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85–735 PDF 2003

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U.S. DEPARTMENT OF THE TREASURY’S

REPORT TO CONGRESS ON

INTERNATIONAL ECONOMIC AND

EXCHANGE RATE POLICY

HEARING

BEFORE THE

COMMITTEE ON

BANKING, HOUSING, AND URBAN AFFAIRS

UNITED STATES SENATE

ONE HUNDRED SEVENTH CONGRESS

SECOND SESSION

ON

THE U.S. DEPARTMENT OF THE TREASURY’S REPORT TO CONGRESS ON

INTERNATIONAL ECONOMIC AND EXCHANGE RATE POLICY

MAY 1, 2002

Printed for the use of the Committee on Banking, Housing, and Urban Affairs

(

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

PAUL S. SARBANES, Maryland, Chairman

CHRISTOPHER J. DODD, Connecticut

TIM JOHNSON, South Dakota

JACK REED, Rhode Island

CHARLES E. SCHUMER, New York

EVAN BAYH, Indiana

ZELL MILLER, Georgia

THOMAS R. CARPER, Delaware

DEBBIE STABENOW, Michigan

JON S. CORZINE, New Jersey

DANIEL K. AKAKA, Hawaii

PHIL GRAMM, Texas

RICHARD C. SHELBY, Alabama

ROBERT F. BENNETT, Utah

WAYNE ALLARD, Colorado

MICHAEL B. ENZI, Wyoming

CHUCK HAGEL, Nebraska

RICK SANTORUM, Pennsylvania

JIM BUNNING, Kentucky

MIKE CRAPO, Idaho

JOHN ENSIGN, Nevada

STEVEN B. HARRIS, Staff Director and Chief Counsel

WAYNE A. ABERNATHY, Republican Staff Director

MARTIN J. GRUENBERG, Senior Counsel

THOMAS LOO, Republican Senior Economist

JOSEPH R. KOLINSKI, Chief Clerk and Computer Systems Administrator

GEORGE E. WHITTLE, Editor

(II)

CONTENTS

WEDNESDAY, MAY 1, 2002

Page

Opening statement of Chairman Sarbanes ........................................................... 1

Opening statements, comments, or prepared statements of:

Senator Bunning ............................................................................................... 2

Senator Johnson ............................................................................................... 2

Senator Miller ................................................................................................... 3

Senator Corzine ................................................................................................ 4

Senator Akaka .................................................................................................. 4

Senator Gramm ................................................................................................ 12

Senator Stabenow ............................................................................................. 51

Senator Hagel ................................................................................................... 51

WITNESSES

Paul H. O’Neill, Secretary, U.S. Department of the Treasury ............................. 4

Prepared statement .......................................................................................... 52

Report to Congress .................................................................................... 57

Response to written question of Senator Akaka ..................................... 137

Richard L. Trumka, Secretary-Treasurer, American Federation of Labor and

Congress of Industrial Organizations ................................................................. 25

Prepared statement .......................................................................................... 66

Report submitted ....................................................................................... 68

Response to written questions of Senator Bunning ................................ 137

Jerry J. Jasinowski, President, National Association of Manufacturers ............ 27

Prepared statement .......................................................................................... 101

Response to written questions of Senator Bunning ................................ 138

Bob Stallman, President, American Farm Bureau Federation ............................ 29

Prepared statement .......................................................................................... 115

Response to written questions of Senator Bunning ................................ 139

C. Fred Bergsten, Director, Institute for International Economics ..................... 31

Prepared statement .......................................................................................... 123

Ernest H. Preeg, Senior Fellow in Trade and Productivity, Manufacturers

Alliance/MAPI, Inc. .............................................................................................. 35

Prepared statement .......................................................................................... 127

Response to written questions of Senator Bunning ................................ 140

Steve H. Hanke, Professor of Applied Economics, Johns Hopkins University ... 37

Prepared statement .......................................................................................... 130

Response to written questions of Senator Bunning ................................ 141

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

Prepared statement of the American Forest and Paper Association ................... 142

Prepared statement of the American Textile Manufacturers Institute, (ATMI) 154

Prepared statement of the Coalition for a Sound Dollar ...................................... 156

Miscellaneous letters submitted for the record by Senator Paul Sarbanes ........ 159

(III)

(1)

U.S. DEPARTMENT OF THE TREASURY’S

REPORT TO CONGRESS ON

INTERNATIONAL ECONOMIC AND

EXCHANGE RATE POLICY

WEDNESDAY, MAY 1, 2002

U.S. SENATE,

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS,

Washington, DC.

The Committee met at 10:02 a.m. in room SD–538 of the Dirksen

Senate Office Building, Senator Paul S. Sarbanes (Chairman of the

Committee) presiding.

OPENING STATEMENT OF CHAIRMAN PAUL S. SARBANES

Chairman SARBANES. The hearing will come to order.

We are very pleased to welcome Treasury Secretary O’Neill to

the Committee this morning to testify on the Treasury Department’s Report to Congress on International Economic and Exchange Rate Policy.

He will be followed by a panel of representatives of American

manufacturers, workers, farmers, and academics, who will comment on the impact of the exchange rate of the dollar on U.S.

trade, employment, and long-term economic stability.

Mr. Secretary, we apologize. We had a vote and we had no alternative in terms of when to start. And I understand that you have

some time pressures and we are mindful of those. So when the

time comes that you have to leave, we will certainly recognize that.

The Omnibus Trade and Competitiveness Act of 1988 requires

the Treasury Department to submit a report to Congress annually

in October, with an update after 6 months, on international economic policy, including exchange rate policy.

The Banking Committee originally planned to hold this hearing

last October, at the time of the submission of the annual report,

but delayed it because of the events following September 11.

This morning’s hearing is technically on the 6 month update of

that annual report, but obviously, will encompass the report as

well. It is important to just take a moment, and I will be very brief

here because I know we want to move along, to understand the

origin of this reporting requirement, so we can understand its

purpose.

The report required in the 1988 Act was a response to the experience in the early 1980’s when the exchange rate of the dollar rose

2

to very high levels and there was a sharp deterioration in the U.S.

trade and current account balance.

Initially, there was a denial that there was any issue, any concern. But the Treasury Department—this is in the Reagan years,

Secretary Baker—shifted positions and organized an effort by the

Group of 7 industrial countries in 1985, known as the Plaza Accord, to address lowering the value of the dollar and begin to ease

the deterioration in the U.S. current account.

In the aftermath of that experience, the Congress realized that

it did not have a mechanism by which the Treasury Department

would regularly report or testify on the conduct of international

economic policy. There was a recognition that this was a critical

area of economic policy and that a mechanism similar to the requirement that the Federal Reserve report to Congress semiannually on the conduct of monetary policy, was needed. This report was

the result of that rationale. We regard this report as a serious matter. We intend for the Committee to conduct regular oversight on

this important issue.

I want to commend Secretary O’Neill and the Treasury Department for the timely submission of the report and its 6 month update since the current Administration took office. In this regard,

they have been quite responsive to the requirements of the statute.

I am not going to go through the different requirements of that

statute, many of which have been met specifically in the reporting

requirement. There are some that were not addressed and I may

make reference to those in the question session.

The purpose of the report is for Treasury to present its views in

writing to the Congress and the reasoning behind these views, and

we look forward to hearing from the Secretary this morning.

Senator Bunning.

COMMENTS OF SENATOR JIM BUNNING

Senator BUNNING. Thank you, Mr. Chairman. First of all, thank

you for holding this hearing and thank you, Secretary O’Neill, and

all our other witnesses for being here. This is an important hearing

and I would like to thank everyone here for testifying.

I am entering this hearing with an open mind. There is a divergent opinion on this issue and we need to hear from everyone who

is affected by this. I believe our economy, though growing, is still

rather fragile and we could slide into what is known as a doubledip recession if we are not careful. We need to make sure that we

make the right decisions so we do not jeopardize this recovery.

I believe your testimony today can help us figure out how to keep

the recovery going. I look forward to hearing from you and all the

other witnesses, and I thank you, Mr. Chairman, for holding the

hearing.

Chairman SARBANES. Thank you, Senator Bunning.

Senator Johnson.

STATEMENT OF SENATOR TIM JOHNSON

Senator JOHNSON. Thank you, Chairman Sarbanes, and thank

you, Secretary O’Neill, for joining us here today.

This is an important hearing to discuss international economic

conditions and exchange rate policy. Monetary policy and the

3

strength of the dollar relative to foreign currencies play a critical

role in America’s ability to compete in a free trade environment.

I think it is fair to say that in my home State of South Dakota,

that the appreciating value of the dollar, the differential that increasingly occurs, is significantly undermining support for free

trade negotiations, as our farmers and ranchers in particular find

increasingly that the problem that they have that results in an

unlevel playing field in their perspective is not so much the issue

of tariffs and other nontrade barriers, as it is currency differentials.

I want to focus a bit today on the local economic impact that the

strong U.S. dollar has in my State. I am concerned that, in the face

of cheaper meat imports, cattle and sheep prices continue to fall

and exports stagnate. I am also concerned about small manufacturing firms as well that are unable to compete effectively against

foreign competitors due to the sustained appreciation of the dollar

against other currencies.

This past year, my State saw an 11.6 percent decline in manufacturing employment and a 27 percent increase in personal bankruptcy filings. Some of this, of course, is due to the business cycle

and the recent recession. But the depreciation of the dollar and the

consequent depression in commodity prices appears to be a principal reason why the ag economy did not share in the economic

prosperity that most sectors enjoyed between 1995 and 1999.

Last year, I requested the USDA to complete a study on the U.S.

sheep industry, its future and the factors that have led to its decline. The study focused on the rapid increase in lamb imports in

the mid-1990’s that resulted from price manipulation by New Zealand and Australia. As a result of arbitration, the United States

established a 3 year tariff rate quota, TRQ, on lamb imports from

these countries in July 1999.

Despite implementation of the TRQ, imports did not slow because the effects of the tariff were almost entirely offset by the

strong United States dollar and unusually weak Australian and

New Zealand currencies, in 1998, when the United States dollar

appreciated against the Australian and New Zealand currencies by

more than 18 percent and 24 percent, respectively.

In light of these developments and the impact that it has on U.S.

trade, and the impact it has on the willingness of the American

people to pursue trade agreements that do not take into consideration currency differentials, I think it is very important that we

take a hard look at this, and I welcome, Secretary O’Neill, your report and your willingness to testify to this Committee today.

Chairman SARBANES. Thank you very much, Senator Johnson.

Senator Miller.

COMMENTS OF SENATOR ZELL MILLER

Senator MILLER. Thank you, Mr. Chairman, for holding this

hearing. I will pass on a statement. But I do want the Secretary

to know how glad we are to have him with us and thank him for

his service.

Chairman SARBANES. Senator Corzine.

4

COMMENTS OF SENATOR JON S. CORZINE

Senator CORZINE. Mr. Chairman, I thank you for holding this

hearing, and it is always good to see the Secretary.

This is an important topic that really has a true impact on our

economy and I look forward to his remarks and the other witnesses’ remarks as well.

Thank you.

Chairman SARBANES. Good.

Senator Akaka.

COMMENTS OF SENATOR DANIEL K. AKAKA

Senator AKAKA. Thank you very much, Mr. Chairman. I will also

be brief.

I want to welcome the Secretary and I look forward to your report to us on International Economic and Exchange Rate Policy. I

also welcome the other witnesses.

During today’s discussion, Mr. Chairman, I am particularly interested in the current account deficit and the potential problems that

it may cause.

Given the divergence of opinion on the significance of the current

account deficit, I look forward to an examination of the consequences of the deficit on our economy. Secretary O’Neill, you

have stated that the current account deficit is a meaningless concept. The International Monetary Fund’s chief economist has called

the U.S. current account deficit, and the possibility of a correction,

a significant risk to the global economy.

The Wall Street Journal described the nightmare scenario involving the reversal in account deficit and the possibility of foreign investors withdrawing their money out of the U.S. economy. This

could lead to a weakening of the dollar and stock markets, and

higher interest rates.

I welcome, Mr. Chairman, the witnesses’ assessments of the potential adverse impact of the current account deficit on the global

economic outlook and the consequences of account reversal.

Mr. Chairman, I thank you very much for holding this hearing.

Chairman SARBANES. Thank you, Senator Akaka.

Secretary O’Neill, we would be happy to hear from you.

STATEMENT OF PAUL H. O’NEILL, SECRETARY

U.S. DEPARTMENT OF THE TREASURY

Secretary O’NEILL. Chairman Sarbanes, Ranking Member

Gramm, Members of the Committee, thank you for this opportunity

to appear before you to discuss our international economic policy.

With the Committee’s permission, I will submit my full testimony

for the record and make an abbreviated oral statement to allow

more time for questions.

Chairman SARBANES. Thank you very much, that will be fine. We

appreciate that.

Secretary O’NEILL. Thank you, Mr. Chairman.

At the outset, I think maybe it is important for me to say, because I want to have an opportunity to have a full and clear engagement with the Chairman and Members of the Committee, that

whatever one might try to imply from what I say today, there is

no intent in anything that I say that should give comfort to those

5

who think we are going to change our policy today. I say that to

you because, as I read the wire clips from around the world this

morning, there is apparently some breathless anticipation that I

am going to say something to intentionally indicate a change in

policy position or direction.

I want to assure you at the outset that whatever I may say, that

is not the intent. And again, I want to make it really clear because

the people who benefit from roiling the world currency markets are

speculators. And as far as I am concerned, they provide not much

useful value to the furtherance of advancing the cause of improving

living standards around the world. So, I do not want to give them

any ammunition to say that there is a basis for roiling the world

currency markets out of our conversation here this morning.

I would like to touch on several of the Administration’s policy initiatives for increasing economic growth and reducing economic instability abroad. They are of vital interests to the United States.

First, we are working to reduce barriers to international trade.

Total U.S. trade amounts to about one quarter of our domestic

product, and trade touches every part of our economy and creates

millions of American jobs, paying above-average wages.

To bolster growth and create new exports and job opportunities

for America, the Senate should pass trade promotion authority so

that President Bush can work with nations around the world to reduce trade barriers and open markets to U.S. exports.

Second, we are also working with the International Monetary

Fund to give emphasis to their role in crisis prevention. When crises do occur, we need a more orderly process for resolving them so

that capital continues to flow to emerging markets. We are working

with others in the official sector to implement a market-oriented

approach to the sovereign debt restructuring process. We also support continued work on the Fund’s statutory approach to sovereign

debt restructuring.

Regarding the multilateral development banks, we believe they

can deliver better results by investing in high-impact, productivityenhancing activities.

President Bush has proposed that we transform the World Bank

and other development bank funds for the poorest countries into

grants rather than loans. Investments in crucial social sectors,

such as health, education, water supplies, and sanitation, are crucial to private enterprise-led growth and a necessary basis for development. But they do not directly generate the revenues that

service new debt. As a result, the recipient government is forced to

repay the loan by taking resources from citizens subsisting on less

than a dollar a day. By piling loans on these nations, we are simply

generating the next generation’s debt-forgiveness program. We

ought to recognize that projects that do not generate economic returns should be funded by grants and not loans.

President Bush recently announced his new compact for development, a major new initiative for development based on the shared

interests of developed and developing nations in peace, security,

and prosperity.

The compact creates a new development assistance fund called

the Millennium Challenge Account. To access account funds, developing countries would have to commit to policies that promote

6

growth and development, including governing justly, investing in

people, and promoting economic freedom. We intend to put our development assistance funds into environments where they can

make a difference. Another important aspect of our international

economic agenda is the financial war on terrorism.

Since September 11, the Treasury Department has thwarted supporters of Al Quaeda and other terrorist organizations by freezing

$34 million in assets directly and assisting our allies to freeze

another $70 million. Recent joint discussions with our allies mark

a new level of coordination in the fight against international

terrorism.

I would like to now turn briefly to global economic conditions.

The world economy is still in the early stage of recovery. The GDP

figures released last week confirm that we are on the path back to

sustainable growth of 3 to 31⁄2 percent per year.

I also want to reiterate my feelings on the U.S. current account

deficit. The current account represents the gap between domestic

savings and investment. It is financed by international capital

flows which have risen because of foreign interest in investing in

the United States. As long as we continue to have the best investment climate in the world, people in other nations will send their

savings here, where those resources fuel our economic growth and

job creation.

I believe we should strive in both the private and public sectors

to always be the best place on earth to invest. As long as we are

the most productive economy in the world, our Nation will continue

to be prosperous.

I thank you again for this opportunity to testify and I would be

delighted to take your questions.

Chairman SARBANES. Well, thank you very much, Mr. Secretary.

I want to focus on the current account deficit. I am really seeking

a better understanding of your views. The current account deficit

now as a percent of GDP is higher today than it was at its peak

during the 1980’s. In fact, we have some charts that show a really

dramatic deterioration in the current account deficit as a percent

of the gross domestic product.

This is back in the 1980’s and then this is what has happened

in the 1990’s (indicating).

You have been quoted as saying—‘‘I do not know.’’ I will let you

address the quote—that you view the current account deficit as

meaningless or irrelevant. Would you explain to us the rationale

behind this view?

Secretary O’NEILL. I am sure I must have said that some place.

I am not sure what the context was of when I might have said

something that fits between those quote marks. My view of the current account deficit is this. I think, first of all, one needs to examine what the origins of the idea of the current account deficit are.

I think the answer to that question is, it is a derivative part of

the notions that were put in place in the late 1930’s and early

1940’s about how we should assemble data to look at how the world

works, and to try to draw from the data in these various conventions that we have adopted correlations with good and bad economic activity in the world. When I look at it, I, first of all, ask

myself, is the world the way it was in 1939 or 1940, when Simon

7

Kuznets and his associates put it together? My own answer to that

is that it is not. And it is not in these important ways.

I think in the 1930’s and 1940’s and, in fact, I think one could

argue maybe even through the 1950’s, that the world in fact was

relatively aligned with the ideas that suggested that the world is

run on a nation-state basis, and that nations are basically independent of each other in an economic sense, and that in fact, it is

possible for one nation to substantially change its economic position

by playing off of other nations because of the separateness.

I do not find that to be the way the world is any more. Having

run a corporation with operations in 36 nations, I will tell you

what—I never spent a minute thinking that somehow, I could go

to some of these, any of these other countries, and act as though

that country were independent of the rest of the world.

I did not find that it was possible to do that here in the United

States. In fact, I do not think it is possible for anyone to do it. It

is possible for people to continue to think it, but it is not real world

in terms of the way world economic activities work any more. So,

I have a problem with the construct before I ever get to what the

implications of adding up all of these numbers are? And then I

would submit this—that it is said that the current account deficit

is a U.S. current account deficit.

Now my question is, what does that mean? Does the U.S. Government have a deficit with other countries? That is to say, have

we in the Federal Government gone out and borrowed money from

other countries that they can jerk out from under us?

The answer to that is no.

Who owns the so-called current account deficit? Millions, or

maybe even billions of individual investors who have made decisions around the world to own these investments. Again, in my

brief oral statement, I made the point that the reason money comes

here is because it is treated better than any place in the world, as

measured by the risk-adjusted rate of return on investments that

are made in the United States.

I have a lot of trouble with the construct that, if you accepted

at face value that somehow this is a deliberate decision of the

United States to do something, this is an analogy to an individual

deciding to borrow too much money. I find it is a false analogy. So,

when I have said these words about my problem with the current

account deficit, it is this stream of thinking that I had in mind.

It does not mean that I do not think there is some legitimate

value in thinking about relative capital flows around the world and

the implications that has for interest rates and other important determinants of where money goes. But it does mean that I do not

think the simple correlations that are made are not meaningful or

useful and, in fact, I think are a dangerous basis for making policy

prescriptions.

Chairman SARBANES. Let’s just sharpen the debate for a minute.

I know you are a man who likes to engage in vigorous intellectual

debate. I want to quote to you from The Economist just a week ago,

an editorial. This is what they say:

The International Monetary Fund says that America’s current account deficit

poses one of the biggest risks to the world economy. Paul O’Neill, America’s Treasury Secretary, reckons that the Fund’s economists do not know what they are talkVerDate 11-MAY-2000 11:02 Mar 31, 2003 Jkt 000000 PO 00000 Frm 00011 Fmt 6633 Sfmt 6633 85735.TXT SBANK4 PsN: SBANK4
8

ing about. He says the current account deficit is a meaningless concept. Policymakers should pay no attention to it.

