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Experts Divided on Outlook for Dollar, Euro

Washington's non-government American Enterprise Institute Friday held a forum that discussed the outlook for world currencies over the next year or two. There was no consensus on the likely direction of the dollar or the euro.

Harvard University professor Jeffrey Frankel is particularly worried about the implications of the large U.S. trade deficit. He believes the persistent deficit will eventually lead to sharp decline in the exchange value of the dollar. Pointing to the fact that China and Japan are large purchasers of U.S. treasury securities, Mr. Frankel says eventually they will cut back their purchases and that could trigger a dollar decline.

"People say that because China and Japan hold so many dollars, they won't want to sell because they know that would drive [the exchange value] down and they will lose from that," said Mr. Frankel. "But each central bank, if it is afraid that the others are going to sell and if there is no coordination, each central bank is afraid the others are going to sell, then the dollar is going to go down anyway, so they're going to want to sell."

Alan Meltzer, an economics professor at Pittsburg's Carnegie Mellon University, disagrees. He says no one knows how many dollars the Japanese and Chinese are willing to hold. "When the Chinese had $200 billion, many people said, well, they're not going to buy anymore. $200 billion is a lot," said Mr. Meltzer. "But they're now up around $700 billion. And will they, say, in a year or so be at a trillion? My guess is, more likely than not."

Both economists agree that unless central banks sell their dollar holdings, the U.S. currency is unlikely to depreciate greatly.

The U.S. trade (or current account) deficit equals about six percent of gross domestic product (GDP). By contrast, China's trade surplus equals about eight percent of China's GDP. Economists say these are the principal global economic imbalances that the International Monetary Fund (IMF), whose mandate is maintaining global financial stability, seems unwilling or unable to rectify.

As to the euro, panelists at the forum identified slow growth and lack of structural reform in the 11 member countries as impediments to a strong advance of the euro against the dollar. Uncertainty has also been increased by the political debate in Italy over whether that country should remain inside the European Union's single currency system.