Douglas Cohn and Eleanor Clift

By DOUGLAS COHN
and ELEANOR CLIFT
WASHINGTON — It’s been said that you can tell the true strength of a country by the strength of its currency, and by that measure, it’s no wonder that Americans are nervous. Anyone who has traveled abroad experiences firsthand the impact of the declining dollar. The euro is valued at almost $1.50 to the dollar, and everybody from a Brazilian super-model to leaders in Iran and China are making noises about trading in their dollars for euros, as though the venerable dollar were some third-world currency.
What’s going on here, and how worried should we be? First of all, anyone who under-estimates the resiliency of the U.S. economy is making a mistake. But having said that, the short-term outlook is not rosy. The Federal Reserve Bank lowered interest rates in an effort to head off an even bigger collapse of the sub-prime mortgage market.
Europe and Asia normally would follow suit, but they didn’t, signaling a new independence, even disdain, for the dollar and for America as an economic leader. Iranian President Achmadinijad, emboldened by oil revenues, mused aloud about converting from the dollar to the euro in his country’s trading. Such talk is not surprising coming from Iran, a country that President Bush designated as part of the axis of evil. It is more disturbing when it comes from an official in the Chinese government, which happens to hold billions in U.S. currency and literally bankrolls the wars in Afghanistan and Iraq with loaned money.
China is our banker, a concept that most Americans find difficult to comprehend, if they are even aware that is how the system works. There is a saying that if you owe a thousand dollars to the bank, it’s your problem, but if you owe a million dollars, it’s the bank’s problem. As the dollar loses strength against the euro, the Chinese are watching their holdings lose value. There are rumblings within China and if they change their reserves into euros, it would put further downward pressure on the dollar. That would hurt the U.S. economy, but it could also hurt the Chinese economy, which is why with any luck it may not happen.
Lurking behind all the dire predictions is the very real crisis of the collapsing market in sub-prime mortgages. Federal Reserve Chairman Ben Bernanke’s prescription so far has been to lower short-term interest rates, and if he lowers them enough, long-term interest rates will start to fall and the mortgage market will rebound. Meanwhile, banks are putting in place stricter requirements to lend money, which is good up to a point. There is a danger of over-reaction. The sub-prime crisis did not occur just from lax lending practices, which is what they would have us believe. The banks weren’t duped. There were red flags, but it was boom time, and these less than stellar mortgages were bundled and sold abroad – to the French, to the Chinese, to a variety of willing foreign buyers.
It is not more regulation that is needed but enforcement of existing regulations. Tightening down too much now with a whole new layer of rules could offset the potential benefits of lower interest rates, rendering the Fed’s actions meaningless. The solution isn’t more laws, which is what Congress and the Bush administration did after the 9/11 attacks when they rushed to pass the Patriot Act, a piece of legislation that endangers civil liberties under the guise of providing needed new powers to the executive branch and law enforcement. In reality, the FBI had the power to investigate suspected terrorists; they just missed the clues, like the fellow taking flying lessons who didn’t care about learning to land. The same could be said of immigration reform, and now banking reform. If the rules already in place were enforced, we would be spared a lot of grief because lower interest rates would be free to help right the economic ship of state. It is a matter of regs getting in the way of rates.
Published in The Messenger 11.28.07