Mr. O’Neill’s views fly in the face of experience. A deficit that will require America to borrow from abroad almost $2 billion a day by 2003 can hardly be ignored.

The consequences for the dollar if foreigners’ appetite for American assets even

wanes would give a Treasury Secretary who knew what he was talking about sleepless nights.

Now, I put that out there because this is one serious commentary

and I would be interested in your response to it.

Secretary O’NEILL. If you do not mind, I have two different

things I would like to say about that.

First of all, last November, the International Monetary Fund— we got the World Bank and the International Monetary Fund, the

G–7, together—made a public pronouncement that growth in the

United States in 2002 would be 0.7 percent.

And on the spot, I said to the managing director of the IMF, I

am going to bet you a dinner in a restaurant of your choice that

we are going to far exceed that number. They have now decided

that the number is going to be 2.4 percent. So, at the time, I was

saying we were going to be some place like where, in fact, we are

on the glidepath. And so, maybe you would prefer their economic

judgment to mine. So far, they have not been right.

Now to a different point on this. It is not that I think we should

pay no attention to this issue. But I would ask the question, if you

do not like the current account deficit, what policy instruments

would one use to change the current account deficit? And then,

what is the most meaningful question—are you willing to suffer the

consequences of treating the current account deficit as the objective

variable in the equation?

What I mean by that is this. One way to fix the current account

deficit is to reduce imports. I do not know anyone who wants to do

that because the implications of reducing imports is we become a

more isolated and insulated society. Our citizens pay more money

for goods. The reason goods are coming here is because they are

valued by consumers at the prices they are offered at, as compared

to alternatives.

So if you do not like the current account deficit, we could say,

bugger them, the U.S. citizens. We here in Washington know better. They should not be buying so much stuff from outside the

country. That would fix the current account deficit. That does not

seem like a brilliant thing to me to do.

If you look at the academic work, what I consider to be the best

academic work on this subject, there is a report I would submit to

you by Allan Sinai that was done in December 2000, that basically

says, if you run all the econometric equations and treat the current

account deficit as the dependent variable and you seek to reduce

the current account deficit, every single intervention hurts the U.S.

economy, as compared to leaving the current account deficit alone.

I have not seen academic work that suggests itself to me that

produces a different answer. And so, it is part of the reason why

I am mystified that there seem to be so many people that want to

treat the current account deficit as the objective function for our society, when doing so. This is not a partisan report from Sinai. This

is an academically solid, legitimate report. I do not know of something to counter Alan’s findings.

9

Chairman SARBANES. Well, we could go on at great length, but

my time has expired, and I am going to yield.

I would just note that the panel that is coming along behind you

feels pretty strongly, at least a number of them do, that the currency is manipulated by some of our trading partners, very much

to the U.S. disadvantage, and that is affecting the balance of trade

in a very substantial way. And, of course, that is one of the things

that we are trying to get at in these reports.

Senator Bunning.

Senator BUNNING. Thank you, Mr. Chairman.

Secretary O’Neill, the Treasury Report said there was no current

manipulation by our major trading partners last year. How does

this jibe with the reports saying China purchased $50 billion,

Japan bought $39 billion, and South Korea bought $9 billion last

year? In other words, if there is no importance to that fact, how

does that jibe with your report?

Secretary O’NEILL. By the definitions of law, as we understand

it, the individual actions that have been taken do not amount to

manipulation under the statute. And I think, in a broader sense,

if you look at the Chinese currency against world currencies, they

are running kind of a soft peg.

I do think this. The markets are grinding so finely, and they are

so interlaced any more, that it is not possible any more to actually

fool the market for very long. That is to say, to create an artificial

situation that is not in line with the judgment of the market about

the discounted present value of productivity improvements relative

to other countries.

Senator BUNNING. Currently, I do not disagree with you.

What happens with China having that large a reserve of U.S.

dollars—what happens in a time of crisis, such as a confrontation

at the Taiwan Straits that the Chinese could dump dollars onto the

world market in an attempt to destabilize our economy?

Secretary O’NEILL. First of all, it presumes that the dollars are

held by an authority that has the ability—— Senator BUNNING. The Chinese government.

Secretary O’NEILL. But the Chinese government I think does not

actually hold that money. I think if you go look at how that money

is held, you are looking at first-order effects. Look at the secondorder effects. What did the Chinese do with that money?

I will tell you one thing that they did with it. They built new factories. Now where do they get the technology for the new factories?

They bought it in the UK or they bought it here, or they bought

it—you know, it is in German hands or it is in Brazilian hands. It

is in somebody else’s hands.

It is another problem that I have with the current account deficit. It assumes the world is static and that first-order effects never

become second-order effects.

Senator BUNNING. I do not consider it static. But I understand

that if they do use that currency as hard dollars to do other things,

that they are replacing them with hard dollars. And we are talking

about a fixed period of time where they measured the amount of

dollars that the Chinese had under their control. Are you telling

me that that is not important?

Secretary O’NEILL. I do not think so.

10

Senator BUNNING. You do not think so? In other words, if they got up to $100 billion, you would not think so? Or $200 billion, it

would have no effect?

Secretary O’NEILL. No, I do not think it is a material amount,

in an economy that is a $10 or $11 trillion economy. $100 billion— I am trying to think about it.

Senator BUNNING. As long as the situation in the world is like

it is, I do not disagree with you. But if we have a confrontation,

I think it would have a serious effect on the dumping and devaluing in our economy of the U.S. dollar, if they dumped that on the

world market.

Secretary O’NEILL. I think if it is true that one sovereign had the

ability to make an instantaneous decision, you might be right. I do

not think that is the case.

Senator BUNNING. In the mid-1980’s, our Government worked on

a similar problem through the Plaza Accord. In what circumstances

would you have considered to take a similar action?

Secretary O’NEILL. Well, first, you are going to hear from panel

members and I am sure they will have their own and probably different views.

Senator BUNNING. I want yours. I do not want the panel’s.

Secretary O’NEILL. I just wanted to say, it is not clear to me that

the implication of your question about the Plaza Accord has substance behind it, in this sense: I think it is a real speculation to

know, in fact, whether conditions and trends were moving in the

direction that the Plaza Accord simply hopped on the back of.

What comes to mind is the metaphor of the caterpillar riding on

a log down the stream and thinking they are steering. I think you

have to be really careful in assigning causality to supposed political

interventions. I am not sure that those causalities exist.

Senator BUNNING. In other words, our political intervention in

Afghanistan—— Secretary O’NEILL. I did not say that.

Senator BUNNING. There is no consequences to Afghanistan?

Secretary O’NEILL. No, I did not say that.

Senator BUNNING. What are you saying, then?

Secretary O’NEILL. I am talking directly about intervention attempts in world financial markets. I am saying, I think there is a

real doubt about the effectiveness of interventions or words about

interventions—although I would grant you one thing. It is why I

made my statement at the beginning—it was not my intent to roil

the financial markets today. There is nothing the speculators like

better than to roil the financial markets. And I think it is true, by

changing rhetoric, you can roil or even maybe give direction to the

financial markets over some limited period of time.

But coming from the part of the economy that produces real tangible things you can take home and put on the table, I believe at

the end of the day, while monetary affairs are not incidental, the

real long-run economics of the world depends on the physical production of goods and services and therefore, you can have as much

rhetoric as you want; eventually the world is going to stabilize

around the real production of goods and services.

Senator BUNNING. You may believe that, but I will guarantee

you, the Chairman of the Federal Reserve does not believe that.

11

Thank you, Mr. Chairman.

Chairman SARBANES. Thank you very much, Senator Bunning.

Before I yield to Senator Miller, Mr. Secretary, I am prompted

to quote President O’Neill of the International Paper Company in

1985.

The strong dollar has turned the world on its head. We have suffered a major loss

in competition position because of the loss in exchange rates. And then O’Neill explained that in the last few years, a strong dollar has dramatically eroded the U.S.

forest products industry’s natural advantage in world trade.

This is what we are hearing from all of your former colleagues,

or people who currently hold comparable positions in the business

world. And of course, that is what you were saying in 1985.

Secretary O’NEILL. Do you have the rest of what I said then?

Chairman SARBANES. Well, what else did you say then?

Secretary O’NEILL. What else I said then was, ‘‘what we in the

industry need to do is we need to take matters in our own hands

and we need to create conditions in the goodness of what we do,

the exceptional excellence of what we do, so that we can prosper no matter what is happening with exchange rates. We need to

use our brain power to figure out how to create goods in the currency that we sell them. And we need to take this responsibility

on ourself.’’

I do not think you will be able to find any place where I called

on the Government to intervene in the financial markets. I was

basically calling attention to the fact that, indeed, currency relations had changed and those who were going to prosper were going to have to assume the responsibility for their own individual

companies and industries to fix the problem, not look to Government to make a temporary intervention that would make life

sweeter for us.

Chairman SARBANES. Well, Paul H. O’Neill, Los Angeles Times,

International’s President, doubts that paper prices will rise in step

with the dollar’s decline. But he definitely sees happier days ahead.

‘‘Exchange rates moving back to normal levels would be very good

news for our industry, he says. We would recoup most, if not all,

of our export volume.’’

Secretary O’NEILL. That is a statement of fact. It is not a prescription for the Government to intervene.

And if you go look at the record, which you will find both at IP

and Alcoa, there is a performance. Let me remind you of rate

spread. The Japanese yen–United States dollar rate, as I recall, in

1985, was 240 or something on that order of magnitude. We

reached a low relationship of 80 yen to the dollar, I think, a couple

of years ago.

Through that whole time, the companies I was associated with

prospered, became leaders in the world. And we did not do it by

coming down here asking somebody to fix the world, to make it

easier for us. We did it with our fingernails in 36 different countries around the world.

Chairman SARBANES. Well, it doesn’t square. You have the Plaza

Accord and that helped you tremendously, you and other exporters, and John Gorges, who was with you at International Paper.

Correct?

Secretary O’NEILL. He was the Chairman.

12

Chairman SARBANES. Yes. One of the toughest problems we face

is the very strong dollar, which impacts our export products and

prices a good deal. There are major uncertainties. If the dollar

weakened, we could compete better. And it is not just us. It is other

exporters, too.

Senator Miller.

Senator MILLER. Mr. Secretary, I guess I am going to continue

along that same kind of questioning. I want to say that I understand how you have to look at the really big picture. I appreciate

that and I respect that.

As a Senator from Georgia, though, I have to be a little bit more

parochial. I have to look at those 8 million people in Georgia. There

are some industries in our State, forestry is one of the key ones,

agriculture, textiles. They all have complained to me pretty loudly

that the dollar is making it difficult for them to export profitably,

and making it easier for imports to take the market share here in

the United States.

Continuing on this line the paper industry which the Chairman

mentioned, has seen more than 90 percent of the growth in their

U.S. markets captured by imports, they tell me. I guess my question is, and I know you have to look at it from a different angle,

but how would you respond to my constituent industries that are

so very concerned about this matter?

Secretary O’NEILL. You know, when I come around and I sit on

your side of the table, I understand the pressure that not just you,

but you are reflecting what your constituents are telling you. I understand the pressure that creates.

I said that while I was at Alcoa, we prospered. But it does not

mean that we did not have dislocations. In fact, we did have dislocations because not in every place were we able to push our costs

down enough to compete in the whole world on a competitive basis

with changes in exchange rate positions over time.

I know these are issues where your heart breaks for the people

that are directly affected by these things. And I suppose it is no

solace at all to the individuals who are directly affected. But I

think it is demonstrably clear that in fact we in the United States,

the U.S. citizens as a body, and the world as a body, are better off

if we let competition and best value products lead the world.

It is not an easy thing to follow in practice and that is why we

have lots of people coming to Washington to tell us how they are

hurting. And I think we have to be sympathetic with that. But I

think at the same time we are better off to help the casualties if

it produces a better economic outcome for the whole society than

to let the casualties become the control on our ability to succeed as

a total country.

Senator MILLER. Thank you. I do not have any other questions.

Chairman SARBANES. Senator Gramm.

STATEMENT OF SENATOR PHIL GRAMM

Senator GRAMM. Well, Mr. Chairman, I was over trying to participate in the negotiations to bring our trade promotion authority

bill to the floor, and so I missed our opening statements. So, I

would like to take my time to make a statement.

13

First of all, every day on the world currency market, as I understand it, there are about $1.2 trillion worth of dollar transactions.

This is the purest market in the world in that it has the most participants and it has the largest volumes.

My own belief is that even a country as rich as the United States

of America could affect currency values, could affect the value of

the dollar, only for a very short period of time, just as I could lower

real estate values in my neighborhood if I were mad at everybody

else and wanted to hurt them, by selling my house for $100. But

once the house is sold, then real estate values are basically back

as they were.

I not only believe we cannot affect the value of the dollar, except

by changing policy that would affect people’s perception and the reality of the American economy, but also that currency intervention

is a nonfeasible policy, even if it were desirable, would be my first

thesis.

Second, this is a perfect market, for all practical purposes, where

every day people are buying and selling dollars. Why do they buy

dollars? They buy dollars to buy American goods and they buy dollars to invest in America. And they sell dollars and buy foreign currency to invest abroad or to buy foreign goods.

So when we say we have a current account surplus, by definition,

we have a capital account. We have a huge inflow of capital. Were

that not the case, the value of the dollar would change and the surplus would be eliminated. What you are seeing is a mirror image

of capital inflow versus a current account deficit. Now is the capital

inflow bad? Who’s against investment? Every once in a while people say, well, my God, foreigners own some building in New York.

I have found ownership is not what it is cracked up to be.

[Laughter.]

First, try moving that building back to Japan. Second, I do not

think anybody is willing to come out here and say: Investment is

a bad thing and we want less of it. Then what about loans? Aren’t

you a debtor when you get a loan?

Well, it depends on what you do with the loan. If you invest it

productively, it is an avenue to riches. If you invest it poorly, it is

a path to poverty. The only kind of loan I would be concerned about

is if our Government were borrowing money to invest in Government and they expected value of the investment would be far less

than the service cost alone. And exactly the opposite is true.

This idea about what you said about forest products in my mind

is totally consistent with what you are saying today. There is no

doubt that at any given time there are many industries that would

benefit if the dollar was cheaper. There are industries that would

benefit if the dollar were more valuable. But the question—you are

not here today representing the forestry industry.

Secretary O’NEILL. That is right.

Senator GRAMM. You are here today representing the American

economy. And the point is that if you could snap your fingers and

make the dollar cheaper, there would be some people who would

gain. There would be some people who would lose. So, I do not see

an inconsistency there.

14

Finally, I, quite frankly, do not have a problem with what The

Economist says. For the world economy, looking at the world now,

is it good that all this investment is coming to America?

If you just look at the world economy now, maybe you would

want to redistribute this investment differently. It may be risky for

the world that America gets richer and more prosperous and our

real wages rise and we become more dominant in the world, depending on your perspective. But our question is not the world. Our

question is the United States of America. It seems to me that when

we look at American interest, that it is very clear that we want investment, that we want to have open markets, and that we are succeeding economically as a result of it.

So, I do not disagree with my colleague from Georgia. We have

60,000 jobs in Texas in the forestry industry. A lower value for

the dollar, if you could just wish it and have it, would be beneficial

to them.

But for everybody going to Wal-Mart, it would be a bad thing.

And in this case, there is nothing that we could really do to change

it, other than we could have our Navy blockade our ports. That

would improve our situation. The enemy would do it in war, but

we could do it in peacetime. Or we could stop foreign investment.

I would submit, we do not want to do either one of those things.

I think we need to keep our eye on current account deficit. If it

becomes clear that it is a Government policy that is driving it, such

as we are getting foreign loans to finance Government or foreign

investment—if something artificial is happening, then I think it is

something that we should be concerned about.

But the thing I am never concerned about is that somehow,

somebody is going to manipulate a market where there is $1.2 trillion worth of transactions every day. Even as much money as you

control, you would be a bit player in this market. And foreign countries that try to manipulate the value of the dollar are trying to

get water to run up a rope. It just cannot be done.

The only final point I would make is that we could have a dollar

for exports and a dollar for imports. You could have one that was

valuable and you could have one that was cheap.

The problem is that then you would have to have an exchange

rate between the two dollars. And in the end, I think this is a thing

where individual industries can say, I wish markets were different.

But, A, I do not think there is anything you can do about it and,

B, even if you could do something about it, you might want to do

it if you were in the paper industry. But if you are Secretary of the

Treasury, you do not want to.

I would say that we have been blessed with Rubin and Summers

and with you, Secretary O’Neill, that on this one issue, that there

has never been an equivocation. There has never been any politics

involved in it. I think that the country has benefited a great deal,

even though individual parts of the economy might benefit, but at

a great expense to everybody else. I guess that is my view. I worry

about this. But by the time I get to it on my list, every night I am

asleep.

[Laughter.]

Chairman SARBANES. Senator Corzine.

15

Senator CORZINE. Well, I do not fall asleep thinking about the

dollar, either, in that particular category of concerns.

But I do wonder when you think about the current account,

which I basically think is reflective of the underlying trade imbalances that we have, and it has some other elements in it, that a

lot of the financing that goes on in the world, these flows which are

covered by this $1.2 trillion, which you say is a lot of—I am a little

more comfortable with speculators based on where I came from

than maybe you are.

[Laughter.]

In the sense that it allows for the transition of the flow of dollars

from one place to another, or assets. But it strikes me that while

managing the dollar is not necessarily the issue, worrying about

that underlying trade deficit is a real issue.

And if it were to change our views with respect to how people

look at the capital markets in the United States because they do

not feel they are as secure as they might have thought they were

at another point in time, which can happen for political reasons or

it can happen for underlying economic conditions, the kind of deficits that Senator Gramm is concerned about, which, by the way,

seemed to be reappearing in relatively substantial amounts.

You can then have a completely serious series of events, like

changing price levels and higher interest rates. I think we will hear

Mr. Bergsten talk about that kind of scenario.

Those things do happen. They have happened in history, that

other countries ran large trade deficits. I think that there are reasons to be concerned about underlying trade conditions that work

against our Nation, even at a macrolevel. Get away from the forestry because, cumulatively, these things end up setting a vulnerability that is actually more serious than the Chinese reserves

building up $50 billion, which I think is a drop in the bucket.

But if the investors in American stocks and bonds decide to get

out, that is a lot easier to do than selling that building. Only one

holder of those is the central banks or the reserve holders. And

that is a serious concern. It is a serious concern if we see an erosion in our stock market because people do not have confidence in

our accounting systems or our financial policies.

That to me is a bigger worry than where the dollar is at a given

point in time. And that is why it concerns me when you say it is

irrelevant because it is relevant to the underlying economic conditions, which I agree with you, ultimately, are what determine

where people want to put their money.

There are issues here that could change people’s perceptions

about the United States, our fiscal policy, the management of our

internal structures that surround our markets, the accounting

issue being one that I am concerned about. And so, isn’t that shock

issue a real concern for anyone who is responsible for policy, and

shouldn’t we do things that try to advance more security with regard to those in the long run?

Secretary O’NEILL. Indeed, I think I am very sympathetic to your

notion that we should look at underlying trade relationships. I also

am frankly much more interested in what we can do to advance the

cause of more exports from the United States. And with that, the

development of the world.

16

I am sure you all know this, there is still 1.2 billion people in

the world living on less than a dollar a day. And if you can imagine

raising their standard of living so that they could demand plywood

from the United States and plumbing fixtures and the other things

that we all take for granted, we would quickly get rid of the worry

about current account deficit because we would be exporting goods

and we would be creating well-paying jobs for people here in the

United States that are demanded by people who are growing into

something approaching our standard of living.

So, I see this in a fuller sense because I am not really infatuated

with finance as the prism for thinking about everything. For me,

it is a derivative question. Finance is a derivative question, not a

primary question.

I am very interested in your notion that, yes, we should be worried about this and we should be working on passing the trade promotion authority so we can get on with opening up markets to U.S.

goods. And we can be helping people to realize a decent life instead

of the misery so many of them are living in today.

On your other question about the concern that investors would

make what I would characterize as a cliff decision to withdraw

from the U.S. market, indeed, I do think that we have to be very

careful about the mix of monetary and fiscal policy so that investors outside of the United States look at what we are doing and

take comfort in what we are doing, that we are not running

unsustainable excesses that would weaken their claim on U.S.

goods and services because we are running policy that is a folly.

