FEARS that the dollar could go into a free fall because of big budget and trade deficits are overblown, says Henry Kaufman, known for his longtime work as an economist at Salomon Brothers, where he was often bearish about American economic prospects. Now 77, he is an independent consultant and is on the board of Lehman Brothers. Here are excerpts from a recent conversation:
Q. As someone who has been bearish in general, why are you positive about the dollar?
A. “Positive” is a little bit of an overstatement. I believe the dollar will remain the key reserve currency for the foreseeable future. The United States is the dominant world power, and with world power goes leadership of the currency. If you go back to the British Empire or the Dutch or the Spanish, you’ll find that world power also means a dominant currency.
We have an economy that is performing far, far better than the other industrialized countries. Therefore, profits here are better than they are in most places around the world. Our interest rates are competitive.
Q. But the Bush administration, despite some statements to the contrary, seems intent on expanding government deficits. Isn’t that sending a bad signal?
A. The immediate issue is, “Who is going to finance the American budget deficit?” Let me give you a couple of numbers. Japan will continue to buy about $200 billion of U.S. government debt a year. They have a large export surplus to the United States. China, which also has a large surplus, will also probably buy about $100 billion.
Thirdly, the Federal Reserve is a buyer for monetary reasons, and that will account for $50 billion to $75 billion. Lastly, other buyers have emerged over the past year, namely some of the oil-producing countries. The price of oil has increased very dramatically. That money cannot readily be spent by producers such as Saudi Arabia and Qatar. Therefore, you have to put them in for $50 billion to $75 billion of purchases of American securities. So there isn’t very much left for the time being for domestic investors to finance.
Q. But it appears there is a deeply felt sense in the administration that a cheap dollar will spur American economic growth and reduce the debt to the rest of the world.
A. If it becomes an outspoken approach by the administration, that would be quite dangerous. Talking down your own currency when you’re the key reserve currency and when you are dependent on foreign sources of money would ultimately create problems. The secretary of the Treasury, as well as the president, should always articulate that “we are in favor of a stable currency.” They should never even whisper the idea that “if the dollar goes down, that’s all right with us.”
Q. What do you think of the quotation attributed to Vice President Dick Cheney that “Reagan proved deficits don’t matter”?
A. That is an incorrect observation by the vice president. Deficits do matter over the long term. There are times in the business cycle in which the U.S. Treasury competes very heavily against the private sector. When that occurs, it escalates interest rates. It puts pressure on inflation. It’s a dangerous approach.
Q. In its heart of hearts, do you think the Bush administration agrees with you?
A. I think a number of people in the administration probably believe so. I believe a number of people in the Federal Reserve believe so. But whether the inner sanctum of the administration will say that a stable dollar is a key consideration, that may be questionable. We are just in a fortuitous situation today, meaning this year and probably next year, in which the size of the budget deficit doesn’t matter for the immediate future. But ongoing budget deficits of this order of magnitude over time will matter.
Q. A Chinese official was quoted as saying that his government was not happy with the dollar’s weakness. Do you think the Chinese or Japanese could shift their holdings elsewhere?
A. I doubt that very much. Both China and Japan are big exporters to the United States. I believe that the Chinese and Japanese, down deep, realize that if they shifted from the American dollar to the euro, it would endanger their export drive to the United States.
Q. So what is your prognosis for the dollar?
A. I think there is going to be reasonable stability with occasionally a little bit of a give in the value of the dollar.
Q. Do you think a decline in the value of the dollar sharply stimulates our exports?
A. I do not. It takes much longer this time around for the decline in the dollar to have a significant impact on our trade.
It involves a number of countries such as India and China that provide goods and services to us at a very low labor cost. To turn that around, that will require a really significant decline in the value of the dollar. That’s not about to happen.
Q. In your lifetime, have you seen a time of such huge fiscal and trade imbalances?
A. Not really. Today, there is an enormous international disequilibrium. For the near term, it is in the best interest of all the participants to maintain it.
Q. What could trip that disequilibrium into an economic disaster for the United States?
A. We could have a massive terrorist attack. The price of oil could ratchet very high. No.3, if Europe and Japan lifted economic activity significantly, that would turn things around and put more pressure on the United States.