970's case). In fact, rebuilding confidence in the future value of currencies is even more important than rebuilding confidence in U.S. bookkeeping. Unfortunately, the U.S. government isn't aiding in the confidence-rebuilding process. It's leaving the future of the dollar uncertain. The current U.S. government policy of dollar neglect leaves open the risk that the dollar could double in value over the next ten years (meaning extreme deflation) or halve in value (meaning inflation.) Most likely, neither of these scenarios will occur, but U.S. growth would be faster today if both were ruled out. The stated dollar policy is President Bush's June 26 position that the dollar's value is controlled by the market and depends on "whether our country can rein in spending, recover, and revitalize our manufacturing base." Since Congress is unlikely to rein in spending, and the U.S. manufacturing base has been in a secular decline for decades, the implication of Bush's dollar policy is that the dollar should weaken a lot. But the president - most likely - didn't mean it that way, since it would have such negative effects on the economy, financial markets, and Republican prospects. Still, this currency confusion discourages investment in the U.S. as much as the accounting scandals. Unlike confidence in the accounting system, confidence in currencies is easily rebuilt when governments make currencies a priority. Examples include Germany in 1948, the U.S. in 1979 and 1988, China in 1993, Brazil in 1994, and Russia in 1998. The irony is that the IMF is making more sense in regards to the dollar (at least as of last week) than we are. In a July 4 interview with the Financial Times, IMF Managing Director Hoerst Koehler reportedly contemplated a coordinated central-bank intervention in the case of a rapid or disorderly fall in the dollar. It's embarrassing to think that the U.S. has sunk to needing rhetorical currency help from the IMF. And there's no reason why the U.S. dollar position is so weakened as to need intervention at all. But at least Koehler's interview was an improvement on U.S. confusion over the future value of the dollar. Also ironic is the contrast Koehler creates with U.S. officials when he states clearly his optimism about the U.S. and the dollar. Per the Financial Times, Koehler "doubted the dollar would go into freefall, because Europe was not yet an alternative to the U.S. as a source of growth and demand for capital. The U.S. is more flexible than others, which makes us believe that the U.S. economy may rebound strongly." Right on. — Mr. Malpass is the Chief International Economist for Bear Stearns.
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current worries about "dollar weakness" and a U.S. double dip
are overblown. While U.S. equities declined in June, U.S. bonds rallied,
indicating that there's no sizeable capital flight from the U.S.