So, I think, indeed, we have to pay a lot of attention at the Government level to running sensible, sustainable fiscal and monetary

policies and giving every bit of encouragement we can to the continuation of the extraordinary level of productivity growth that we

are seeing now.

We are expecting when the final numbers are completed, that the

first quarter rate of productivity growth in the United States is

better than the 5.2 percent that we saw in the fourth quarter,

which is truly extraordinary and I think should give lots of comfort

to investors around the world, that the differential rate between

productivity growth in the United States and every place else is

just phenomenal.

And when I sit down and talk with the chancellor of the UK and

Eddie George, the Governor of the Bank of England, they just cannot figure out how we can be doing so extraordinarily well in productivity growth while they are still limping along in the 2 percent

range, and have been for a very long time. It is not even a subject

in Continental Europe. They just cannot imagine how their productivity growth could begin to approach what we have demonstrated

we can do.

Senator CORZINE. Two observations.

First, these shocks do occasionally happen. We had one in 1987

that was pretty clear when people evacuated markets at a given

point in time. And it has real impact on the underlying economy.

I know you are aware of that.

Second, if you are concerned about the underdeveloped world, the

United States—and I think investment is great for the United

States. But the idea that we are sucking up most of the capital

17

that is freely formed is an issue that I think can be a concern for

the development of a lot of the underdeveloped world.

Frankly, I do not know that that relates to TPA. I think it has

a lot to do with those internal structures and viabilities and political stability of a lot of the countries. So one has to figure out what

is the most important ingredient to actually change what those

conditions involve.

Secretary O’NEILL. I believe, these things are very much related

to each other. And it probably escaped your notice because it did

not get much attention, but when the G–7 was here 10 days ago,

we did something which I think is profoundly important.

We resolved that we are going to work with the developing world

to move them all toward a condition of investment grade sovereign

debt. And you will understand and you have indicated by what you

just said, in order to do that, there has to be a real rule of law and

there has to be enforceable contracts, and there has to be an attack

on corruption. And with those conditions, we can begin to help

them create a basis for better competing for capital flows.

Now, I also believe this. I do not believe economics is a zero-sum

game. I think the amount of money that is available for capital formation and capital investment is not limited to the amount that we

are now producing.

If we can grow our own economy at 31⁄2, or maybe even a little

better than that percent of annual growth, we will throw off more

capital and that capital in turn, if it is properly invested, will

produce more economic growth and more economic growth will

throw off the capital that is required to bring others along.

I really do believe the idea that capitalism at its best is a perpetual motion machine, or as close as the mind of man has been

able to come, and that we are not doomed to live with the amount

of capital that is now available as a limit for the whole world’s

growth.

Senator CORZINE. Thank you. Mr. Chairman.

Chairman SARBANES. Mr. Secretary, I want to come back to this

basic point. I am really taken aback that we have a Secretary of

the Treasury who does not perceive any problems associated with

this large current account deficit. Now that flies directly contrary

to what virtually every other economic observer is telling us.

Business Week recently ran an article: ‘‘U.S. Debt Overseas Stirs

Up Trouble At Home.’’ The growing current account deficit might

set the United States up for a fall. And they say the following:

The United States mounting external debt is clearly the most crucial structural

problem facing the economy. And unlike other recent economic troubles, there may

be no easy way out.

The January and February increase in imported goods was the largest 2 month

rise in two decades. Last year’s current account gap hit 4.1 percent of gross domestic

product and it could reach 5 percent by the end of 2002. That would be the largest

rate in the industrialized world and larger than in many emerging market nations.

Now, we asked Chairman Greenspan about this at the Joint Economic Committee, the consequences to the U.S. economy of a growing current account deficit. This is what he responded.

The current account deficit is also a measure of the increase in the level of net

claims, primarily debt claims, that foreigners have on our assets. As the stock of

such claims grows, an even larger flow of interest payments must be provided to

the foreign suppliers of this capital.

18

Countries that have gone down this path have invariably run into trouble. And

so would we. Eventually, the current account deficit will have to be restrained.

Do you differ with that?

Secretary O’NEILL. That is all he said? He did not say at what

level he thinks we have to do restraint or how he would restrain

the current account deficit?

Chairman SARBANES. Are you prepared to concede that at some

level it would need to be restrained? At some point is it a problem?

Are you saying to me, it is not a problem right now, but it could

be a problem? Or, are you saying to me, look, this is a meaningless

concept. It is really irrelevant. It is not something we should worry

about now or in the future or at any time. Forget this kind of

thinking. That is the approach you originally took, I think. Is that

your position?

Secretary O’NEILL. Well, I would want to look at the composition

of where the money is and the circumstances that exist in the rest

of the world.

The implication of saying, yes, we should constrain the current

account deficit is, as I said, as I have looked at the best academic

work I know of, all the interventions that have been modeled would

do damage to the U.S. economy if we decided to reduce the size of

the current account deficit.

I do not find it very appealing to say that we are going to cut

off our arm because some day we might get a disease in it, and this

is an anticipatory move. I just do not understand the thinking that

treats what I consider to be an artificial, intellectually useful construct, and then take it to a policy conclusion that does damage,

that we decide to do damage to our own economy because of this

artificial construct. I do not find that appealing, no.

Chairman SARBANES. Let me go to another line of questioning.

This issue leaves me very concerned because we have a Secretary

of the Treasury who just says there is no problem. Everyone else

is telling us there is a problem in varying degrees, and they have

different approaches as to how to deal with it. But they are not

saying, look, just forget about it. Just go on about your business.

On the currency manipulation, and the Treasury found that

there wasn’t any, but there is a general view that the net purchases of foreign exchange by the Bank of Japan in recent years

probably held the yen at a significantly lower level than would

have prevailed based on market forces alone.

China, which has had a running current account surplus of about

2 percent of GDP, so they are running a very large trade surplus,

they have also had an enormous inflow of foreign direct investment. In fact, the Treasury found that their bilateral trade surplus

with the United States was $46 billion, just for the second half of

2001.

Ordinarily, with a sizable trade and current account surplus, and

a large inflow of foreign direct investment, your currency would appreciate. But that has not happened in China. They have avoided

that by acquiring huge amounts of foreign assets, in effect, doing

what the Japanese are doing. In fact, your own report says that

they expanded foreign reserves by $32 billion in just the second

half of 2001.

19

Now why doesn’t this represent a concerted policy on the part of

China, to get the trade surplus, to get the foreign direct investment

and sustain that position by making the purchases, huge purchases

of foreign assets, in order to hold their currency in place, all to

their advantage? That is not the workings of the market forces.

They are intervening in the workings of the market forces in order

to sustain an advantage, are they not?

Secretary O’NEILL. I do not know. What would you prescribe as

a policy intervention? Which one of those things would you see us

changing somehow?

Chairman SARBANES. I think you have to look at something like

the Plaza Accord again. You have to address, in effect, the overvalue of the U.S. dollar in relationship to that. If they won’t, in effect, allow their currency to depreciate, if they seek to sustain it

in this way, then you have to do it on the American side.

You are putting our manufacturers in an incredible position, it

seems to me. They may be quite competitive. You talked about the

productivity improvements. It is a real tribute to labor and to management that have been doing that. But they are coming and they

are saying to us, look, we are just at a 25, 30, 35 percent handicap

because of the currency. Not because of the underlying economic

realities.

Then you say, well, the currency value is going to be set by the

market. But then we look at what some of these major trading

partners are doing who are running these very large trade surpluses with us and it looks as though, pretty clearly to me, that

they are intervening in ways to affect the currency relationship in

order to sustain a very substantial and significant trade advantage.

I will concede to you, on many of these problems, just as you said

earlier about the current account deficit, it is a very difficult call

to figure out what to do. I do not gainsay you on that. But that

is different than saying there is no problem here. That is different

than saying, it is all irrelevant. It really dosn’t matter. The whole

concept is faulty and we are just not paying any attention to it.

Secretary O’NEILL. I think, just as you said, it makes a lot of

sense to pay attention to this issue, but at the level of detail that

we are talking about it now.

When you mentioned the elements of what China is doing, I

would submit to you, at least for myself, looking at this data, it is

not at all clear to me that China has been able to change the relation of its currency to the dollar because of the combination of policies that they are running. In fact, it is not clear to me that any

nation has enough reserves any more to run even an intermediate

length intervention program that the market does not believe is associated pretty directly with the expectations for discounted productivity expectations as between countries.

It is true that I think it is clear on the face of it, I have been

to China and sat down with the Governor of the Bank of China and

talked with them about their currency regime and their intentions

toward the rest of the world. And it is true that they are running

what I would characterize as a semisoft peg. But I do not think,

however much of their reserves may be, that they can get away

very long with, in effect, defeating the market or producing a different relationship between their currency and the other major curVerDate 11-MAY-2000 11:02 Mar 31, 2003 Jkt 000000 PO 00000 Frm 00023 Fmt 6633 Sfmt 6633 85735.TXT SBANK4 PsN: SBANK4
20

rencies in the world by using reserves to do it. And I think if it

were true, then Argentina would not be where it is today.

Chairman SARBANES. First, I think the Chinese and Japanese

are very skillful about this.

Second, if the United States is not resisting what they are doing,

but, in effect, is going along with it, which is essentially what

would flow out of an attitude that says, this is an irrelevant concept and there is no problem here, it makes it easier for them to

work this game to their advantage. That is what is happening.

The figures just will not sustain, it seems to me, the position you

are coming from. I think there is a problem. You keep saying, no

problem. Manufacturers say that there is a problem. Economic

commentators say there is a problem. You say, no problem. Well,

look, as long as you say no problem, then their ability to have an

impact is enhanced, not diminished, in my view.

Secretary O’NEILL. Senator, may I say just one word to that?

Chairman SARBANES. Sure.

Secretary O’NEILL. Again, I look at the objective evidence and I

hear Japan. And I noticed this. In the last 12 years, the Japanese

economy has performed dismally at something close to an average

GDP growth of zero, as compared to a spectacular performance by

historical measure for the U.S. economy over the same period of

time. And we appear to be headed back toward our potential rate.

The same facts pertain to Western Europe. I do not find a basis

for deciding that what we have been doing is fundamentally wrong

in the experience that we have had as an economy as compared to

any other economy in the world.

Chairman SARBANES. We have heard you talk about short-term

benefits and long-term vision and so forth in a different context in

talking about the budget, having sort of self-discipline and so forth.

The fact of the matter is that we are building up these large obligations. We will have to pay or service those obligations into the future. So the gap between what we must produce and what we can

reserve of that production for ourselves is growing because more

and more of it is going to have to be committed to servicing these

foreign claims that we have built up.

You may say, well, the economy is going well. Everything’s

hunky dory, and so forth and so on. But, nevertheless, this burden

continues to build. And it carries with it, it seems to me, potentially very severe problems in the future. And you are the only one

I find who denies that. Alan Greenspan says, at some point, we

have a problem. Most everybody says that. I cannot even get you

to say here today that at some point, we would have a problem. It

is still no problem.

Senator Gramm.

Secretary O’NEILL. As you know, Senator, I am not reluctant to

be alone.

[Laughter.]

Chairman SARBANES. I understand that. That is pretty clear. But

you worry when the Secretary of the Treasury of the leading economic power in the world is pursuing an attitude and a policy that

no one else thinks is on all fours.

Senator GRAMM. First, I would like to say, Paul, that I appreciate

what you said today. I think it is very important, it is very temptVerDate 11-MAY-2000 11:02 Mar 31, 2003 Jkt 000000 PO 00000 Frm 00024 Fmt 6633 Sfmt 6633 85735.TXT SBANK4 PsN: SBANK4
21

ing in this world we live in, in politics, what I guess would be the

politics of political correctness, for people to say, oh, yes, there is

a problem.

You fall in love with somebody and they fall in love with you.

Well, there is a problem because something could happen to them.

There is a problem at the bottom of every good thing. To me the

problem with going around talking about the problem is that there

are people who have a vested interest to create a problem for their

own benefit. I do not blame them. I am not being critical of them.

It seems to me that the cold reality is that even if you wanted

to manipulate the value of the dollar, that you could manipulate

it maybe for a week. And that is for our financial position, and it

would be money completely squandered. I think that that is the

first place I am coming from.

Second, we are all accustomed from early age, neither a borrower, nor a lender be. The plain truth is our country was built

with foreign money from the time the first Pilgrim stepped on

Plymouth Rock. At least until a couple of years after World War

I, we were far and away the greatest debtor nation in the world.

The British built our railroads. They built our canals. They built

post roads. They invested in our manufacturing. But all those were

good investments. So it was true, we had to pay all this money to

Britain, but we made more money. Maybe I am so poor because I

have never been a debtor. But I was never confident enough that

I would have known what to do with the money any way.

The one thing we could do that would clearly lower the value of

the dollar would be increase domestic savings rates, no question

about it. If we could get Americans to save more money, we would

depress real interest rates and we would change the flow of capital.

And that would be a positive for the world, as well as for us. So

trying to create incentives or an environment to encourage thrift,

I think all those would be very positive things. But I think, in the

end, when you get right down to it, obviously, there are a combination of circumstances whereby current account deficits could become a problem.

Chairman SARBANES. Were you nodding your head to that?

Secretary O’NEILL. I was. I agree with this formulation.

[Laughter.]

Senator GRAMM. It depends on what is causing it.

Secretary O’NEILL. Right.

Senator GRAMM. That is the factor. Looking at the underlying

things. And as I look at this trade deficit, I do not see anything

right now we would want to change that is causing it. It is not as

if it doesn’t accrue benefit to some people.

The other day, I had left a shovel I was using in a truck, the

shovel was gone. I had a limited amount of time, so I went to Home

Depot and I was going to buy a shovel. I bought a shovel for $4.52.

Now, I would say that never in the history of the world, has a quality product sold for less than that. The plain truth is we live in a

golden age. Now if I were manufacturing shovels, I would be

damned unhappy about it.

[Laughter.]

I would be calling me up, if I were a manufacturer in Texas— I do not think we have any shovel manufacturers in Texas. But,

22

I would be saying, we need to do something about it because I

am going out of the shovel business. And if you are in the shovel

business, it is a terrible thing. But if you are buying shovels, it

is not a terrible thing. And Government has got to balance all these

interests.

The only way I know to balance them is do it in a way that in

the long-term benefits the most people. And it seems the way to do

that is freedom and trade and that in the long-term, that is what

benefits people the most.

So there is a dark side of it. If you are trying to sell products

on the world market or compete against imports, this high-value

dollar with this massive inflow of capital, which, God knows, we

do not want to stop and we could use more of it in Texas. The

dark side of it is it does hurt some people. But any change in any

policy hurts somebody. The vacationer is hurt by rain. The

farmer is helped by rain. Anything you do has advantages and

disadvantages.

I guess if you are going to worry about it, you can. But in the

end, I do not know under the circumstances we face now, I guess

my view, and I will stop, Mr. Chairman, is I do not know what we

could do differently other than better Government policies that

would encourage more thrift in the United States.

I do not think we ought to be discouraging people from investing

in America. I do not think we ought to blockade our ports or impose tariffs. In fact, I am not sure a tariff would do anything to this

problem. If you put a tariff on everything, exchange rates would

change and it would have no effect. Only if you put it on some

things not on others, do you help anybody.

So, I think it is so tempting to say under these circumstances,

yes, there is a problem. And I do not know exactly what Chairman

Greenspan was referring to, but I just think that it is important

to have somebody, and this happens to be you today, who says, I

do not see a problem as to where we are now with this that we

would want to fix. I think that is right. And I agree with it. But

I do not agree with you about speculators.

Secretary O’NEILL. You do not?

Senator GRAMM. No. I knew you were a manufacturer when you

said that.

[Laughter.]

Speculators are public benefactors who make money by making

markets work better. And God bless ’em.

Secretary O’NEILL. Let me substitute manipulator for speculator.

Senator GRAMM. Well, manipulators in a market like this lose

their shirt.

Secretary O’NEILL. That is what I want.

Senator CORZINE. Senator Gramm, I have never loved you so

much.

[Laughter.]

Senator GRAMM. Well, I give credit where it is due.

[Laughter.]

Secretary O’NEILL. May I make just two quick points?

Senator GRAMM. You did not get rich without providing value.

Secretary O’NEILL. Just two quick points, Senator. Thank you

very much for your comments.

23

First, on the issue of current account deficit. Economists—we did

not know what this was back in the 1800’s. But it turns out we had

a huge, overwhelming current account deficit in the late 1800’s. I

guess it is a good thing that we did not know about it. We might

have stopped the British investment.

Chairman SARBANES. Well, does the same thing work today? The

world’s most advanced economy, as opposed to a nation seeking to

develop itself. You apply the same test.

Senator GRAMM. You develop it.

Secretary O’NEILL. One of the things that I find, frankly, a little

disconcerting about the notion of a current account deficit, and,

again, I think it is a static concept.

I have to tell you what I was doing when I was running Alcoa.

Yes, I was borrowing money and getting more equity investment.

But I was taking it around the world. So the idea that it was stuck

here, the fact that ownership here did not mean it was stuck here.

It was helping to create economic development around the world.

Second, the other point I wanted to make was about this issue

of savings. Inherent in that is a sense that we here in Washington

know better than what individuals are now doing collectively they

ought to do. I think that if you really stop and think about it, you

really believe we here in Washington know better what individuals

ought to do about savings and how we measure savings.

Many people think their home is a savings and in fact, the evidence has demonstrated that people are getting real savings and

ascension into the middle class by homeownership, which is an important form of savings. The other face of that, of course, is that

we have more savings and we have less consumption. So these are

not questions without consequence.

Chairman SARBANES. Senator Bunning.

Senator BUNNING. Chairman Sarbanes, thank you. I have heard

enough conversation. I pass.

Chairman SARBANES. Jon.

Senator CORZINE. Mr. Secretary, I want to go back.

Chairman SARBANES. I told the Secretary that we would have

him out in short order. Go ahead.

Senator CORZINE. Okay. It strikes me that we have a risk by this

current account cumulative element that has built up over the

years. And that is a dynamic. It keeps growing and our trade

issues are ones, and it is a problem at a microlevel for a lot of individuals. There is no trade adjustment kinds of facilities that are

accompanying a lot of the problems that end up occurring as a

function of exchange rates. And if they are sustained at relatively

high levels, whatever that might be, then I think we have reason

as public policymakers to wonder whether the system is working

fairly.

We have talked about China with the soft peg. And the fact is

that that is an intervention into the market, not because of their

purchases of dollars on the market, although, you know, at the

margins some place, that increases the value. But if their currency

depreciates versus the dollar, even within their pegged range, it

undermines our manufacturers’ ability to compete fairly in a marketplace, if one is talking about fair markets.

24

So, I think that is a legitimate problem. And if you put that cumulatively across a lot of different countries in the world, and

there are places where there are soft pegs in other areas—you look

in a lot of the developing world, there are soft relationships on

what currencies are.

I do not know. I think that is the case in Korea. I think that is

the case in Taiwan. I think that is the case in the Hong Kong manufacturing areas.

And with smaller currencies, it is easier to manipulate and opposed to how it is with respect to the yen or the dollar or the Euro.

I think that there are other structural elements of the marketplace which you are trying to address here. But I think our manufacturers and our workers end up on the short end of the stick with

regard to how these systems work.

I am not arguing that we ought to be in the manipulation of the

currency markets. But I think we have a real policy responsibility

to do something about changes in some of these structures that

work to the disadvantage of American workers and American business. I do not think that all of those are not necessarily in the

trade arena. They are in structural reforms that I think we have

the impact to have real change brought to bear on how some of

these markets work.

A lot of these things do not even hit the radar screen of trade

agreements. They are the regulations that slow down the flow of

how people can participate in the markets. And that I think is a

serious problem and I think it contributes to the long-term risk

which has to do with what is the nature of the structure of American markets, whether people lose confidence in our markets because our accounting statements do not make sense or that we end

up running huge deficits at the Federal Government that competes

for that flow of inflow of capital. I think these things are serious

and they are potentially riskier in a dynamic context because we

build up these current account deficits over a period of time. I

guess I am siding with the Chairman here that we have something

to be concerned about.

Senator GRAMM. That is a smart thing to do. That is a very

smart thing to do.

[Laughter.]

Chairman SARBANES. Mr. Secretary, we promised you that we

would have you out, actually a little sooner. This has been a very

interesting session, as it invariably is when we have the opportunity to exchange views with you. As you depart, I want to leave

you with one image in your mind. This is the real foreign exchange

value of the dollar. This is 1980. This is 2002.

