Allison Nathan: Where do you think the dollar goes from here?
Fred Bergsten: I think the trade- weighted dollar (TWD) will continue to rise. The real question is by how much? As a basis of comparison, the dollar rise of all time was in the first half of the 1980s when the dollar basically doubled in value over a five-year period – 1980 to 1985. The second biggest run was from 1995 to 2002, which was a run-up of about 50%. My strong suspicion is that the TWD will not repeat the magnitude of either move mainly because the dollar is unlikely to appreciate much against the RMB and other emerging market currencies, which now play a much greater role in the world financial system and the exchange rate indexes than in the past. However, if you focus on bilateral exchange rates, the dollar move against the yen is already approaching 50%, which I think could go somewhat further, and the move against the euro about 10%, which I think could double. But, in reality, one could characterize these past and future moves as yen and euro weakness rather than as dollar strength; on a trade-weighted basis, which is what counts, the yen and the euro have gone down against everything, while the dollar has gone up against the yen and the euro but not against other key currencies like RMB. Allison Nathan: How do current conditions globally compare to these other periods of past dollar strength?
Fred Bergsten: The most striking similarity is the outperformance of the US economy relative to its main country competitors -- Europe and Japan. In the Reagan boom of the 1980s, the US economy experienced a strong V-shaped recovery from the deep recession at the start of the decade. The late '90s was an even better period for the US economy – arguably the best period in the post-war era – given the combination of rapidly rising productivity growth and job creation, which also helped push the budget into surplus. Today, the US economy is also exhibiting relative strength although more due to weakness in other economies -- the Euro area and Japan -- than in the past. Another similarity with the early 1980s that seems to be playing out is a collapse in the oil price that should keep the US trade deficit from rising as far as it otherwise would on the strengthening dollar.
In terms of differences, I have already mentioned the main one, which is the increased importance of emerging markets in the global economy and, increasingly, in currency markets. In the early '80s, the financial markets were still almost entirely comprised of the G5/G7, so when you needed to correct the huge over-valuation of the dollar, the G5/G7 were able to work together to resolve it. It is interesting to note that implementation of the Plaza Accord, in which the G5 intervened heavily to bring down the dollar, marked the first period when emerging markets became important. The so- called Newly Industrializing Countries (NICs) -- Korea, Taiwan, Hong Kong, Singapore -- maintained their dollar pegs and rode the dollar down against all the other G5/G7 currencies; they therefore became the big surplus countries of the late 1980s. Of course today China, India and others are important considerations in the global markets. It will be particularly interesting to see what China does here because just as the NICs rode the dollar down in the '80s, China is now riding the dollar up given that the RMB basically remains pegged to the dollar.
Allison Nathan: How might dollar strength affect trade relations? Could it spark a rise in protectionism?
Fred Bergsten: That depends of course on how much the dollar moves; the doubling of the value of the dollar in the early '80s that pushed the current account deficit to unforeseen levels led to a huge political reaction. This reaction was a key motivation of the Plaza Accord that largely aimed to reduce the risk of protectionist trade pressure and a blowup of the global trading system. Despite a substantial rise in the current account deficit during the late 1990s run-up, protectionist pressure was lower in part because the economy was doing well; this pressure did not begin to rise again until the heightened focus on Chinese foreign exchange intervention in the early part of the 2000s.
This time around there is already substantial congressional pressure for the US to take legislative action against currency intervention – not just against China, but against Japan, Korea and others if they were to start intervening again. If the dollar were to continue to appreciate enough to significantly increase the trade deficit and, in turn, slow growth and job creation, that pressure would very likely intensify. And Congress would have a lot of leverage because the administration is currently pursuing a very active trade agreements agenda that includes negotiating the Trans-Pacific Partnership, the Trans-Atlantic Trade Investment Partnership and potentially trying to secure Trade Promotion Authority again. This White House trade agenda gives Congress a shot not only at trade policy in the usual sense, but at the exchange rate. So if the situation ran far enough, Congress could force the Obama Administration's hand. I think that is the sleeper scenario that has not gotten enough attention.
