The Meaning of a Dropping Dollar

By Michael Elliott

There are only a few indicators that can be used to measure bragging rights among nations. There's the size and power of your armed forces. (No fun: the U.S. always wins.) There's the number of medals won at the Olympic Games, preferably weighted by population size (which usually makes Australia top nation). Or--very fashionable in Asia these days--you can look at the size of your tallest building, a contest in which Taiwan has just nosed ahead of Malaysia. Or you can dwell on the relative strength of your currency. Which is why you might expect American self-esteem to be in decline, for the dollar has fallen 24% against the euro since the beginning of 2003, touching a record low last week, and 15% against the Japanese yen. But the U.S. economy being a strange beast, few Americans have felt any impact from the dollar's fall. Yet.

Outside the U.S., the psychological impact of currency fluctuations is well known. The strength of the deutsche mark in the 1950s and '60s was a key component in West Germany's recovery of national confidence after World War II. Britons over age 60 were born into a world with four dollars to the pound and then lived through periods in the 1980s when there was near dollar-pound parity--which contributed to a pervasive sense of national decline. The strength of the yen in the bubble years of the late '80s convinced many that Japan had become "Number 1."

But the relative strength of currencies has a popular impact only if people travel outside the borders of their native land. As the U.S. is a nation that spans a continent, it is quite natural that the proportion of Americans who travel abroad each year is far less than, say, that of Germans. So it is only those Americans who either visit foreign countries or live in them who have been hammered by the dollar's decline. TIME readers, being sophisticated folk, will know that you never, ever take a taxi from Heathrow Airport into central London. (You jump on the express train instead.) Less savvy travelers now have to shell out the equivalent of $100 for the joys of being stuck in west London's traffic. The New York Times recently reported that Irish immigrants to the U.S. who had decided to return home were discovering that their dollar savings didn't go far. The cash that you get from selling a house in Woodlawn in the Bronx won't buy you much of anything in boomtown Dublin, where the euro rules.

Even Americans who never leave their shores may have started to hear about some puzzling consequences of the dollar's decline. China's sidewalk banks--illegal but tolerated money changers--are doing a land-office business swapping dollars for renminbi (RMB), the Chinese currency, because canny Chinese now think that the RMB is a "safer" currency than the greenback. They are making the same "one-way bet" as currency traders all over the world, who calculate that the only way in which the record U.S. trade deficit can be brought under control is if the dollar declines, hence making American exports relatively cheaper in foreign markets and, say, Chinese imports relatively more expensive at your local Wal-Mart.

But currency markets have a historical tendency to overshoot, and if they did so now, even stay-at-home Americans would feel the pain. In the markets, where the euro ended last week at $1.30, there is a sense that the greenback still has plenty of room to fall. Those fears were exacerbated last Friday when Federal Reserve Chairman Alan Greenspan said that international investors would "eventually adjust their accumulation of dollar assets"--which means sell them--or "seek higher dollar returns"--which means that U.S. interest rates might soar. Rising interest rates could lead to loan defaults and a reduction in consumer spending, which could easily plunge the U.S. into a recession.

Meanwhile, spend a moment thinking of those Chinese sidewalk banks. The RMB is pegged to the dollar, which means that when the dollar declines, so does the Chinese currency. The U.S. authorities say this is unfair, because it means that Chinese goods continue to be relatively cheap in American stores, which contributes to the U.S.'s massive trade deficit with Beijing (although China's global-trading account is roughly in balance). So at every opportunity (most recently at last weekend's Asia-Pacific Economic Cooperation summit in Santiago, Chile), U.S. officials take the chance to jawbone the Chinese into letting the RMB appreciate in value.

The RMB may well appreciate, a little, over the next year. But the Chinese have made it very clear that they will take their own sweet time about when to let the currency rise and by how much. So although Americans who don't travel haven't noticed it yet, here's one way in which the dollar's decline really has changed the world: today the U.S. Administration is a supplicant to Beijing. Oh, and by 2008, Shanghai plans to have the tallest building on the planet. That's bragging rights to China, twice over. Get used to it.