[Paleopsych] Warning From the Markets (NY Times editorial)

[Steve Hovland]

Warning From the Markets
When a seemingly innocuous remark from the central bank of South Korea 
makes the dollar tank, as happened on Tuesday, all is not well with the 
United States' position in the world economy.

The dollar has been on a downward trajectory for three years, thanks in 
part to the Bush administration's decision to try to use a cheap dollar to 
shrink the nation's enormous trade deficit. (A weak dollar makes exports 
cheaper and imports costlier, a combination that theoretically should 
narrow the trade gap.) To be truly effective, however, a weak dollar must 
be combined with a lower federal budget deficit - or even a budget surplus, 
something the administration clearly hasn't delivered. So predictably, the 
weak-dollar ploy hasn't worked. The United States' trade deficit has 
mushroomed to record levels, as has the United States' need to borrow from 
abroad - some $2 billion a day - just to balance its books.

Enter South Korea. On Monday, its central bank reported that it intended to 
diversify into other currencies and away from dollar-based assets. And why 
not? It holds about $69 billion in United States Treasury securities, or 4 
percent of the total foreign Treasury holdings. Such dollar-based 
investments lose value as the dollar weakens, leading to losses that any 
cautious banker would want to avoid. But as the Korean comment ping-ponged 
around the world, all hell broke loose, with currency traders selling 
dollars for fear that the central banks of Japan and China, which hold 
immense dollar reserves - a combined $900 billion, or 46 percent of foreign 
Treasury holdings - might follow suit.

That would be the United States' worst economic nightmare. If it appeared 
that the flow of investment from abroad was not enough to cover the 
nation's gargantuan deficits, interest rates would rise sharply, the dollar 
would plunge further, and the economy would stall. A fiscal crisis would 
result.

Tuesday's sell-off of dollars did not precipitate a meltdown. But it sure 
gave a taste of one. The dollar suffered its worst single-day decline in 
two months against the yen and the euro. Stock markets in New York, London, 
Paris and Frankfurt dropped, and gold and oil prices, which tend to go up 
when the dollar goes down, spiked.

Luckily, the markets calmed down yesterday, as Asian central banks said 
they they did not intend to shun dollars. While such damage control is 
welcome, it's no fix. Tuesday's market episode has its roots in American 
structural imbalances that will be corrected only by new policies, not more 
of the same tax-cut-and-weak-dollar deficit-bloating ploys.

If Mr. Bush were half the capitalist he claims he is, he would listen to 
what the markets are telling him.