This was the Plaza Accord. And we have heard this morning that

if you try to do something, it won’t sustain itself. But it worked for

quite a period of time. Now, we are back up here. My anticipation

is that this is going to go, it will be above where we were at the

time of the Plaza Accord. So, I leave that with you. The Treasury,

in effect, brought others together and took an initiative to try to

address that.

Secretary O’NEILL. May I make one observation about the basing

point in the chart for 1980?

Chairman SARBANES. Sure.

25

Secretary O’NEILL. I would remind you, that around 1980, the interest rate in the United States was 20 percent and the unemployment rate was 11 percent.

And so, if 1980 is a desirable position, that is not my notion of

desirable economic circumstances. In fact, if you look at the period

since—it is hard for me to see from here, but it looks like 1994,

1995, when the value started rising. We have arguably had among

maybe the five best years in our economic performance in modern

history.

Chairman SARBANES. Well, accepting all of that, we still have, it

seems to me, a real problem here.

Thank you very much.

Secretary O’NEILL. Thank you. I will read the transcript of what

follows very carefully because I want you to know that I do not

have a closed mind on these subjects. I am open to listen to information and insights that can help us advance policy in a constructive way. So, I do not want you to take from what I have said that

I think I have the answer. No one else knows what they are talking

about. I just have not seen compelling evidence that is connected

to possible public policy levers that would advance the cause of our

society.

Chairman SARBANES. We have some very good panelists coming,

and I am encouraged to hear that you intend to look carefully at

their testimony and the transcript.

Thank you very much for being with us this morning.

Secretary O’NEILL. Sure.

Chairman SARBANES. If the panel would come forward and take

their places, we will continue.

[Pause.]

Chairman SARBANES. We are pleased to have a distinguished

panel now to address this issue. I believe they were all here at

least during part of the Secretary’s testimony and exchange. So, we

will proceed now, and I will introduce each as we move across the

panel, instead of everyone at once.

First, we will hear from Richard Trumka, the Secretary Treasurer of the AFL–CIO.

STATEMENT OF RICHARD L. TRUMKA

SECRETARY–TREASURER

AMERICAN FEDERATION OF LABOR AND

CONGRESS OF INDUSTRIAL ORGANIZATIONS

Mr. TRUMKA. Thank you, Mr. Chairman, and Members of the

Committee.

Chairman SARBANES. And I would say to the panel, your full

statements will be included in the record, and if you can summarize them, we would appreciate that very much.

Mr. TRUMKA. I will do just that, Mr. Chairman.

I am glad to have the opportunity to talk with you today on behalf of the 13 million working men and women of the AFL–CIO,

about the economic impacts of the overvalued dollar.

As we struggle to escape the grip of recession, the overvalued

dollar represents a serious problem. It is also causing long-term

damage by destroying our manufacturing base. Failure to redress

26

the problem risks undermining our fragile recovery and pushing us

into a double-dip recession.

Manufacturing is ground zero of the recession, and its troubles

are intimately connected to the dollar. Since March 2001, we have

lost 1.4 million jobs, of which 1.3 million have been manufacturing

jobs. Manufacturing has therefore accounted for 93 percent of all

job losses despite being only 14 percent of total employment. Today,

manufacturing employment is at its lowest level since March 1962.

Business has slammed on the brake of investment spending, but

fortunately the American consumer has kept the recession milder

than anticipated. However, a strong recovery that restores full employment needs a pick-up in investment spending, and that will not

happen as long as currency markets give a 30 percent subsidy to

our international competition.

Over the last 5 years, our goods trade deficit has exploded, costing good jobs across a wide array of industries. Last year, in the

paper industry there were mill and machine closures at 52 locations, all considered permanent, indefinite or long-term. In the textile industry, 2 mills per week closed in 2001, and closures continue

this year.

The weakening of the yen has given Japanese car companies a

huge price advantage. The result has been loss of market share by

our Big Three automakers that threatens some of the best jobs in

America.

Boeing, which operates at the cutting edge of technology, is losing market share to Europe’s Airbus. And losses today mean future

losses because airlines work on a fleet principle. They will therefore

order Airbus aircraft 5 years from now when they expand their

fleets.

Moreover, job losses are not restricted to manufacturing. Tourism

and hotels are hurt by the strong dollar, and film production is

moving offshore to cheaper destinations such as Canada, Australia,

and New Zealand.

Many of these jobs will never come back. These are high paying

jobs that have been the ladder of the American Dream for millions

of Americans. But now we are kicking the ladder away.

Manufacturing has faster productivity growth, and productivity

growth is the engine of rising living standards. But now we are

shrinking our manufacturing base, and that is bad for future living

standards.

The Administration, as previously noticed, has refused to address

these problems. Arguments for a strong dollar, in our opinion, simply do not wash.

Inflation is not a problem, and there is no evidence that a lower

dollar will lower the stock market or raise interest rates. Those

who say we need a strong dollar to finance the trade deficit have

the reasoning backward. We need to finance the trade deficit because we have an overvalued dollar.

It is time for a new policy that puts American jobs and American

workers first. It is unacceptable that Japan depreciates its currency. This will not solve Japan’s problems, and will only export

them to its neighbors and to us.

China exemplifies all that is wrong with currency markets. It has

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27

ment. In a free market, China’s currency should appreciate, but it

does not because of government manipulation. This is a problem

that appears in different shades in many countries.

American workers are paying the price for currency manipulation. Trade cannot be fair when we allow countries to manipulate

exchange rates to win illegitimate competitive advantage.

Those who argue that we can do nothing about exchange rates

abdicate, I believe, the national interest. The historic record and

the 1985 Plaza Accord intervention show that we can. Academic research shows the same. Just as we manage interest rates, so too

we can manage exchange rates.

Currency markets are speculative and respond to policy signals.

The Treasury and the Federal Reserve must take immediate action

with their international partners. The upcoming G–7 summit provides an appropriate moment to do so.

Beyond intervention today, we must avoid a repeat of today’s

overvalued dollar, just as today’s problems are a repeat of mistakes

made in the 1980’s. The dollar must be a permanent focus of policy,

and the Treasury and the Federal Reserve must be made explicitly

accountable.

Every trade agreement, Mr. Chairman, must include strong language that rules out sudden currency depreciations that more than

nullify the benefits of any tariff reductions.

The Senate Banking Committee has a vital oversight role to play

in ensuring that the Treasury and the Federal Reserve live up to

these obligations.

Thank you for the opportunity to testify and submit a report, and

I would be happy to answer any questions that you may have.

Chairman SARBANES. Thank you very much. We appreciate your

testimony.

Next, we will hear from Jerry Jasinowski, President of the National Association of Manufacturers. Jerry has been before the

Committee a number of times in the past. We are pleased to welcome him back.

STATEMENT OF JERRY J. JASINOWSKI

PRESIDENT, NATIONAL ASSOCIATION OF MANUFACTURERS

Mr. JASINOWSKI. Thank you very much, Mr. Chairman, Senator

Gramm, and all the other Members of the Committee for your leadership on this important issue.

I have enormous respect for Paul O’Neill. He is an old friend. I

think his leadership and his dedication to the country have been

extraordinary. And I think that it is only in the spirit that he himself invoked, which is to say, he is welcoming a debate, that I

would like to confine my oral remarks to a fairly direct response

to what the Secretary said, because I think that will be the most

useful thing to the Committee.

My prepared statement makes the case for why we think the dollar has run amok, not just for manufacturers, but also for this

broad coalition here—and why it is bad for the economy. It is not

just a matter of a few special interests indicating that this is important. There is a growing global consensus.

Let me make five points that go fairly directly to what Secretary

O’Neill talked about, that I think will be useful to the Committee.

28

The points all go to the argument that, essentially, the Secretary

is not addressing the reality that we see and the growing consensus in the world sees.

The first reality is, there is an extraordinary consensus now of

academics, business leaders, union leaders, international leaders,

and others, who say the dollar is overvalued. And in my statement,

I talk about everybody from the IMF to particular economists who

say it is overvalued by historic standards.

I think for the purposes of the Committee, though, the Big Mac

index illustrates most dramatically the reality. This is an index the

Economist Magazine uses to determine the extent to which the dollar is overvalued. It is the cost of a Big Mac in places around the

world. The index is, according to the Economist Magazine now,

more overvalued than it has ever been in history.

I think the chart you showed, Mr. Chairman, reflects this. The

Big Mac index reflects the reality in terms of real products and is

similar to the kinds of issues associated with products that manufacturers and agriculture face very broadly.

The second reality that I think the Secretary really does not address is the fact that the current account is a growing problem and

that it is directly related to the exchange rate.

I have here a chart, which is in my testimony as well. The chart

essentially tracks, as you can see, the ratio of imports to exports,

and the exchange rate for the dollar index.

What you see is an unequivocal correlation between——

Chairman SARBANES. Which line is which in that?

Mr. JASINOWSKI. The top line, the darker line, shows you the

ratio of imports to exports, and that is a rough proxy for the trade

deficit.

Chairman SARBANES. Right.

Mr. JASINOWSKI. What we are talking about is the current account. Unequivocally, you see that the dollar exchange rate affects

that.

Now the Secretary says in his report, and others will say, that

the current account and our trade problems are affected by interest

rates, growth, and all the things you, Mr. Chairman, and the Committee, know very well. But I am here to say that, right now, the

most important thing affecting the current account problems, the

growing trade deficit that we have heard so much about, and our

enormous loss of exports, is the exchange rate.

The third reality that the Secretary does not address is the enormous negative effect that this is having, not just on manufacturing,

but also on the entire economy. It affects the trade deficit. It affects

employment. It affects growth. It affects the international global

stability on which we are all resting our hopes for a recovery in the

economy. That is why the IMF and many others have suggested

there is a problem.

The fourth reality, and this gets to the heart of what do you do

about this, is that the Secretary is a major part of the problem

through his statements that fail to recognize the problems associated with the dollar trade and the current account. This misinformation distorts the markets that in fact are supposed to be functioning correctly.

29

I am here to argue that we do not have a perfect market in terms

of the currency markets. We do not, principally because the Treasury has taken the policy position that it is not a problem. Second,

and most importantly, by being for a strong dollar, you put a floor

under the currency. So, I would argue that we do not have a perfect market in the exchange rate for that reason, and that the

Treasury is part of the problem.

My final point, Mr. Chairman, is that the solution is therefore,

at least in a first instance, pretty simple. That is, that the Treasury ought to simply acknowledge that the current account is a

problem, the dollar is a problem, and it ought to get out of advocating a strong dollar and instead say it is for a sound dollar based

on market fundamentals. If we do that, I assure you we will not

have a huge drop in the dollar. We will have a gradual movement

back toward the equilibrium that all of us that are part of a sound

dollar coalition are for. And I think that would mean less Government intervention in this market, in some respects, and a return

to a truly perfect market.

Thank you, Mr. Chairman.

Chairman SARBANES. Thank you very much. Also, we want to

thank you for this very well considered prepared statement, which

we very much appreciate having. But I think it was helpful for you

to directly address some of the points that the Secretary made.

Our next witness is Bob Stallman, President of the American

Farm Bureau Federation. We do not usually have you before our

Committee, Mr. Stallman, but we are pleased you are here today.

We would be happy to hear from you.

Senator GRAMM. Mr. Chairman, could I just say a word about

Bob Stallman, and I will be brief?

Chairman SARBANES. Certainly.

Senator GRAMM. I have known Bob since he was a rice farmer

in our State. He started out as a farmer talking to his neighbors,

became involved in the county farm bureau, became President of

the Texas Farm Bureau, and became President of the American

Farm Bureau.

I am sure Bob and I are not going to agree on the subject today,

but I would like to say that Bob Stallman is living proof that talent

wins out in America, if you have ability and ideas and you feel passionate about stuff, that your neighbors will elevate you and that

starting out as a rice farmer in southeast Texas, you can become

the spokesman for American agriculture if you have what it takes

to become that. So it just reassures me, having known somebody

this has happened to. Bob, we appreciate your being here.

Chairman SARBANES. Thank you.

Mr. Stallman.

STATEMENT OF BOB STALLMAN

PRESIDENT, AMERICAN FARM BUREAU FEDERATION

Mr. STALLMAN. Mr. Chairman, Senator Gramm, thank you for

the kind words. Incidentally, for the record, I still am a rice farmer,

though just not to the extent I used to be. It is a pleasure to be

before this Committee today.

As the Nation’s largest agricultural organization, our farmer

members produce nearly every type of farm commodity grown in

30

America and depend on access to foreign markets for our economic

viability.

We certainly appreciate this opportunity to testify on the importance of the exchange rate to U.S. agriculture. The exchange rate

is the single most important determinant of the competitiveness of

our exports. U.S. farmers and ranchers have been losing export

sales for the past 3 years because the dollar is pricing our products

out of the market, both at home and abroad.

Agriculture is one of the most trade-dependent sectors of our

economy. Our sector has maintained a trade surplus for over two

decades, but that surplus is rapidly shrinking. One of the primary

factors affecting our declining trade balance is the strong value of

the dollar.

We are also deeply concerned about countries that engage in currency devaluations in order to gain an export advantage for their

producers. The real trade-weighted exchange rates for agricultural

exports from our major competitors have exhibited a long-term

trend of depreciation against the dollar, leaving it hard to conclude

that this is not a deliberate monetary policy of these and other

governments.

U.S. agriculture relies on exports for one-quarter of its income.

In addition, and coincidentally, about 25 percent of the agricultural

production in the United States is destined for a foreign market.

With a strong dollar, we have the double challenge of our products

being less competitive in foreign markets, while products from

other countries are more competitive in U.S. markets.

There is a strong relationship between the value of the dollar

and the domestic price of our commodities. As the value of the dollar rises, foreign buyers must spend more of their currency to purchase our exports, which causes them to decrease their consumption of our commodities, or buy from our competitors instead. The

resulting drop in consumption drives U.S. commodity prices down

even further.

The increasing strength of the dollar, and steady depreciation of

the currencies of our major export competitors, has had a profound

impact on our ability to export. In fact, the rising appreciation of

the dollar is one of the primary reasons why the agricultural economy did not experience the economic prosperity that most other

sectors of the U.S. economy enjoyed between 1995 and 1999. This

is also a jobs issue. USDA estimates that 14,300 jobs are lost for

every one billion dollar decline in agricultural exports. As a result,

agricultural employment lost 87,000 jobs between fiscal years 1997

through 2000, a period wherein the real agricultural exchange rate

was rising rapidly and U.S. agricultural exports were stagnating.

For some commodities, the rising value of the dollar has directly

contributed to the export competitiveness of our foreign rivals. The

strong dollar enables our competitors to expand their production

and gain market share at our expense. Let me give you a few commodity-specific examples.

Beef: Since 1995, the dollar has appreciated 42 percent against

the currencies of beef producing countries. And I know we had the

Big Mac index over here, but that U.S. McDonald’s Big Mac is

going to have more foreign beef in it, given their recent announcement to purchase more beef from Australia. The relative exchange

31

rate, strong value of the dollar, has caused that economic decision

to be implemented.

Fruits: From 1995 to 2000, U.S. imports of fruits and nuts

jumped 33 percent, largely due to the dollar’s 18 percent gain with

respect to the currencies of foreign suppliers of these commodities

to the United States.

Corn: The U.S. dollar appreciated 39 percent relative to the Japanese yen from 1995 to 1998, adversely affecting our corn exports

to that market.

Soybeans: The cost of U.S. soybeans to Japanese buyers increased 8 percent from 1996 to 1998, due to the appreciation of the

U.S. dollar, even though U.S. prices fell 181⁄2 percent during the

same period.

In conclusion, America’s farmers are the most productive in the

world. However, the comparative advantages that our producers

generally enjoy are certainly mitigated by the rising appreciation

of the dollar.

Exchange rate issues are certain to increase in importance for

our sector, and if these issues are not resolved by macroeconomic

policies, there will be continued pressure to find solutions in traditional farm and trade policies.

The effect of long-range financial planning at the farm and ranch

level and the overall economic health of U.S. agriculture depends

on more stable exchange rates that do not overvalue the U.S. dollar

against our competitors’ currencies.

Thank you, and I look forward to answering any questions at the

conclusion of the presentations.

Chairman SARBANES. Thank you very much, sir.

Our next panelist is Fred Bergsten, who is the Director of the

Institute for International Economics, and a frequent contributor to

our discussions. We are very pleased to have you here, Fred.

STATEMENT OF C. FRED BERGSTEN

DIRECTOR, INSTITUTE FOR INTERNATIONAL ECONOMICS

Mr. BERGSTEN. Mr. Chairman, thank you very much. As I listened to the discussion this morning, there seemed to be two questions before the House.

Chairman SARBANES. Before the Senate.

Mr. BERGSTEN. Excuse me? Sorry. Before the Senate.

[Laughter.]

Bad error.

[Laughter.]

Change the words in the transcript.

[Laughter.]

Two questions before the Senate. One, is it a problem? And two,

is there something you can do about it?

My answer to both is a resounding yes, and let me briefly summarize my statement in trying to answer those questions.

First, is it a problem?

We have to keep clearly in mind that there are not one, but two

problems, a real economy problem and a financial risk problem.

The real side problem is the loss of output, loss of jobs, and loss

of agriculture that were talked about. The financial risk problem

32

is the possibility that all this could come crashing down in a huge

financial crisis with enormous consequences for the economy.

Now what is the size of the problem?

Since the dollar hit its all-time record lows in 1995, it has risen

by 40 to 50 percent against the various trade-weighted averages

that the Fed calculates every day. And that is like a rise in 40 to

50 percent in prices of the entire economy in world trade. When a

company sees its prices go up 40 to 50 percent in a few years

against its main competition, it is usually in Chapter 11. That is

what has happened to the United States as a whole.

Every rise of 1 percent in the trade-weighted average of the dollar produces an increase of at least $10 billion in our current account deficit. And so it is clear that this rise of 40 to 50 percent

in the exchange rate over the last 6 or 7 years explains the vast

bulk of the half-trillion dollar trade deficit that we face today and

which is getting bigger.

Indeed, we have projected the current account over the next few

years on reasonable economic assumptions, and assuming no policy

change, more of what we heard from the Secretary this morning,

and no untoward external events, the deficit would hit 7 percent

of GDP—that is $800 billion—by 2005 or 2006.

Every study ever done, including by the Federal Reserve itself,

and they published this, shows that once you hit 4 to 5 percent of

GDP, you are in the danger zone.

Indeed, the big crashes of the dollar which have occurred once

per decade since the early 1970’s, have occurred without our current account deficit ever getting to 4 percent of GDP, the all-time

high in the mid-1980’s, before the Plaza Accord Agreement, and the

50 percent correction in 2 years, was 3.8 percent. We are well beyond that. We are headed toward twice that. We are clearly on an

unsustainable path.

Now, in financing terms, what this requires is even worse than

you think because we not only have to import $500 billion of capital each year to finance our current account deficit but we also

have to cover our capital outflows.

Remember that the United States itself invests lots of money

abroad. This is a good thing. I am certainly not criticizing it. But

that amount is another half-trillion dollars a year. So the result is

that the U.S. imports a trillion dollars of foreign capital per year,

to balance the books, which is a little more than $4 billion every

working day.

It is certainly not a bad thing. The point is, if that $4 billion per

day dropped to just $3 billion, let alone reversed into an outflow,

the dollar would fall sharply. And it would fall, by our calculations,

at least 20–25 percent to get back to some kind of sustainable equilibrium level. Since markets overshoot, it would probably go much

more than that in the short run.

That would cause sharp inflation, a sharp rise in interest rates

by several percentage points, and a sharp fall in the stock market—a triple-whammy that would hit the economy. That is why I

agree with the statements you made before that this is the single

biggest risk to the U.S. economic outlook, and that the Secretary

of the Treasury certainly ought to be concerned about it.

33

It is stunning that he said the things you quoted this morning

that he did say. It is reminiscent—this is a nonpolitical statement,

just an economic analysis—of what happened in the first Reagan

Administration, with Secretary Don Regan and Beryl Sprinkel,

which was the epitome of benign neglect.

That turned out to be so wrong and so costly to the economy that

the second Reagan Administration had to reverse it, do the Plaza

Accord Agreement, and drive the dollar down by 50 percent in the

next 2 years. So it is not as if we have not seen this happen before.

We have seen exactly this happen before. The Administration that

permitted it to happen then had to reverse itself 180 degrees, enlist

the rest of the world to help to save us from the enormous costs

of that policy.

