Heavyweight Champ

By GEORGE J. CHURCH

Add one more to the list of myths exploded by the record U.S. boom. Remember when any unemployment rate lower than 6%, or any rise in national output of more than 2.5%, was supposed to light a bonfire of inflation? Come on, it wasn't that long ago--those beliefs died even harder than the '80s idea that the U.S. was becoming a corporate colony of Japan. And as late as the end of 1998, some economists feared that a ballooning U.S. trade deficit and the launch of a rival international currency, the euro, would send the American dollar into a headlong slide--maybe even a "dollar crisis."

What has happened is the exact opposite. Far from becoming dangerously weak, the dollar, if anything, may be a bit too strong. So far this year it has risen about 6% on average against the currencies of the 19 most important U.S. trading partners. In May the greenback hit a four-year high against the British pound, while the euro, introduced 17 months earlier at a price of $1.17, fell briefly below 90[cents].

The development is great for U.S. tourists abroad; especially in Europe and Canada, they will need fewer dollars to buy a hotel room, a dinner, a bus ride or whatever. But it may also seem especially mystifying because America has been spilling more dollars abroad than pessimists feared. The U.S. deficit on current account, which measures all sorts of money flows--merchandise imports vs. exports, trade in services, tourist spending, investment flows--jumped more than 50% in 1999 to almost $339 billion. This year it seems headed higher still, to around $400 billion. In theory that creates an excessive supply of dollars in the world. Like an excessive supply of wheat or anything else, that ought to drive down the international price of a buck.

As with so many other things these days, though, classical theory is being rewritten by the sheer strength and dynamism of the American economy. Not only is the U.S. growing faster than any other major nation, but it is also enjoying a surge in productivity that promises to keep growth going well into the future, if a bit less exuberantly than today. And, for all Federal Reserve Chairman Alan Greenspan's fears of renewed inflation, price and wage increases have not eaten up any significant part of the gains.

Accordingly, the U.S. right now is the best place in the world to invest. So foreigners are sending back to the U.S., as investments, many of the dollars they accumulate in trade and other business dealings. That trend keeps global demand for dollars high enough to balance--or even outbalance--the increased supply.

Just under $151 billion of net direct investment--money to build plants or buy companies--poured into the U.S. last year, mostly from Europe. An additional $160 billion net, again mostly from Europe, flooded into purchases of U.S. corporate bonds; overseas investors actually snapped up more than two-thirds of all this debt issued in 1999 by American corporations. In 1998 U.S. buying of foreign stocks exceeded foreign purchases of American shares, but last year the balance swung the other way, pulling $108 billion more into the U.S.

Foreign investors, including Canadians, think the U.S. economy "is where the action is," says Michael McCracken, chairman of Informetrica, an economics think tank based in Ottawa. Ed Yardeni, chief economist and global-investment strategist of Deutsche Bank Securities, elaborates: "I go to Europe, Japan, have overseas investors coming to see me in my New York City office, and to a large extent they all want to be invested in technology. And it's very hard to find enough names of high-tech companies to invest in abroad. If you want to invest in technology, you've got to invest in U.S. companies."

Still there is a growing suspicion in global financial circles that the dollar may be at its peak and poised for at least a slight decline. While the Federal Reserve is trying hard to slow the U.S. economy, growth is picking up in other parts of the world. Output is forecast to rise about 3% this year in "Euroland" (the 11 nations that use the euro as a trading currency). Japan is crawling out of recession, and though growth there is feeble, it has still been enough to hold the yen steady against the dollar. Europeans point out too that there are growing opportunities for high-tech investment on their continent, if not quite as many as in the U.S. A new index of European technology stocks rose two-thirds last year.

There are reasons, however, to think--and devoutly hope--that any slide in the dollar will be modest and gradual. Though the gap is shrinking, economic growth will remain faster in the U.S. than in Europe--and certainly than in Japan--for this year at least. Asian countries are recovering rapidly from their 1997-98 debacle; forecasts for expansion this year range from 3.4% in the Philippines to 6.8% in Malaysia. But Asian economies must reduce a huge overhang of debt before they can siphon away any investment now going to the U.S.

Longer range, says Gary Dugan, London-based global equity strategist for the J.P. Morgan investment bank, many investors think Europe is moving too slowly to reform the tax, labor and regulatory restrictions that make it a less attractive target for capital than the U.S. And though rising interest rates may eventually slow American growth, right now they increase the already substantial premium that investments in the U.S. pay over investments in other countries.

American analysts further point out that foreign direct investment at least does not wash in and out with the economic tides; once turned into bricks, mortar and machinery, it stays put. Portfolio--that is, stock and bond--investment is more volatile. But Lawrence Kudlow, chief economist of CNBC.com points out that the 37% nose dive in the NASDAQ index from its March 10 high to its May 23 low did not appear to scare away much foreign investment--at least not enough to make any difference in the dollar's price. "I was holding my breath on that one," says Kudlow.

A small and orderly decline in the dollar would not be at all unwelcome to most economic analysts. It would help U.S. exports, by making them cheaper in terms of foreign currencies, and bring U.S. trade accounts closer to balance. A sudden and sharp drop in the buck's value, however, would be a very different matter--in fact, a disaster. It would greatly worsen U.S. inflation by driving up the price of imports. Foreign goods and services directly account for about 15% of all American gross-domestic purchases and have a real influence far beyond that because so many American products either compete with imports or are assembled partly from imported components.

Though the odds are against it, a dollar implosion cannot be ruled out. Allen Sinai, president and chief global economist for Primark Decision Economics, a global forecasting firm, assigns it about a 30% chance. One reason is that money traders, once moved in any direction, have rarely been noted for moderation; they often push the price of any currency up or down far beyond what might be justified by economic fundamentals.

Fundamentals too could turn against the dollar. The doomsday fear is that the Fed, in its zeal to head off inflation, will hit the monetary brakes too hard, causing a severe slowdown in the U.S. economy. That frightens away some foreign investment, causing the dollar to drop sharply. Then inflation rises despite the slowdown, prompting the Fed to crack down harder still, and so on around a truly vicious circle.

The innate strength of the U.S. economy and the vigor of American productivity ought to prevent that circle from starting, and keep the dollar at least relatively strong for a long time to come. But as the dollar pessimists of 1998 have discovered, exchange markets are so volatile that any prediction at all about what they may do should be made with crossed fingers and accompanied by repeated knocks on wood.

--With reporting by Bernard Baumohl/New York, Moira Daly/Toronto, Helen Gibson/London and Wendy Kan/Hong Kong

With reporting by Bernard Baumohl/New York, Moira Daly/Toronto, Helen Gibson/London and Wendy Kan/Hong Kong