The declining dollar--symptom and symbol of U.S. financial negligence.

• Author: Horne, J. Paul
• Position: Cover story - Essay

Looking beyond the current turmoil in global capital markets, that long-running subject--what outlook for the dollar?--seems likely to involve further decline in its value against the euro and other major currencies. There is scant evidence of willingness on the part of U.S. political and monetary leaders, today's or tomorrow's, to do what is necessary to make the dollar fundamentally stronger. Indeed, American policy-makers have powerful reasons to let the dollar depreciate over time, shifting the cost to the rest of the world of U.S. international borrowing to cover shortcomings in economic policies pursued by Washington.

In addition, this "benign neglect," to put it euphemistically, coincided with the Bush administration's aversion to using regulatory tools that might have provided timely transparence about some new financial instruments and averted some of the current turbulence in markets. These U.S. policies have deepened doubts about the long-run reliability of the dollar as a store of value.

Ironically, the factor most likely to prop up the dollar's exchange rate would be international disasters that cause foreign capital to flee to the United States. Such a shift back to the United States would probably prove temporary, and the more significant result of any severe crisis would be to further shake international faith in the solidity of financial institutions. A poll published in January 2008 for the annual Davos meeting on world economics showed a prevailing view (60 percent of respondents) that central banks have lost control of the situation they are supposed to be managing. And the United States is certainly not alone in being singled out: the leading French bank, Societe Generale, has blamed its recent staggering loss of $7 billion on a rogue individual in its trading department, but this has still shaken confidence in the bank and its supervisory system.

Despite these European policy mistakes, a larger reproach can be addressed to Washington about sowing systemic problems. These stem largely from the hands-off, laissez-faire attitude of the Bush administration toward markets. In practice, this has meant a U.S. aversion to using regulatory tools that could have insisted on adequate transparency and timely accountability about new financial instruments and banking practices.

One egregious example is the absence of oversight for the practice of repackaging U.S. sub-prime mortgages--high-risk loans with little information about credit-worthiness and the degree of risk involved. These complex securities, which became even more opaque when they were bundled into large packages, were misleadingly marketed to investors worldwide.

Similarly, the Federal Reserve has been reluctant to use its regulatory authority and immense influence to pre-emptively discourage the growth of asset bubbles built on such securities and on excessively-leveraged borrowing. This ideological mindset against regulatory interference with markets alarms international investors, many of whom worry about the foundations of the U.S. banking system. The U.S. central bank's preference for acting after bubbles burst--in this case, frantically cutting interest rates and resorting to emergency measures to shore up the banking system--reduces international confidence in the U.S. financial system and, symptomatically, in the U.S. currency.

Senior European officials have publicly criticized the United States for the international sell-off in securities that started in July 2007--which they trace to U.S. excesses and lack of regulatory discipline. France's Finance Minister, Christine Lagarde, said on French radio: "We are not in the same situation as the U.S.A. American households can be 100 percent in debt, with floating interest rates. Unemployment in the U.S. is increasing, in France it is decreasing. U.S. economic growth has slowed." Similarly, according to EU Economic and Monetary Affairs Commissioner Joaquin Almunia, "the main reason why the equity markets have this extreme volatile situation these days is the risk of a recession in the U.S.; it's not about a global recession. Big imbalances have been created; have built over the years in the U.S. economy--a big current account deficit, a big fiscal deficit, (and) a lack of...