Second question, is there something we can do about it, as Senator Gramm, Secretary O’Neill, and others raised, and you yourself

acknowledge? That is the more difficult question.

I believe there are policy changes that can rectify the situation

substantially without significant adverse costs elsewhere in the

economy. And that is because I believe, and I will try to document

briefly, that sterilized intervention in the exchange markets works

and can change currency movements in important terms.

The Secretary mentioned Allan Sinai and economic theory. There

is something now in economic theory called multiple equilibria.

Economists have now realized that for any given set of economic

fundamentals, there is in fact, a large set of possible market outcomes, glorified by the term multiple equilibria, indicates there is

firm theoretical basis for what I am about to say. I would suggest

a four-part change in policy.

First is what Jerry Jasinowski just said—change the rhetoric,

absolutely.

Second, if the dollar were to rise further, as it may because of

the rapid U.S. recovery, the United States and the G–7 should certainly lean against the wind of any new dollar rise. That would

make it worse.

Third, however, and more importantly, we should now begin easing the dollar down toward equilibrium levels, and I will explain

briefly why I think now is the time to do it.

Fourth, we should of course make it very clear to other countries

that we will not tolerate efforts to competitively depreciate their

currencies.

The Treasury Report is stunning in that it acknowledges huge

intervention by the Japanese, but does nothing about it. I can tell

you that immediately after the rise in the yen last fall, the Japanese began talking it down. I thought they had quit, but they are

at it again this week.

The leadership of Japan’s Ministry of Finance has been saying

very clearly this week, after the yen rose four or five yen against

the dollar, that any further rise would be inconsistent with our economic fundamentals and they are against it. They are again trying

to avoid any rise in the exchange rate of the yen. And we should

make clear that that is verboten and will not be accepted.

On U.S. currency policy itself, it was encouraging that Secretary

O’Neill today, as for many months, did not repeat the term, ‘‘strong

dollar.’’ You will notice that he has assiduously avoided saying that

34

for some time now. However, he said, there will be no change in

policy, so I suppose it has the same implication.

I would agree with what Jerry Jasinowski said, that the Administration should change the wording and now start supporting a

sound dollar or some equivalent that made clear that they wanted

to see it in sustainable equilibrium terms, in terms of our external

position.

The presumed reason they do not want to change is they are

afraid that the dollar would then collapse. But at a time when the

U.S. economy is booming, as the Secretary said, with huge productivity growth, at a time when there is no dramatic growth in

Europe or Japan to suck money away, I think it is very unlikely

that a change in rhetoric would lead to a free fall, and that is why

this is the ideal time to make the change—when we are doing well,

when we are recovering strongly, and when the others are not

doing so well, unfortunately. Now is the time to do it.

The worst policy is to wait until there is an inevitable change in

economic circumstances that drives the dollar down when we are

not in such good shape, when we cannot accept it so well, which

would cause enormous costs to our economy. And so, it seems to

me that now is the time to do it.

Final point, again, how do you do it? Change in rhetoric and direct intervention.

Notice that the Rubin–Summers Treasury intervened on three

and only three occasions, from 1995 through the end of its tenure

in 2000. Every one of those changes, in my view, worked like a

textbook.

In 1995, when the yen was rising too far, got to 80, the dollar

in fact was at its all-time record lows against both yen and

Deutschmark. We intervened jointly with the G–7. We stopped the

rise of those other currencies, stopped the fall of the dollar, turned

it around, and within a few months, the dollar was headed up, and

in fact, it has never stopped since. We were 100 percent successful.

In 1998, the yen was becoming too weak, just like it is today. It

got to 145. The United Stated intervened, along with Japan, and

stopped the decline of the yen. It stabilized in that range for a couple of months and then rose back to 100. It was a total success.

Third intervention, September 2000. The Euro fell to its all-time

lows. The Europeans got upset. Again, that was pushing the dollar

to get further overvalued. Joint U.S.–E.U. intervention stopped the

decline on a dime. The Euro turned around, rose 10 percent, subsequently fell back halfway. It has been there ever since.

On my reading, in all three cases, three out of three, it worked.

I believe, incidentally, the Plaza Accord was a huge success and the

notion ex-post that it was just riding along going down the stream,

frankly, is post hoc ergo propter hoc reasoning, and was not clearly

in the minds of the people who did it at the time, who saw an enormous need to change the trend and do something about it.

There has been scholarly work by Franckel and Domingues at

my institute. The Banca d’Italia’s working with classified data suggested that every major intervention in the 1980’s and 1990’s

worked and turned the currency relationships around in the desired direction.

35

So my conclusion is very simple. There is a big problem and

there are policy tools available to deal with the problem without

adversely affecting other parts of our economy.

At a minimum, we should try it. The costs are too high. The risks

of trying this I think are very modest if it were to fail, but the prospects for success are very strong and I think that alternative policies should be pursued.

Thank you.

Chairman SARBANES. Thank you very much.

Our next panelist is Ernest Preeg, who is the Senior Fellow at

the Manufacturers Alliance. We would be happy to hear from you.

STATEMENT OF ERNEST H. PREEG

SENIOR FELLOW IN TRADE AND PRODUCTIVITY

MANUFACTURERS ALLIANCE/MAPI, INC.

Mr. PREEG. Thank you very much, Mr. Chairman. It is a pleasure to be here today.

I will focus my remarks on one particularly disturbing aspect of

the trade deficit, namely currency manipulation to commercial advantage by certain trading partners, and in particular, by China.

I do want to say, though, as in my written statement, that I see

the current account deficit and accumulated foreign debt as a problem. The most immediate concern is that a rapid rise in our trade

deficit this year, almost all of which will be in the manufacturing

sector, could be the Achilles’s heel for the hoped-for sustained recovery because it is hitting our investment sector particularly hard,

and that is the lagging sector.

As for currency manipulation, the IMF clearly proscribes it.

There is an IMF statute that members should not be manipulating

their exchange rates to gain an unfair competitive advantage. And

a principal indictor of such manipulation under IMF surveillance

procedures is very precise. It says that members should not make

protracted, large-scale interventions in the market in one direction—namely, to buy dollars and other foreign currencies—to keep

their currencies down and to gain an unfair competitive advantage.

Japan has gotten the most attention on this because for several

years, they have made such protracted, large-scale interventions,

$250 billion all told. Fred has given some examples of this.

And I should state here, to clarify earlier discussion, what I call

the great asymmetry in central bank intervention. If you are trying

to keep your currency up, as Argentina did with the peso, you have

to sell dollars. Everybody thus knows when you are going to run

out of dollar holdings, and it is a limited time.

In the other direction, as we are talking here, when you want to

keep your currency down low, that is manipulate it down, you can

buy unlimited dollars year after year, indefinitely, as Japan and

China have been doing—as much as $50 billion each year—to offset

the market forces in the other direction stemming from a trade surplus, for example.

Turning to China, they have also manipulated their currency,

but it is a more complicated situation. It has not received as much

attention perhaps for that reason, because China has a fixed rate,

but the currency is not convertible on capital account. In effect, the

exchange rate is not really market-oriented.

36

But the facts are nevertheless very clear, as was cited earlier by

Senator Bunning. Last year, for example, China had a $25 billion

trade surplus, globally, and a $45 billion inflow of foreign direct investment. This would put major upward pressure on the exchange

rate. At the same time, however, the central bank bought $50 billion, to take dollars off the market and ease the pressure.

More precisely, the Chinese central bank has taken away threequarters of the upward pressure on its currency from the trade surplus and foreign direct investment. And here, again, another technical comment on the earlier discussion. What counts are not the

gross flows in markets, a trillion dollars a day. Most of this is just

in and out, offsetting. It is the net flow of trade and foreign direct

investment, and the net borrowing of central banks that needs to

be considered. And on this net basis, the numbers for Japan and

China have been very large and have had substantial impact in

keeping the exchange rate down.

So the net result, in my judgment, is that China has a substantially under-valued exchange rate for the yuan and the direct impact, of course, is a larger trade surplus with us—export jobs they

gain and export and import-competing jobs we lose. There are several other benefits to China from its currency manipulation in my

statement. I won’t go into detail. One was mentioned earlier, that

perhaps at some future point, they could use their excessive currency holdings for foreign policy leverage.

A more immediate benefit for China is that with $220 billion in

their central bank—fungible money—there is no financial constraint to buying large amounts of armaments from Russia or elsewhere. They have huge amounts of money in the bank that they

could use it for this, and for several other reasons as explained in

my statement.

I agree with the others that we need a clear and forceful response to this now chronic trade deficit. It is headed toward record

levels over the next couple of years. And a $3 trillion net foreign

debt accumulation is headed toward $5 trillion by mid-decade.

What should we do?

First, as Senator Gramm mentioned, we have to save more because we are currently living beyond our means. The foreign borrowing is not being used for investment, as was indicated, but

mostly for immediate consumption. Eighty percent of our foreign

borrowing, more or less, is for immediate consumption and we

leave the consequent foreign debt to our children and grandchildren to pay interest and principle. I do not think that is right.

So, we need to save more. And at the same time, we have to get

trading partners such as China and Japan to save less and consume more, so that their economies do not have to be dependent

on a large trade surplus, for which they manipulate their currency.

They don’t now have a domestic economy growing fast enough, and

thus rely on a chronic trade surplus to maintain growth. We need

to achieve a better balance, to save more and not spend beyond our

means. And others need to do the opposite.

The other immediate objective, in my view, is to stop others from

manipulating their currencies so as to have bigger trade surpluses

than they would have based on market forces alone.

37

We have a clear opportunity to do this in the IMF based on very

explicit surveillance criteria. All we have to do is ask for a consultation to say that the others should stop their currency manipulation. We have never done that.

There is even an article in the GATT and the World Trade Organization, I believe Article XII, along the same lines. We have never

thought seriously about that, either.

We should take steps, both through bilateral consultations, and

within the IMF context in a more formal way, to try, particularly

with East Asians including Japan and China to stop further currency manipulation, which distorts exchange rates from what markets would determine.

And for China, finally, the bilateral consultations should be a

very high priority. We have a mutual interest in reducing the very

lopsided, 5:1 trade imbalance, with $100 billion U.S. imports and

only $20 billion exports, last year, and we should begin with the

question—why is the bilateral trade so imbalanced?

We should request, clearly, of China, that the central bank stop buying dollars at $50 billion a year, and that they bring their exchange rate up by 10 percent, 20 percent, or whatever is a reasonable first step.

The longer-term transition of China to a fully convertible floating

rate relationship with the dollar should also be discussed. We

should look at this seriously because that is what I believe the

longer-term objective should be. It is a mutual interest and it is the

best way to avoid trade conflict from further unjustified Chinese

currency manipulation.

Thank you, Mr. Chairman.

Chairman SARBANES. Thank you very much.

Our concluding panelist is Steve Hanke, a Professor of Applied

Economics at Johns Hopkins University.

Mr. Hanke.

STATEMENT OF STEVE H. HANKE

PROFESSOR OF APPLIED ECONOMICS

JOHNS HOPKINS UNIVERSITY

Mr. HANKE. Thank you, Mr. Chairman, Senator Gramm.

Let me just briefly make a few points that pick up on some of

the things that have been discussed in the morning session. My remarks will highlight points that are developed in my prepared

statement.

Chairman SARBANES. We will include your full prepared statement in the record and we appreciate your condensing it.

Mr. HANKE. Thank you, Mr. Chairman.

We have hearings in which ‘‘exchange rate policy’’ is stated, as

one of the phrases in the title of the hearings themselves. And interestingly enough, if you look at the U.S. evolution of exchange

rate policy in general, we really did not have any coherent policy

stated in the United States, until 1999, when Secretary Rubin, in

April, articulated the policy.

Then Summers followed in September 1999, after he was appointed Secretary, and Stanley Fischer at the IMF weighed in with

essentially the same conclusion in January 2001.

38

Now what did they say about exchange rate policy and why are

their statements important?

There are three generic types of exchange rates—a floating rate,

which Rubin and company said was suitable for the United States.

And that is a rate in which the exchange rate itself is on autopilot.

You only have a monetary policy. You have no exchange rate policy

under a floating exchange rate regime.

At the other extreme, you have an absolutely fixed exchange rate

regime in which an exchange rate policy exists, but monetary policy is on autopilot. And that would be things like orthodox currency

boards or dollarized systems.

Rubin, Summers, and Fischer came to the conclusion that I think

all economists have come to, and that is, in a world of mobile capital and free capital flows, those two extreme free-market, automatic systems are desirable. And everything else in between is undesirable.

Now what is in the middle?

A pegged-type system is in the middle. For example, Secretary

O’Neill mentioned that China has a soft peg. Well, they do have a

soft peg. And the reason the thing doesn’t blow apart is that China

has extremely rigorous capital controls—the capital account is completely controlled.

So those are the three systems and as you can see, as a matter

of principle, the Chinese system would be undesirable, according to

Rubin, Summers, Fischer and most economists, certainly the major

consensus.

What does this have to do with the hearings?

Well, it has a couple of things to do with the hearings. The Bush

Administration has never gotten around to articulating and reaffirming what Rubin and Summers did. And Krueger has never

reaffirmed what Fischer did. So, we need some clarity. I think you

should push Secretary O’Neill to come forward with some clarity on

the U.S. broad policy position.

For the United States, we accept floating. Now that has some implications, especially for the strong dollar rhetoric. Our exchange

rate policy is a floating exchange rate. It is not a strong dollar policy. A strong dollar policy is nothing but rhetoric and absolute economic nonsense. It doesn’t mean anything in economic terms. The

dollar’s value is determined in the market and under a floating exchange rate, that determination is on autopilot.

So, I would agree with Jerry and Fred on this thing. Any adjective for the dollar—whether it is strong, sound, or weak—doesn’t

mean anything if you accept free capital mobility and a floating exchange rate because the dollar’s price is simply on autopilot.

I think, Mr. Chairman, I see a red light on your little gauge.

Chairman SARBANES. Why don’t you go ahead if you have a few

more points you want to make.

Mr. HANKE. This rhetorical point would be one thing on which,

oddly enough, Fred, we are in agreement.

Now let me mention something on which Fred and I probably

would not agree. The world is already very much unofficially

dollarized. That means that 90 percent of all foreign exchange

transactions have the dollar on one side of the trade. Ninety percent of all commodities traded in the world are invoiced in dollars.

39

So, you do not have this so-called exchange rate problem that we

have been discussing. They are buying and selling in dollars and

invoicing in dollars.

Now, in terms of manufactured goods, Mr. Chairman, the issue

gets a little bit tricky to sort out and make generalizations. But I

can tell you that about 35 percent of exports from Japan are actually invoiced in dollars. They are dollarized. And almost 65 percent

of all the imports going into Japan are dollarized.

The point here is, if you really want to get around these problems with exchange rates, Fred, and the competitiveness, uncompetitiveness, competitive devaluations and so forth, what we should

do is try to encourage the official dollarization of most smaller

countries—I am not suggesting Japan or Euroland because that

would put them in the same currency bloc as the United States and

we would not have to spend much time with these conversations

because everyone would be buying and selling and invoicing and

dealing in dollars. I would point out that, generally, the U.S. dollar

can be characterized as a vehicle currency in the world that is truly

dominant in staggering ways.

We had an earlier conversation about dollar reserves held at the

Chinese central bank, as well as the Bank of Japan and changes

in those. About 66 percent of all the foreign reserves held at central

banks in the world are in dollars or assets denominated in dollars.

So, I think if we go after every central bank using dollars in this

way, in an official way, we have a lot of villains out there that we

are going to have to go after, just not Japan and China.

Mr. Chairman, I appreciate your letting me overindulge on time.

I think I have made some of the main points I wanted to make,

in any case. Thank you for giving me the extra time.

Chairman SARBANES. Thank you very much, Professor Hanke.

I might mention that the Committee has received a number of

letters from across the country from various manufacturers and

producers with respect to this hearing, expressing their viewpoint

which has been expressed by some of our earlier panelists here

today, which we will place in the hearing record. What is the response to this dollarization statement that Professor Hanke made?

Mr. JASINOWSKI. I think it makes general sense. I do not know

how far it can go in terms of dealing with the central problem of

the strong dollar policy being advocated by the Treasury. But it

does, I think, help on the demand side with respect to dollars. And

therefore, I think it is good in that sense. It is also good in the

sense of the dollar currency being a more stable currency than

most. So, I would initially be positive toward that.

Chairman SARBANES. As I understand it, the assertion is that a

good part of the Japanese trade is invoiced in dollars. I take it you

then draw from that the conclusion that the exchange rate difference is not affecting the trade balance. Is that right?

Mr. BERGSTEN. Mr. Chairman, let me take a stab at that.

In this context, dollarization is a narcotic because, with most of

the world’s trade financed in dollars and with most of the reserves

in central banks held in dollars it is very easy for us to finance

these big deficits relative to other countries whose currencies are

not widely used in international finance.

40

Charles de Gaulle 35 years ago said that the United States ran

deficits without tears. And the reason he said that was because

he argued, and he was right then, and it is happening right now—

that foreigners acquire dollars as they run their trade surpluses,

tend to hold them in dollar terms, and that, ipso facto, finances our

deficit.

So it is quite easy for us, relative to anybody else, to finance

these huge boxcar deficits, and there is no secret, in fact, to why

we have been able to run them. In part, it is because the dollar is

the world’s currency.

The flip side of that, however, is that it is quite difficult for the

United States to change its exchange rate if it decides it wants to

do so because its exchange rate—our dollar exchange rate—is essentially in the hands of other countries.

As Hanke said, we float freely. So if Japan wants to intervene

and buy dollars for their reserves, they have the perfect right to

do that under the way the system works.

We then have to take an initiative to counter that and say,

quoting Ernie Preeg, but that is not consistent with the IMF rules

and with international equilibrium. But we are in a free-floating

system where the kind of debate we are having around this table

today is replicated in every G–7 and other meeting where they address this, because there are really no rules of the game and there

is no notion of what is an equilibrium exchange rate.

That is why for many years I have supported a target zone exchange rate system. I do not agree with Hanke that there is a consensus on the so-called two corners approach. The world has been

moving very rapidly away from that because it realizes the shortcomings. But that is for a different day.

The point is when the United States decides that it needs to do

something about its current account and the exchange rate, it has

to take a major initiative.

John Connally did it in 1971 and brought down the Bretton

Woods system of fixed rates in order to get the dollar depreciated.

Jim Baker did it at the Plaza Accord in 1985. To bring the dollar

down, he had to get G–7 agreement to bring the dollar down. The

United States could not do it by itself.

I am thinking now of Senator Gramm’s comment about the cheap

shovel. The fact that the dollar is international currency makes it

much easier for us to buy the cheap shovel and that has big consumer benefits. But the fact that it does create deficits without

tears and makes it easy to finance, makes it easy for the dollar to

get overvalued and to cause the problems that we are talking about

today.

One other historical example that proves the point is the U.K.

All through the period of the sterling’s dominance as the world’s

currency, in the 19th century, and into the early 20th century, the

exchange rate of the sterling was vastly overvalued.

The British manufacturing sector ran into the ground and here

they are 100 years later without much. I hope we do not go that

way. It is a slow process. It is more like termites in the woodwork

than it is a crashing crisis, although every once in a while the sterling and the dollar had a crisis.

41

But the role of the dollar is actually, in this context, rather insidious, and it sets us up for the kind of competitive problems we have

and the occasional crash in the exchange rate, which I repeat, we

have experienced once a decade now throughout the modern postwar period.

Chairman SARBANES. Mr. Preeg.

Mr. PREEG. Mr. Chairman, in response to your question about

when should countries dollarize, it is their choice. This goes back

to the optimum currency area discussions and analysis of 40 or 50

years ago.

My own assessment, and it is widely shared, is that smaller

economies that are very open to trade investment, and that are

predominantly dependent on one major trading partner like the

United States, are the most apt to be net beneficiaries of dollarization. There are pluses and minuses that have be considered,

and this is a net assessment.

In my judgment, the countries of the Caribbean Basin, and I believe also Canada and Mexico, based on the numbers, plus and

minus, would thus benefit from dollarization. Argentina is not in

that category and has paid a heavy price.

The second point, trade is invoiced in dollars, but that is not, in

my judgment, relevant because it is the dollar prices that count.

Toyota car exports to the United States may be invoiced in dollars, but at what dollar price? And if Japan keeps the exchange

rate down, Toyota can maintain lower dollar prices.

Chairman SARBANES. That is the point I was trying to make.

The fact that you are invoicing in dollars does not take out of the

picture the problem of a mismatch in the exchange rates. Is that

correct?

Mr. JASINOWSKI. I think that is right, Mr. Chairman, it does not.

I should have said that myself, and that is what Ernie’s saying.

Chairman SARBANES. Yes. Did you want to add something?

Mr. HANKE. If I may. One thing you asked, is it desirable to

dollarize?

Chairman SARBANES. Now, I wasn’t really addressing that question because I think that depends a lot on the countries and the

nature of the trade. I was trying to get to the question, the assertion that the Japanese were invoicing in dollars. You gave some figures of the percent of trade.

Mr. HANKE. Right.

Chairman SARBANES. I was really trying to explore whether that

means that it renders the exchange rate discrepancy irrelevant.

I think Mr. Preeg essentially answered that question because it

is still relevant in terms of what dollar level you place on the invoice, so to speak. So that is affected by the exchange rates.

Mr. BERGSTEN. The exchange rate would become irrelevant only

for a country that dollarized and adopted the dollar as its official

currency, not one that just invoices dollars. You are right, the

invoicing is a technical thing.

Chairman SARBANES. Well, that is what I was trying to get at.

Mr. HANKE. It gets a little bit tricky because, let’s say you are

importing, one big import, and it is oil. And it is priced in dollars.

Well, that affects your cost structure because that is an input that

you are bringing into your economy. It is purely priced in dollars.

42

Chairman SARBANES. That is a reasonable point on oil. But we

do not have that in either the Japan or China trade where we are

running these extremely large deficits.

I am struck by how disproportionate the trading relationship is.

It is 5:1 in China and it is about 2:1, I think, in Japan. With the

Europeans, they are at about 45 percent, I guess, of the trade is

our exports and 55. So that is in a much narrower range. But this

China and Japan trade, particularly China now because that is a

growing trade, the disproportion, I do not know how long you can

sustain that disproportion.

Mr. HANKE. I have spoken at least to Under Secretary Taylor

privately about this, and he has an appreciation for the bipolar

view expressed by Rubin and Summers. If we adhere to that, we

should be putting a lot of pressure on the Chinese to change their

exchange rate set-up and get rid of capital controls. Right?

Mr. PREEG. Right. Short of that, they should stop intervening

now and bring their currency down 10 or 20 percent.

Mr. HANKE. Now one thing I would like to ask Fred—— Mr. PREEG. Well——

Mr. HANKE. If I could ask Fred——

Chairman SARBANES. Let me regain control here because, as interesting as this is—— [Laughter.]

Time is passing us by and I want to make sure Senator Gramm

gets his shot.

Senator GRAMM. Mr. Chairman, I appreciate that. I do not want

to miss my cheap lunch.

[Laughter.]

Let me first say that I never met anybody who said to me, I want

to have a strong dollar. If there is such a person out there, I never

met them. I have to believe that this strong dollar business is a

strawman. I represent 21 million people and they have greatly diverse views. Some of them even oppose me.

[Laughter.]

But I cannot help but believe that, out of 21 million people, there

would be some strong dollar guy and I would have heard from him.

So, I am just mystified by all this strong dollar business. And I

have to conclude that it is a strawman.

Second, we have not had a crisis in the dollar since we went on

flexible exchange rates. I remember I was an economist and I took

the world very seriously.

[Laughter.]

I remember when Nixon went on price controls. We got a group

of people together, my sweet wife, who is also an economist, and

several of our colleagues, and we decided, since the world was

going to hell, a Republican president had gone on wage and price

controls and they had not worked since Diacletian, or the Code of

Hammarabbi, that there was reason to be disturbed.

So in 1971, we went out to eat, and we did note that one thing

about flexible exchange rates, and there was a debate then that the

dollarization debate then was the gold standard. There was a little

debate, should we be on a gold standard flexible exchange rate?

But nobody with any sense thought we ought to have pegged exchange rates, because we were always defending the dollar.

43

Though I would have to say, when I was a graduate student, I

thought, well, maybe I would want to defend the dollar. It sounds

exciting. You have your sword. You are defending it. We have had

no crisis in the dollar that I can see, and I have been here. I have

watched every day. My keen observations, I have not seen it.

Now let me turn to this chart. I cannot afford one of these big

charts. But I see a lot of different things on this chart than other

people see.

First of all, let’s just go 3 years on either side of 1985. In 1982,

1983, 1984, and 1985, the economy was blowing and going and the

value of the dollar was just shooting right through the roof. Did a

crisis occur and the value of the dollar just collapse in 1985? Well,

if it did, I missed it, and I was here.

In 1985, the value of the dollar falls right through the floor and

yet, I remember no crisis. And the economy was about as good in

1986, 1987, and 1988 as it was in 1983, 1984, and 1985. Now what

does that tell me? Well, it tells me that market forces produced the

high-value dollar and market forces produced the low-value dollar

and market forces generate what market forces generate in terms

of underlying economic forces. In fact, I could have a theory based

on these numbers that elections determine the value of the dollar.

When Ronald Reagan was elected President and a Republican

Senate was elected, the value of the dollar went up like a rocket.

And when Republicans lost control of the Senate, the value of the

dollar collapsed.

[Laughter.]

And when Republicans won control of the House and Senate in

1995, the value of the dollar went up like a rocket.

Now do I really believe that there is an election theory of currency values? Well, I believe it more than I believe that there is

manipulation of exchange rates. I think there is more scientific

basis to it because there is a logic to it.

Where would you get $50 billion a year to put into currency manipulation, Mr. Preeg?

Mr. PREEG. What they do to keep their currency down is you buy

dollars.

Senator GRAMM. Yes, but where do you get the money to buy it?

Mr. PREEG. With the Chinese printing press.

Senator GRAMM. Fifty billion dollars—printing? They do not print

dollars.

Mr. PREEG. No, yuan. They are buying dollars, paying out their

currency in order to take those dollars off the market and keep the

exchange rate down.

It is the opposite of what Argentina went through. China is simply taking those dollars off the market because people have all

these dollars from the trade surplus and the FDI. The dollar holders want to convert them into yuan. And the capital account is constricted.

So what the Chinese central bank does is to print yuan, $50 billion last year, and give it to these people who give the central bank

in return the $50 billion. The dollars are thus taken off the market

and there is less upward pressure on the exchange rate in formal

and informal markets.

44

That is the great asymmetry, as I said before. There is an entirely different situation when you are trying to defend an overvalued currency and you only have so many dollars to sell. But

when you are buying dollars that people are willing to sell, as has

been happening in Japan and China, there is no limit to the official

purchases.

Senator GRAMM. Why does it work in China and fail in Japan?

Mr. PREEG. It has been working in Japan the last 5 years, too.

Senator GRAMM. Well, the economy has gone to hell. How is it

working? Why haven’t they protected all these manufacturing jobs

that we are exporting?

Mr. PREEG. No, they haven’t. The objective is simply to keep a

big trade surplus. We economists call it mercantilist.

Senator GRAMM. Is that your objective?

Mr. PREEG. No, that is the Japanese objective.

Senator GRAMM. But our objective is prosperity. Right?

Mr. PREEG. Well——

Senator GRAMM. It is mine. Is that yours?

Mr. PREEG. My objective is to have market-oriented exchange

rates.

For the Japanese, it may be a foolish policy, but they have kept

the largest trade surplus in the world over the past 5 years, to a

large extent because they have manipulated their currency below

market-determined levels.

You may say that they shouldn’t do that. I would say that they

shouldn’t do that. You shouldn’t make your economy dependent on

a large trade surplus as they have. They should do the structural

reforms that everybody advises them to do.

Senator GRAMM. I am running out of time and I am not going

to get into an argument with you. But let me tell you what I think

is happening.

Chairman SARBANES. Actually, the Japanese now are looking for

the trade to pull their economy up.

Senator GRAMM. I would say that Japan has had a huge net capital outflow because people are not investing there and people there

that are able are investing here, and that has been the determining

factor.

Mr. BERGSTEN. Except, Senator, that, as he said, part of their, ‘‘capital outflow,’’ has been a huge build-up in the official reserves of the Bank of Japan, which now exceed $400 billion. It has—— Senator GRAMM. I am glad they have it. The policy in China

under your thesis would be it would be just as good to not sell us

the goods, but take them out to sea and throw them overboard.

Mr. BERGSTEN. No. In their case——

Senator GRAMM. And print the money to pay for them, and just

go right on.

Mr. BERGSTEN. Just to elaborate on what Ernie said, in the Chinese case, because of exchange controls, they require the export

earnings of a Chinese exporter to be sold to the central bank for

local currency.

Senator GRAMM. I understand they do that. Their economy would

be better if they did not. Are you proposing that we do it?

Mr. PREEG. No.

Mr. BERGSTEN. I am proposing that we suggest they not do it.

45

Mr. PREEG. Right.

Senator GRAMM. I do not mind suggesting they not do it.

Mr. BERGSTEN. That is what we are saying.

Senator GRAMM. If you are in China, do not do it. It is stupid.

Mr. BERGSTEN. That is what we are saying.

[Laughter.]

But the implication would then be an appreciation of the

renminbi and some modest depreciation of the dollar, which would

help solve the problem that we are talking about here. But it would

be through their change in that case, and likewise, with Japan.

Chairman SARBANES. Jerry, did you want to add something?

Mr. JASINOWSKI. Since Senator Gramm liked the chart, and certainly saw a number of things in it beyond what I saw, I wanted

to just say, Senator, the chart always reflected the fact that there

are a number of variables that influence trade, as you know better

than anyone, from growth to interest rates to the performance of

the economy—and the chart reflects that. And therefore, your comments are correct.

We are not here to say that the exchange rate is the only determinant of trade, I should say. We are here to say, though, that

anybody who says that the exchange rate does not affect trade—

that is our position—is dead wrong.

Senator GRAMM. Oh, of course it does. But what affects exchange

rates? That is where we differ.

Mr. JASINOWSKI. Okay. But then I want to go on to repeat the

point that I said earlier. If you have a Treasury policy, and we certainly have heard it and we would be happy to document it for the

Committee, about a strong dollar, and the rhetoric—— Senator GRAMM. The Secretary never uttered strong dollar when

he was here. And he was belligerent and he would have said it had

he meant it.

Mr. JASINOWSKI. Well, I also can tell you if you go back to the

Reagan Administration, I was involved with the Plaza Accord. I

was involved with Secretary Baker and others and there were comments that came out of that Administration about a strong dollar

and how wonderful it was. If you have any Administration that is

shouting from the rooftop, even if they do not use the term, ‘‘strong

dollar’’ about how unmitigated higher and higher exchange rates

for the dollar are desirable you are going to affect trade flows. That

is the only point that I would make.

Senator GRAMM. Well, the only thing I would say is that, of all

the times that I met with President Reagan, and of all the conversations that I listened to, I never heard him mention strong dollar. I never heard him mention it.

Mr. BERGSTEN. Mr. Chairman, could I say one other thing to

Senator Gramm because you said, ‘‘Senator, you had not experienced any crises under floating exchange rates?’’

Senator GRAMM. I did not see one in 1985.

Mr. BERGSTEN. I want to give you two examples.

Senator GRAMM. Okay.

Mr. BERGSTEN. If the chart went back a couple of years earlier— and I have scars on my back because I was in the Carter treasury—there was a dollar crisis in the late 1970’s under floating

rates. The dollar collapsed——

46

Senator GRAMM. Because of inflation.

Mr. BERGSTEN. Because of inflation and it added, then, to the inflation and it pushed up interest rates, and we had to do a huge

intervention in the exchange markets in addition to doing things

on the domestic front.

Paul Volcker finally came to the Fed.

That was a real crisis under floating rates. But I want to make

a more subtle point. There was a crisis in 1985 with that strong

dollar, even aside from jobs and all that. The crisis was in trade

policy.

You may remember, friends of mine in the House—I cannot

quote any Senators—said, if the Smoot–Hawley tariff itself had

come to the floor at that time, it would have passed, because of the

huge decline in our competitive position.

You remember, there were Gephardt amendments—— Senator GRAMM. Listen, I remember the automobile industry

came to me and said, we are going to have to go out of business.

General Motors could go broke. We were producing crappy cars. We

were producing crappy trucks. The guys on Monday were thinking

about the weekend. The guys on Friday were thinking about the

weekend to come. They were having—what is the country song—

daydreams about night things in the middle of the afternoon.

[Laughter.]

We got the hell kicked out of us. They came here and said to

Reagan, protect us. And Reagan, in essence, said, compete or die.

Mr. BERGSTEN. No.

Senator GRAMM. And now we make the best trucks in the world

and our cars are as good as anybody’s in the world. Why? Because

we had to.

Mr. BERGSTEN. No, but Senator——

Senator GRAMM. You all created the crisis in the Carter Administration.

Mr. BERGSTEN. No. President Reagan put import controls on

cars. He had the Japanese do the so-called voluntary export restraints that limited car exports here for 10 years. He did it on

steel.

Senator GRAMM. He did it absolutely as little as he could get

away with. He jawboned.

Chairman SARBANES. How much did the Plaza—— Mr. BERGSTEN. It was because of the overvalued dollar.

Chairman SARBANES. By how much did the Plaza Accord, done

during the Reagan Administration by Secretary Baker, affect this

relationship of currencies?

Mr. BERGSTEN. The dollar came down 50 percent on average over

the next 2 years.

Chairman SARBANES. Fifty percent.

Mr. BERGSTEN. Fifty percent, having gone up 50 percent from

1980 to 1985. I am not criticizing President Reagan. I am——

Senator GRAMM. Cause, or did it just happen?

Mr. BERGSTEN. It was a response to the policy mix of the huge

budget deficits and very high interest rates that brought in huge

amounts of capital, drove the dollar sky high, and I actually had

sympathy with the Reagan Administration when they went for import controls on autos, steel, machine tools, all those things. But

47

it was because the exchange rate had driven the firms into an uncompetitive position. My point is simply, that is what we are confronting again today.

Chairman SARBANES. Mr. Preeg, you wanted to add something?

Mr. PREEG. Just a technical correction. I believe it was closer to

40 percent. But it had already come down 10 percent before the

Plaza meeting. The Plaza participants agreed that the dollar

should go another 12 percent, which is an awfully precise projection. And there was a very modest intervention. They were very

small numbers compared with today. And then the dollar overshot

and went down another 30 percent.

So my judgment is that the market forces were already in play

because the dollar had already come down 10 percent, and we may

be starting that way today. Very heavy market forces were in play,

although the official intervention did help.

Also, politically, calling for G–7 intervention is something I

would advocate today. Rather, we should say that it is in our mutual interest to gradually bring down the U.S. trade deficit. If we

once said that and let the market forces respond, I believe that the

dollar would begin to move down somewhat.

Senator GRAMM. Mr. Chairman, I am going to lunch. But I want

to thank you. It was an excellent hearing.

Chairman SARBANES. Yes. We are going to draw it to a close.

I want to read into the record an interview that Secretary O’Neill

had with the AFX News Limited Service. These are quotes. Of

course, the Secretary is not here and I guess he could argue that

he has been misquoted, but anyhow, this is what people read and

this is what they take their message or signals from. This was on

March 15, so it was not that long ago:

We have a so-called strong dollar policy and it is consistent and

constant and there is no change, he said, suggesting he is immune

to U.S. industry complaints. I do not feel pressured to change the

strong dollar policy, he stressed.

That is because, earlier, they asked him about whether he was

experiencing a lot of pressure. Actually, he said, O’Neill would not

comment on whether he expects the rebound in U.S. manufacturing

to help ease the pressure manufacturers have put on the Bush Administration to change the strong dollar policy. I hadn’t noticed, he

facetiously said of the repeated lobbying attempts by manufacturing associations and U.S. automakers to get the Administration

to abandon his policy. And then he went on with this quote about

a strong dollar and not feeling pressure.

The Treasury Secretary also said he does not regard the current

account deficit to be a risk to the economy because it is irrelevant.

I just think it is a meaningless concept in a globalized economy, he

said, despite some forecasts that the deficit could reach 6 percent

of GDP within the next 3 years. Economic policymakers should not

pay attention to the deficit, he said, explaining that the only reason

that I pay attention to it at all is because there are so many people

who mistakenly do so.

I think today was more or less consistent with these statements.

Let me ask this question. Do you think that the exchange rates,

that a Plaza-like effort, or a major effort—has the economy developed in such a way worldwide that your ability to have an impact

48

has been diminished or undercut? Or if you prepared to move

ahead with an active policy, could you have an impact?

Mr. JASINOWSKI. Mr. Chairman, let me just start the response by

saying that most of us have stressed a several part policy correction. The first part of the correction is for the Secretary of the

Treasury to acknowledge the problem, to stop talking about a

strong dollar, and to allow markets to make some judgment—apart

from the Treasury putting a floor under the dollar.

Words do make a difference. Rhetoric affects the markets. That

is policy step number one. And that will clearly work. There is wide

consensus on that. In fact, there is a quote in my testimony about

how much the market-makers believe the dollar would adjust by

that alone.

The second step, which Fred has emphasized, is that if we proceeded with an effort to get agreement among our major trading

partners and have them support a new set of policies that would

stress fundamental factors, and intervention, yes, it could have an

effect.

Mr. BERGSTEN. Just to echo what I said earlier, Mr. Chairman,

I actually think the prospects for intervention working now are at

least as good as in the past at the time of the Plaza Accord.

I noted that the Rubin–Summers Treasury tried it only three

times in 5 years. I think it worked just like a textbook would say,

on all three cases. The fact that they have not intervened much actually means that, if they were to do it now, it would clearly have

more effect. If intervention is done every day routinely——

Chairman SARBANES. It would require a joint effort, I take it, by

the G–7.

Mr. BERGSTEN. There are several criteria. It has to be sustained,

cooperative, well-coordinated. The rhetoric has to be consistent.

Chairman SARBANES. Do you think it is likely we would get a cooperative, well-coordinated effort on the part of the others?

Mr. BERGSTEN. I think the Europeans clearly would agree to intervene to strengthen the Euro. There would be difficulty with

them on how much. The Europeans would agree to move the Euro

back at least to 1:1 against the dollar. They might begin to get

hesitant beyond that, even though more than that is clearly necessary, but I think they would clearly agree to start it.

Japan, given the weakness of its economy that we have talked

about, and the fact that it is scrambling for any scrap of positive

news, would be reluctant right now. But they have the world’s biggest trade surplus. It is soaring again because of the recent decline

in the yen. We would simply have to insist that they cooperated,

which, incidentally, would then put more pressure on them to

make the kind of domestic structural reforms they need, anyway,

and I think would be beneficial in the broader sense as well.

Chairman SARBANES. Mr. Preeg.

Mr. PREEG. I think the interventions that Fred mentioned earlier

are really token interventions of a few billion, $5 or $10 billion.

Mr. BERGSTEN. Which is so amazing why they work.

Mr. PREEG. They give a political signal, and it is not the economics. And the comparison of figures, again back to China. China intervened with $50 billion last year, while China has one-fifth the

trade that we do. So for a comparable impact on our trade or our

49

exchange rate, we would need $250 billion of U.S. intervention per

year. And we are talking about $2 or $3 billion during the decade

of the 1990’s.

The orders of magnitude compared with what Japan and China

are doing, comparing their trade levels and ours, indicates token

U.S. intervention in economic terms. But even token intervention

can have political significance in that markets would sense that the

dollar is going to go down.

Chairman SARBANES. At any rate, I take it it is your view that

even just the rhetoric that we are using is helping to skew this

thing in the wrong direction.

Mr. BERGSTEN. That is clear, and the market people say that repeatedly. One question another time to ask the Secretary is, what

would be the downside of changing your rhetoric? Why does he not

want to change his rhetoric?

The reason is he fears he would drive the dollar down too far,

too fast. Now, I think that is not a realistic fear, but that is the

reason. That is the only argument he and his predecessors could

make for not changing the rhetoric when they were implored to do

so. They clearly think it would have an impact, or else they would

accept to do it.

Ernie made also a very important point. The three cases I mentioned, the amounts of intervention were very modest. And to me,

that makes it all the more clear how effective the tool is. You do

not have to spend a lot of money. It is the signaling effect. It is

indicating with your money where your mouth is. You want to see

a change. You want to correct the current account problem.

Mr. JASINOWSKI. Mr. Chairman.

Chairman SARBANES. We have to draw this to a close.

Mr. JASINOWSKI. One suggestion to make along these lines, going

back to a point that Steve made, is to seek a precise written statement from the Treasury as to what our policy or nonpolicy is,

which is what I have been arguing in part for that would help clarify where we are.

Here we have one of the most important policy issues before the

country and nobody is quite sure what the Treasury policy is. And

it does seem to me greater clarity is essential.

Chairman SARBANES. The Secretary says there is no problem.

Mr. JASINOWSKI. Well, I think there is.

Chairman SARBANES. I am going to have to draw to a close. Did

you want to add anything?

Mr. HANKE. I would like to briefly make a remark on this last

round of things.

Chairman SARBANES. If you could keep it brief.

Mr. HANKE. Yes. I think if we have an exchange rate policy that

is a floating exchange rate policy, the Secretary should refrain from

all open-mouth operations in all respects and just keep quiet—say

absolutely nothing on it.

The second point, Mr. Chairman, is, I think I detect in your view,

and the views of my colleagues here, that, well, somehow, the balance of payments is getting a little bit out of whack and extreme

values are showing up and we have to do something about it.

My own view on that is a little bit different. That is, a little bit

more like the Secretary’s. We have a floating exchange rate policy,

50

which acts automatically. And therefore, these balance of payments

adjustments just take care of themselves, Fred.

Mr. BERGSTEN. Yes, but they do not.

Chairman SARBANES. They won’t take care of themselves if the

currencies are being overvalued for one reason or another, either

because we are making these pronouncements about the strong dollar and/or because China and Japan are sort of working against the

way the market forces work in order to make the purchases. My

perception is that the market is not working pure and simple as

a market. It is being impinged upon in a lot of ways.

Mr. HANKE. Fred, let me make my third point because it fits into

this. We agree on this thing.

Chairman SARBANES. Yes.

Mr. HANKE. My view is we should become neutral and sanitized

on the whole exchange rate comment thing. Let the balance of payments accounts adjust naturally and over time, market forces will

take care of that, too.

Back to your question, Mr. Chairman, about whether some kind

of policy change now, intervention, three-part thing like Jerry says,

would work. My view is that the market is set up to be taken

down.

So right now, I am Chairman of the Friedberg Mercantile Group.

Our business is trading currencies. And we are short the dollar

against 10 very peripheral currencies. And the reason it is a great

trade is because we pick up the carry and make interest carrying

a short position against the so-called strong dollar.

The war on terrorism has changed things enormously. And the

perception that people have in the world about the United States

and how great the prospects might be in the future for the U.S.

economy—cranking up a big war machine against an enemy that

even our Secretary of Defense says is elusive—is that we are in a

war of indeterminate duration that is going to start eating up real

resources in the economy and start whacking away at productivity

in the economy.

The story we are getting about the economy has been very rosy

and that is why there have been deficits without tears, Fred.

But this thing, I think, is a little bit on a pivot now. So even

though I disagree with Fred and Jerry in terms of an activist policy

to correct the balance of payments imbalances, I would have to

agree that, if you were going to do it, I think now is a great time

to do it, in a technical sense.

Chairman SARBANES. Well, this has been a very helpful panel,

obviously.

Mr. Trumka and Mr. Stallman, I just want to say to you, when

we were talking about the cheap shovel, I was thinking to myself,

if we do away with these jobs, who is going to have a paycheck that

will enable them to buy the shovel, whether it is a worker or a

farmer? So, we have to keep that in mind as well.

Thank you all very much. It has been a very good panel. The

hearing is adjourned.

[Whereupon, at 12:58 p.m., the hearing was adjourned.]

[Prepared statements, response to written questions, and additional material supplied for the record follow:]

51

PREPARED STATEMENT OF SENATOR DEBBIE STABENOW

Thank you, Mr. Chairman. I welcome the opportunity to discuss exchange rate

policy and I appreciate that the Treasury Secretary and our other witnesses have

come to testify before us today.

The issue of exchange rates and, in particular, currency manipulation is one that

has a profound impact on my home State of Michigan, especially as it relates to the

automotive sector. I am concerned that the Administration does not seem to be aggressively addressing this issue.

It is not a coincidence that the on-going weakening of the yen has occurred at the

same time that Japanese automakers are experiencing record profits and American

automakers are facing significant losses. Indeed, recently, the weakened yen has effectively given Japanese automakers up to a 30 percent cost advantage over U.S.

manufacturers.

On the floor of the Senate, we are beginning a discussion on promoting trade.

Free and fair trade can be good for our country, but we must be outspoken about

anticompetitive tools in the global marketplace. Currency manipulation is one of

those anticompetitive tools.

Japan intervened in the currency market a staggering 11 times last September

alone. This resulted in an 11 percent decline in the value of the yen against the

dollar. I understand that the Japanese face difficult economic challenges that create

incentives for them to devalue their currency, but our Government cannot stand idly

by and watch our domestic manufacturers lose out.

It is not fair to our domestic auto manufacturers who deserve to compete on a

fair and level playing field. It is not fair to our auto workers who will lose jobs due

to this invisible tariff caused by currency manipulation. Indeed, Mr. Chairman, it

is not fair to a whole number of industries who suffer unfairly.

I look forward to hearing from the Treasury Secretary today about what the Bush

Administration is going to do about this problem and I also look forward to hearing

the perspectives of our other witnesses.

—————

PREPARED STATEMENT OF SENATOR CHUCK HAGEL

Thank you, Mr. Chairman, for holding this hearing today to explore concerns

about the value of the dollar against other currencies.

I know there are sectors of the economy that have been hit hard over the last

year by the recession and September 11. Farmers, textile workers, manufacturers,

and all exporters have especially been impacted.

There are several factors that have helped create this situation, including the

trade barriers of other countries, production subsidies that distort markets both

here and abroad, technological advances that have lowered the prices of production,

and lower demand in other countries that are going through recessions. Some will

also say the blame lies with the strong dollar. I am not persuaded that the strong

dollar is a primary factor attributing to the difficulties in our economy. There are

down sides to a strong dollar. However, an appreciating dollar can be compatible

with a rising value of exports, a falling value of imports, a growing trade surplus,

and increased employment.

Given the degree in which traders around the world value the dollar, can one say

that the dollar is overvalued? It is true that the dollar is at a stronger level relative

to other currencies, but this reflects the productivity, creativity, and value of American labor and resources.

I am concerned about the unintended consequences of intervention in the value

of the dollar. For instance, how will our interest rates, Government expenditures,

and capital inflow be impacted?

There are many benefits to having a strong dollar. Most importantly, a strong

dollar attracts investment which provides new capital resulting in new jobs and

increased productivity in the United States.

One reason for the current strength of the dollar is that foreign investors desire

to purchase American assets. In large part, this is due to the increase in national

productivity that has raised the rate of return on American capital.

I am looking forward to hearing Secretary O’Neill and our other panelists discuss

these issues today.

Because the strength of the economy is based on many different factors, attempting to manage one of those factors will have an impact on all of the others. We need

to be cautious when we talk about intervening in the market when there is no way

52

to be even relatively certain of how other pieces of the market will move as a result

of any action taken.

—————

PREPARED STATEMENT OF PAUL H. O’NEILL

SECRETARY, U.S. DEPARTMENT OF THE TREASURY

MAY 1, 2002

Chairman Sarbanes, Ranking Member Gramm, Members of the Banking Committee, I thank you for this opportunity to appear before you this morning to discuss

our International Economic and Exchange Rate Policy.

The April 2002 Report reviews global economic developments in the second half

of 2001. This interval and the most recent months encompass a turbulent period in

which the events of September 11 and their aftermath shook the United States and

world economies, and a period when the underlying strength in the U.S. economy

showed itself forcefully, leading the world back to recovery. I have said before that

creating economic growth and jobs in the U.S. economy is our overriding concern

and that getting our economic policies right at home is one of the best contributions

we can make to global economic growth.

Increasing economic growth and reducing economic instability are vital interests

of the United States. For this reason, I would like to touch on several of the Administration’s broad policy initiatives for facilitating growth and stability.

Reducing Barriers to International Trade

The global economic slowdown, from which we are recovering, brings into sharp

focus the importance of international trade. Total U.S. trade in goods and services

amounts to about one quarter of GDP. It now touches almost all parts of our economy and is a vital ingredient in its health, creating millions of jobs that pay aboveaverage wages.

President Bush achieved a key objective in his trade agenda with the WTO Ministerial decision in Doha to launch multilateral trade negotiations. Negotiations are

already underway for a Free Trade Area of the Americas (FTAA) and for Free Trade

Agreements (FTA’s) with Chile and Singapore. In January 2002, the United States

announced that it will explore an FTA with the countries of Central America. An

FTAA, when combined with existing free trade agreements, and bilateral FTA’s with

Chile and Singapore, will fully open market access overseas for nearly 50 percent

of U.S. exports.

The Treasury has a special interest in promoting further liberalization of trade

in financial services. The growth potential in many countries is being held back by

a lack of deep and liquid capital markets. The swift removal of barriers in key markets will help strengthen financial systems internationally. It will also mean more

American jobs in a sector with above-average wages.

In sum, both to help bolster growth and create new export and job opportunities

for America, it is vital for the Senate to pass, and the Congress to expeditiously

enact, Trade Promotion Authority.

Reform of the International Monetary Fund

The primary role of the International Monetary Fund is to foster conditions in the

international economic and financial system that support growth. First and foremost, the IMF must seek to prevent crises that undermine and reverse growth. The

IMF is making progress in enhancing crisis prevention, including through increased

transparency. For example, nearly all countries borrowing from the IMF now release

the details of their reform programs, but more steps are needed to release information and encourage policymakers to take quick action to avert potential crises. Indeed, no matter how good the IMF’s analysis and policy advice are, their impact will

be limited if they do not serve to inform the public and markets. We look forward

to further progress on transparency in coming months.

To help prevent financial crises and better resolve them when they occur, we are

working with others in the official sector to implement a market-oriented approach

to the sovereign debt restructuring process. This contractual approach would incorporate new clauses, which would describe as precisely as possible what would happen in the event of a sovereign debt restructuring process, into debt contracts. We

have proposed three clauses: Super majority decisionmaking by creditors; a process

by which a sovereign would initiate a restructuring or rescheduling—including a

cooling-off, or standstill, period; and a description of how creditors would engage

with borrowers. While we believe it is important to move forward with this contractual approach as expeditiously as possible, we also support continued work on the

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IMF’s statutory approach to sovereign debt restructuring. We believe that the two

approaches are complementary.

Reform of the Multilateral Development Banks

Rising productivity is the driving force behind increases in economic growth and

rising per capita income. The multilateral development banks (MDB’s) can deliver

better results by being rigorously selective in their lending, focusing their activities

on a discrete set of high-impact, productivity-enhancing activities that diversify the

sources of growth, foster competitive and open markets, promote accountable governance, raise human productivity, and expand access of the poor to physical infrastructure, new productive technologies and social services.

Education and private sector development in particular need to feature more

prominently as a critical element in lifting people out of poverty.

Private capital flows now dwarf official development assistance; the challenge is

to deploy development assistance in areas where we know it will unleash the entrepreneurial and creative capacities of people living in the poorest countries and to

encourage individual investment. Investment climate reforms and capacity-building

at the Government and enterprise level should be at the front and center of development policies. The scale of global poverty and unrealized human potential underscores the importance of the MDB’s (and all other donors) focusing much greater

attention on improving the effectiveness of their assistance. Delivering results

means insisting on rigorous quantifiable measures of each aid project and accountability from each aid institution’s impact in improving living standards. An incentive structure must exist where performance will be rewarded and nonperformance

will not. The United States has proposed such a structure for the IDA–13 replenishment in which the U.S. base-case annual contribution to IDA can be increased if

specified input and output triggers are met in priority growth and poverty-reduction

areas such as private sector development, primary education and health.

President Bush proposed that up to 50 percent of the World Bank and other MDB

funds for the poorest countries be provided as grants rather than as loans. Investments in crucial social sectors (e.g., health, education, water supply and sanitation)

do not directly or sufficiently generate the revenue needed to service new debt.

Grants are the best way to help poor countries make such productive investments

without saddling them with ever-larger debt burdens.

Millennium Challenge Account

Effective assistance means delivering against a set of priority objectives that is

measurable. It requires a solid partnership between donors and client countries on

priority reforms that drive growth and poverty reduction, while underscoring the

need to measure the impact and accountability of those reforms.

On March 14, President Bush outlined a major new vision for development based

on the shared interests of developed nations alike in peace, security, and prosperity.

The President’s compact for global development proposes a truly historic, shared

commitment to stop the cycle of poverty in the developing world and is defined by

a new partnership between developed and developing countries to achieve measurable development results.

The compact creates a separate development assistance account called the Millennium Challenge Account. It will be funded by substantial increases over and above

the approximately $10 billion in existing U.S. development assistance (better known

as Official Development Assistance or ODA).

To take advantage of Millennium Challenge Account funds, developing countries

must be committed to sound policies that promote growth and development, including the need to fight poverty. We will channel these funds only to developing countries that demonstrate a strong commitment to:

• Governing justly (e.g., rule of law, anticorruption measures, upholding human

rights).

• Investing in people (e.g., investment in education and healthcare).

• Economic freedom (e.g., more open markets, sustainable budget policies, strong

support for development, policies promoting enterprise).

Experience has shown that policies that are effective in promoting these goals

underpin successful growth, productivity increases, and poverty reduction. Further,

these goals are mutually reinforcing.

Over the coming months we will be asking for ideas from our development partners—donors, developing countries, academics, NGO’s—on developing a set of clear,

concrete, and objective criteria for measuring progress in these areas.

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Combatting Financing of Terrorism

Depriving terrorists of financial resources is critical to the war on terrorism. The

President has directed me to take all measures necessary to pursue this goal.

On September 23, 2001, President Bush issued an Executive Order listing 27 terrorist organizations and individuals and directing the blocking of their property.

This Executive Order has now been extended to a total of 202 individuals and entities. To date, all but a handful of countries have committed to join this effort. There

are now 161 countries and jurisdictions that have blocking orders on terrorist assets

in force and over $104 million in terrorist assets has been frozen globally since September 11—some $34 million here in the United States, and another $70 million

by other countries or jurisdictions. A portion of that amount linked to the Taliban

has recently been unblocked for use by the new Afghan Interim Authority.

On April 19, I announced with my counterparts from the Group of Seven an unprecedented joint listing of terrorist targets. In March, the United States and Saudi

Arabia designated jointly the Bosnia and Somalia offices of the Saudi-based charity

Al-Haramain. These joint designations mark a new level of coordination in the fight

against international terrorism.

Cooperation on International Tax Matters

International cooperation and coordination on tax matters are critically important

for reducing investment distortions and for promoting the proper functioning of

financial markets and systems. Tax rules should not serve as an artificial barrier

to cross-border investment.

The United States has bilateral income tax treaties with approximately 60 countries. The purpose of those treaties is to coordinate our respective income tax systems so as to avoid double taxation and to reduce or eliminate tax ‘‘toll charges’’

on cross-border investment. We are working to update and modernize existing tax

treaties and to expand our treaty network.

As I have said many times, we have an absolute obligation to enforce the tax laws

of the United States, because failing to do so undermines the confidence of honest

taxpayers in the fairness of our tax system. This can be done more efficiently, given

the increasingly global nature of economic activities, with the cooperation of other

countries. Currently, we have effective tax information exchange arrangements with

many of the world’s financial centers. We are working to extend and deepen this

network.

International Economic Conditions

I would like to turn now to global economic conditions.

As you know, the U.S. economy began slowing in the summer of 2000 and this

weakness extended through the first half of 2001. Then, the terrorist attacks of September 11 set off disruptions that quickly swept through our economy. The events

battered consumption as consumers stayed at home, and with our passenger transport system significantly impacted, many associated industries such as tourism and

hotels were badly hit. Activity fell at a 1.3 percent annual rate in the third quarter.

Prior to September 11, I had been optimistic about the prospects for U.S. recovery.

My optimism now appears to have been well justified. The fourth quarter showed

a healthy rebound at a 1.7 percent annual rate. Economic indicators for 2002 already paint a hopeful picture of an economy bouncing back. I believe that the data

will show in the final analysis that last year’s downturn in real GDP will be the

shortest, shallowest on record.

Why was the optimistic view well founded? Even before September 11, the economy appeared to be moving forward at a slow, but positive rate. The inventory overhang was being reduced. The Administration and Congress had responded with

timely relief action. The tax rebates and rate cuts from the Economic Growth and

Tax Relief Reconciliation Act of 2001 had put money in people’s pockets and increased incentives in the economy to work, save, and invest. The Federal Reserve

had aggressively lowered interest rates and energy prices were then coming down.

Most importantly, the fundamental strengths of our economic system remain well

intact—the American people are hard working; our markets are the most flexible

and dynamic in the world; and our macroeconomic policies are sound. Our economy

is the most advanced in the world because our economic structures are predicated

on the recognition that the private sector drives growth, and that the role of Government is to provide a framework that promotes competition and encourages individual decisionmaking. This has produced, among other things, financial markets

that are the deepest and most liquid in the world.

The confluence of these factors is reflected in the remarkable productivity growth

of our economy. Unlike in past recessions, productivity continued to rise last year

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ter. Meanwhile, trend productivity growth remains around 21⁄2 percent, sharply

higher than the 11⁄2 percent trend rate from 1973 through 1995, keeping inflation

pressures well at bay.

I am convinced that the United States has regained its economic footing. In fact,

the figures released just last week showed real GDP rising at an exceptionally

strong 5.8 percent annual rate. This performance is a testimony to the inherent resilience of our economy that over the past 6 months has continually surprised on

the upside.

So far, I have focused on the United States. The world economy, while beginning

to recover from the recent slowdown, is still in the early stage of recovery. Last year,

global growth was highly anemic, at roughly 21⁄2 percent. Prospects for 2002 are

somewhat better but strong growth may not be fully visible until the second half

of the year.

Before becoming the Secretary of the Treasury, I had the pleasure of gaining a

special appreciation for the strength of the Japanese economy and its people. Over

the last decade, however, Japan’s economic performance has been well below its potential. The resulting cost has been high not only for Japan, but also for the world

economy. Restoring strong Japanese growth is one of the keys to unlocking strong

global growth.

President Bush has expressed support for Prime Minister Koizumi’s commitment

to reform. The United States also shares his view that it is important for Japan to

increase price competition through deregulation and structural reform and to vigorously tackle its banking sector problems. We in the United States learned from the

S&L crisis the importance of comprehensively addressing banking sector problems

and returning distressed assets to private hands by selling loan claims and underlying collateral rapidly in the market.

We also learned that these reforms can take place only in a supportive macroeconomic environment. For the last 7 years, except for 1997 in response to a onetime tax increase, Japan’s economy has been mired in deflation. Last March, the

Bank of Japan committed to expand the money supply until the CPI was either stable or increased slightly on a year on year basis. Since then, a welcome and sharp

expansion in monetary aggregates has indeed taken place. So far, however, deflation

remains entrenched.

The Euro-zone recorded its best growth in a decade in 2000. Going into 2001,

there was substantial optimism that the foundations for sustained growth were well

in place. But despite these expectations, Euro-zone growth slowed markedly and

was negative in the fourth quarter. While Europe too was affected by the events of

September 11, Europe’s slowdown in 2001 underscored the fact that the interactions

and transmission mechanisms among our economies run deep and extend well beyond the realm of trade.

The Euro-zone is poised to begin growing anew. However, the consensus outlook

is that the recovery will lag and be slower than the U.S. upturn. That said, it is

in many respects difficult to speak about the Euro-area as a single entity. Indeed,

there are many very successful pockets of reform, such as Ireland, Spain, and the

Netherlands. But European policymakers recognize the need more generally to implement tax reforms within the context of efforts aimed at achieving medium-term

fiscal stability and to undertake structural reforms targeted especially at increasing

employment and raising potential growth.

On April 19–20, I hosted a meeting of the G–7 Finance Ministers and Central

Bank Governors. We recognized that a recovery is already underway in our economies, influenced by macroeconomic policies put in place last year. Nonetheless,

while confident about our collective prospects, we also agreed that downside risks

remain, especially those arising from oil markets. In this spirit, we agreed that each

of our countries has a responsibility to implement sound macroeconomic policies and

structural reforms to sustain recovery and support strengthened productivity growth

in our own economies and in the global economy.

The U.S. current account deficit was around 11⁄2 percent GDP in the mid-1990’s.

It rose to 41⁄2 percent in 2000 before falling, during last year’s global slowdown, to

just over 4 percent in 2001. We have all heard the view that this is a threat to

America’s economic fortunes and global financial stability. I believe that this view

ignores forces that are working in the market. The current account represents the

gap between domestic savings and investment and has grown in the face of a productivity-fed U.S. investment boom for the past decade. It is financed by international capital inflows that have risen over this period due to strong foreign interest in investing in the United States.

In the last 2 years, these capital inflows were sustained despite a slowing of U.S.

economic activity, a fall in U.S. interest rates, and a decline in equity prices. This

is a clear demonstration that foreigners regard investment in the United States as

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continuing to offer extremely attractive rates of return. These inflows are attracted

by the long-term soundness and relative strength of our economy’s fundamentals:

Our underlying productivity growth, our low inflation and sound macroeconomic

policies, our flexible labor markets, and our financial markets which are the deepest

and most liquid of any in the world. As I often say, these investments in our economy’s future are not a gift. They are made because of the prospect of a sound return.

Emerging market and developing economies also felt the effects of the slowdown

in the major economies in 2001, and their prospects were also set back by the uncertainties stemming from the events of September 11. However, I am hopeful that

their prospects will brighten over the course of this year. The truth is that many

emerging markets have not performed well in recent years and investment flows

going to these markets have declined sharply. On the positive side, though, many

emerging market economies are now better able to withstand external shocks, having reduced short-term external liabilities and built up reserves. Many countries,

such as Brazil, Indonesia, and South Korea, have moved to more flexible exchange

rates regimes, which allow their exchange rates to absorb the brunt of external

shocks. I think there is a much greater appreciation throughout these countries on

the need to run sound policies. And there has been very little contagion from recent

events in Argentina.

I would also like to submit for the record the Report to Congress on International

Economic and Exchange Rate Policies as mandated by Section 3004 of the Omnibus

Trade and Competitiveness Act of 1988.

In conclusion, I thank you again for this opportunity to testify before you. I would

be delighted to answer any questions you may have.

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PREPARED STATEMENT OF RICHARD L. TRUMKA

SECRETARY–TREASURER

AMERICAN FEDERATION OF LABOR AND

CONGRESS OF INDUSTRIAL ORGANIZATIONS

MAY 1, 2002

Chairman Sarbanes, Members of the Committee, I am glad to have the opportunity to talk with you today on behalf of the 13 million working men and women

of the AFL–CIO about the economic impacts of the overvalued dollar.

As we struggle to escape the grip of recession, the overvalued dollar represents

a serious problem. It is also causing long-term damage by destroying our manufacturing base. If we fail to redress the problem there is a danger that our fragile

recovery will be short-lived, pushing us into a double-dip recession.

Manufacturing is ground-zero of the recession, and its troubles are intimately connected to the dollar. Since March 2001, we have lost 1.4 million jobs, of which 1.3

million have been manufacturing jobs. Manufacturing has therefore accounted for

93 percent of all job losses despite being only 14 percent of total employment. Today,

manufacturing employment is at its lowest level since March 1962.

Business has slammed the brake on investment spending, but fortunately the

American consumer has kept the recession milder than anticipated. However, a

strong recovery that restores full employment needs a pick-up in investment spending. And that will not happen as long as currency markets give a 30 percent subsidy

to our international competition.

Over the last 5 years our goods trade deficit has exploded from $198 billion to

$427 billion, costing good jobs across a wide array of industries.

• Last year, in the paper industry there were mill and machine closures at 52 locations. All are considered permanent, indefinite or long-term.

• In the textile industry two mills per week closed in 2001, and closures have continued this year.

• The weakening of the yen has given Japanese car companies a huge price advantage. The result has been loss of market share by our Big Three automakers that

threatens some of the best jobs in America.

• Boeing, which operates at the cutting edge of technology, is losing market share

to Europe’s Airbus. And losses today mean future losses because airlines work on

a fleet principle. They will therefore order Airbus aircraft 5 years from now when

they expand their fleets.

• Moreover, job losses are not restricted to manufacturing. Tourism and hotels are

hurt by the strong dollar, and film production is moving offshore to cheaper destinations such as Canada, Australia, and New Zealand.

Many of these jobs will never come back. These are higher paying jobs that have

been the ladder to the American Dream for millions of Americans. But now we are

kicking away that ladder.

Manufacturing has faster productivity growth, and productivity growth is the engine of rising living standards. But now we are shrinking our manufacturing base,

and that is bad for future living standards.

The Administration has shown blind indifference to these problems. Arguments

for a ‘‘strong dollar’’ do not wash.

Inflation is not a problem, and there is no evidence that a lower dollar will lower

the stock market or raise interest rates. Those who say we need a strong dollar to

finance the trade deficit have the reasoning back-to-front. We need to finance the

trade deficit because we have an overvalued dollar.

It is time for a new policy that puts American jobs and American workers first.

It is unacceptable that Japan depreciate its currency. This will not solve Japan’s

problems, and will only export them to its neighbors and us.

China exemplifies all that is wrong with currency markets. It has a massive trade

surplus and vast inflows of foreign direct investment. In a free market, China’s currency should appreciate, but it does not because of government manipulation. This

is a problem that appears in different shades in many countries.

American workers are paying the price of currency manipulation. Trade cannot

be ‘‘fair’’ when we allow countries to manipulate exchange rates to win illegitimate

competitive advantage.

Those who argue we can do nothing about exchange rates abdicate the national

interest. The historical record and the 1985 Plaza Accord intervention show we can.

Academic research shows the same. Just as we manage interest rates, so too we can

manage exchange rates.

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Currency markets are speculative and respond to policy signals. The Treasury and

the Federal Reserve must take immediate action with their international partners.

The upcoming G–7 summit provides an appropriate moment to do so.

Beyond intervention today, we must avoid a repeat of today’s overvalued dollar,

just as today’s problems are a repeat of mistakes made in the 1980’s. The dollar

must be a permanent focus of policy, and the Treasury and the Federal Reserve

must be made explicitly accountable.

And every trade agreement must include strong specific language that rules out

sudden currency depreciations that more than nullify the benefits of any tariff reductions. We have been NAFTA-ed once, and that is more than enough.

The Senate Banking Committee has a vital oversight role to play in ensuring that

the Treasury and the Federal Reserve live up to these obligations.

I thank you for the opportunity to testify before you, and I will be happy to answer any questions you may have.

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PREPARED STATEMENT OF JERRY J. JASINOWSKI

PRESIDENT, NATIONAL ASSOCIATION OF MANUFACTURERS

MAY 1, 2002

Mr. Chairman, Members of the Committee, I am pleased to be here this morning

on behalf of America’s manufacturers to participate in this discussion of U.S. International Economic and Exchange Rate Policy. U.S. manufacturing is suffering very

strong negative effects from current U.S. exchange rate policy, and we appreciate

the opportunity to state our views on the value of the U.S. dollar and the impact

it is having on American industry.

The National Association of Manufacturers represents 14,000 American firms—

10,000 of which are small- and medium-sized companies. Manufacturing is vital to

America. It comprises one-fifth of all the goods and services produced by the U.S.

economy and directly supports 56 million Americans—the nearly 18 million American men and woman who make things in America and their families.

I am pleased to join the other members of this panel today, and am particularly

pleased to be testifying along with Richard Trumka, the Secretary-Treasurer of the

AFL–CIO. The National Association of Manufacturers and the AFL–CIO differ on

many things, but we are united in lock-step in our need to have the dollar begin

reflecting economic fundamentals.

The Dollar is Overvalued, and Everybody Knows It

Mr. Chairman, I would like to make three points today: First, the U.S. dollar is

very overvalued; second, this overvaluation is having a devastating effect on U.S.

manufacturing and on jobs; and third, the overvaluation is fixable—for it is the result of market imperfections that are preventing the dollar from adjusting to a more

normal level. How do we know the dollar is overvalued?

To begin with, NAM members are on the cutting edge of U.S. trade; and our members have been telling us that after years of being highly competitive in world markets, their customers are now saying the foreign currency price of made-in-the-USA

products have become 25–30 percent more expensive than foreign products. This did

not happen because U.S. producers became less productive or efficient. And it did

not happen because they raised their dollar prices. It happened only because the

price of the dollar rose in terms of foreign currencies.

About two-thirds of the companies represented at the recent NAM Board of Directors meeting said that the dollar is having serious effects on their firms, and this

is an important reason why the NAM Board passed a resolution calling on the Administration to act to correct the dollar’s overvaluation. A copy is attached to my

statement.

The dollar is now at its highest level in 16 years. After remaining fairly stable

for the better part of a decade, the dollar began a sharp climb starting in January

1997. It has now appreciated about 30 percent against major currencies, as measured by the Federal Reserve Board’s widely-used price-adjusted index of major currencies. The sharp rise in the dollar is clearly evident in Figure 1, appended to my

statement. This graph makes it plain that the dollar is not in any sense in ‘‘normal

territory.’’ In fact, the extent of the post-1997 climb of the dollar has been exceeded

only once before—the severe overvaluation of the dollar in 1982–1985 that put U.S.

trade into a tailspin. Unfortunately, a close look at Figure 1 shows an uncomfortable

parallel to the path followed by the dollar in the early 1980’s.

The dollar’s rise has exactly the same effect as the sudden imposition of a new

30 percent tariff against U.S.-made goods. Congress and the Administration would

howl with anger if Europe, Japan, Canada, and others were to slap such huge new

tariffs on United States products—yet there has so far been little concern for an

overvalued dollar that is doing the same thing. Worse, the dollar is also making

many foreign products artificially cheap in the U.S. market. The Bureau of Labor

Statistics’ capital goods import price index, for example, has fallen nearly 20 percent

in the last few years.

The NAM may have been the first in saying that the dollar was overvalued, but

we are now in growing company. We are joined by over 50 trade associations

representing manufacturing and agriculture, who have come together in the Coali

tion for a Sound Dollar—advocating a dollar that is consistent with economic fundamentals.

We are also joined by the International Monetary Fund, whose just-released

Global Economic Outlook says that one of the principal risks to the sustainability

and durability of the upturn in the United States and elsewhere is the overvaluation of the dollar. The European Central Bank concurs in saying the Euro is

‘‘very undervalued’’ and the dollar is ‘‘very overvalued.’’ The Chairman of the Bank

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of England and of the G–10 Group of Central Bankers also said the dollar is overvalued.

U.S. Government officials have also commented. New York Fed President

McDonough has said the dollar is overvalued. The Chairman of the President’s

Council of Economic Advisors, Glenn Hubbard, told the press that the strong dollar

is bad for U.S. manufacturers.

The President’s Trade Representative, Ambassador Zoellick, has said the strong

dollar is leading to a flood of imports and providing export-led growth to other countries. Former Federal Reserve Board Chairman Paul Volcker testified last year that

maintaining a stable U.S. economy might require ‘‘strengthening of the Euro and

the yen relative to the dollar.’’ And Keith Collins, Chief Economist, U.S. Department

of Agriculture, said ‘‘The high value of the dollar is expected to continue to impair

the U.S. competitive position in world markets. . . . The strong dollar not only

makes U.S. products more expensive, it insulates foreign competitors from market

price declines . . .’’

Additionally, we are joined by the financial community. For example, Larry

Kantor, Global Head of Currency Strategy for J.P. Morgan Chase told National Public Radio that, ‘‘We judge the dollar to be high relative to its fundamentals, something on the order of 20 percent at most . . .’’ And Morgan Stanley currency expert

Joachim Fels, stated flatly to Fortune Magazine that, ‘‘The dollar is overvalued, and

everybody knows it.’’

Then, finally, there is the Big Mac Index. Don’t laugh, The Economist Magazine’s

Big Mac Index, comparing Big Mac prices around the world, has consistently been

among the most accurate indicators of currency valuation and future currency

changes. The current issue of the Economist says, ‘‘Overall, the dollar now looks

more overvalued against the average of the other big currencies than at any time

in the life of the Big Mac Index.’’

Even Paul O’Neill has commented on dollar overvaluation, and has in the past

agreed that the dollar can become overvalued and depart from its normal level—

harming U.S. industry. Of course, he wasn’t Secretary of the Treasury when he said

so. Nevertheless, his words from 1985 are surely indicative of his belief. When the

dollar became badly overvalued in 1985, he said the strong dollar ‘‘. . . has turned

the world on its head. We have suffered a major loss in competitive position because

of exchange rates.’’ He went on to say, ‘‘Exchange rates moving back to normal

levels would be very good news for our industry. We would recoup most if not all

of our export volume.’’

Mr. O’Neill’s words were good advice then, and are just as relevant today.

The Overvalued Dollar is Having a Huge Effect

The overvaluation of the dollar is one of the most serious economic problems—

perhaps the single most serious economic problem—now facing manufacturing in

this country. It is decimating U.S. manufactured goods exports, artificially stimulating imports, and putting hundreds of thousands of American workers out of work.

It is leading to plant closures and to the offshore movement of production away from

the United States, with harmful long-term consequences for future U.S. economic

leadership.

This is a matter to be taken seriously not only because of the cost in terms of

jobs that have been lost, but also because manufactured goods comprise over 85 percent of all U.S. goods exports—and two-thirds of all exports of goods and services.

America’s ability to pay its international bills depends on America’s manufacturing

industry.

Effect on Trade and Jobs

The effect on U.S. manufacturing has been huge, as is detailed in the NAM analysis titled, ‘‘Overvalued U.S. Dollar Puts Hundreds of Thousands Out of Work,’’

which I ask be made part of the record of this hearing. That report shows the dollar’s overvaluation has had a major impact on exports, imports, the trade balance,

and jobs.

Exports of U.S. manufactured goods have plunged $140 billion in the last 18

months, at an annual rate—the largest such fall in U.S. history (Figure 2). This fall,

which is more than a 20 percent drop, is so huge that it accounts for close to twofifths of the entire fall in U.S. manufacturing output and jobs in the current manufacturing recession—over 500,000 lost factory jobs.

The recession from which we are beginning to emerge was, to a remarkable degree, a manufacturing recession. Comprising 14 percent of the American workforce,

the manufacturing sector accounted for 80 percent of the job loss in the entire U.S.

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cipally due to the overvalued dollar, are a key factor explaining why the manufacturing sector has fared so much more poorly than the rest of the economy in this

recession.

To put the $140 billion export drop in a different perspective, it is instructive to

realize that the NAM estimates a successful Free Trade Area of the Americas agreement (FTAA) could triple U.S. exports to South America from $60 billion to $200

billion within 10 years of implementation—which is scheduled to begin in 2006.

Thus over the next 14 years, the FTAA may result in a $140 billion increase in U.S.

exports. American exports have fallen by that much in just the last 18 months!

Additional hundreds of thousands of jobs have been lost on the import-competing

side as well, though this is more difficult to measure. From the beginning of 1997

through the first quarter of 2002, U.S. manufacturing output rose 12 percent, while

the volume of goods imports soared 45 percent—almost four times as fast. Much of

this is due to the fact that import prices fell 10 percent relative to domestic manufacturer’s prices. Import prices fell even more rapidly in some sectors—such as in

imported capital goods, where they fell 17 percent, reflecting the rising dollar.

This is evident in what has happened to some individual industries. For example,

prior to 1997 the U.S. paper industry routinely supplied about 80 percent of the

growth in the U.S. market for paper. Since 1997, however, 90 percent of the growth

in demand for paper in the United States has been met by imports. The U.S. paper

industry has closed 60 plants since 1998.

The U.S. textile industry, through large investments and productivity improvements, and generally stable prices for Asian imports, had been able to hold its own

until 1997. Since the dollar began to rise in that year, dollar import prices for textile

products fell 23 percent, imports from Asia soared, and 177,000 U.S. textile jobs

were lost.

The Treasury Department’s periodic examinations of exchange rates and trade

curiously have not mentioned any effect of exchange rates on trade. Instead the

Treasury attributes all the U.S. trade changes solely to faster economic growth in

the United States than abroad. While slower economic growth abroad certainly has

contributed to the U.S. export slowdown, it has been a subordinate cause, and the

principal cause has been the huge shift in relative prices brought about by the rise

of the dollar.

For example, U.S. exports to the European Union dropped 20 percent over the last

year and a half. European industrial production declined only about 4 percent during that time period. While this slowdown certainly had some influence on declining

U.S. exports, typically each 1 percent change in European industrial production

results in a little less than a 2 percent shift in U.S. exports. Thus, the decline in

European industrial production should have cut U.S. exports by about 7 percent—

leaving a 13 percent residual that can only be explained by the dollar’s overvaluation.

A much stronger relationship exists between currency misalignment and trade

shifts, as is depicted in Figure 3, attached to my statement, which clearly shows

how dollar overvaluation affects trade flows. The graph shows two economic series:

(1) the ratio of U.S. imports to U.S. exports—i.e., how much larger imports are than

exports; and (2) the Federal Reserve Board index of the value of the dollar. Even

a cursory examination of the graph shows the close relationship. The time lag between a change in exchange rates and a change in trade patterns is visible as well,

particularly in the exchange rate peak in 1985 that resulted in imports cresting at

being 80 percent larger than exports in 1987.

Largely as a result of the import and export effects of the overvalued dollar, the

manufactured goods trade deficit has grown so much that it has reached a record

21 percent of U.S. manufacturing GDP (gross value added in manufacturing)—more

than double what it was in 1997.

Treasury Secretary O’Neill was quoted recently in the press as saying that he

thought the trade deficit was of no consequence because capital inflows are strong.

We differ sharply with this statement, as does the International Monetary Fund and

the vast preponderance of economic evidence. The current account deficit has three

very significant consequences. The first is that the continuing deficit generates an

ever-increasing load of foreign debt that one day will have to be paid, and at large

cost. Federal Reserve Chairman Greenspan and many others, including a worried

International Monetary Fund, have pointed out that there could be serious consequences on the United States and global economies.

The second aspect is its damage to U.S. industry—particularly to manufacturing.

Perhaps one of the most worrisome aspects of the dollar-induced shift in the U.S.

trade balance is what has happened to U.S. trade in technology-intensive products.

This is America’s most competitive sector, and is based on the best of American reVerDate 11-MAY-2000 11:02 Mar 31, 2003 Jkt 000000 PO 00000 Frm 00107 Fmt 6633 Sfmt 6621 85735.TXT SBANK4 PsN: SBANK4
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search and development, productivity, and innovation. It is always a sector we have

taken for granted in trade.

Indeed, as recently as 1997 it generated a $40 billion trade surplus for the United

States. That surplus has been declining at an accelerating rate, and has now, for

the first time in our history, moved into a substantial deficit, running at an annual

rate of $20 billion. If the United States cannot compete in knowledge-intensive,

technology-intensive trade, where can it compete?

The third aspect is that dollar overvaluation and the consequent huge trade and

current account deficits erode support for free trade policies and contribute to rising

protectionist sentiments. When industries and displaced workers see their sales and

jobs disappearing because of falling exports and rising imports despite their best

efforts to be competitive, their natural reaction is to urge that trade policies be

changed. America’s historic support for free trade policies was threatened in the

1980’s overvaluation, and the current overvaluation and trade deficits are the principal reasons why public support for further trade liberalization is weak.

Effect on Small- and Medium-Sized Firms

While manufactured goods exports are widely assumed to be associated with large

firms, in truth more than 95 percent of all exporters are small- or medium-sized

firms. Exporting has been a major source of growth for small-manufacturers. For

example, according to the NAM’s surveys of small- and medium-sized member companies, the proportion of these companies that generated at least 25 percent of their

total business from exports grew from 5 percent in 1993 to almost 10 percent in

1998—nearly doubling. With 95 percent of the world’s consumers outside our country’s borders, small manufacturers have found world markets to be a major source

of growth and jobs.

Unfortunately, the sharp rise in the dollar over the last few years has led to a

major reversal. Based on the most recent NAM survey of its small and medium

membership, all the export gains since 1993 have been erased. Last year the proportion of smaller companies exporting at least 25 percent of their production fell to

only 4.2 percent. And for this year, only 3.8 percent anticipate exports to be at least

25 percent of their business.

Effect on Earnings

Finally, American firms’ profits have been strongly affected, including from the

fact that profits from overseas operations have been reduced sharply as earnings

from abroad are converted back into dollars. After recovering from a drop due to

the Asian financial crisis in 1997, manufacturing after-tax earnings peaked at $76

billion in the first quarter of 2000. By the first quarter of 2001, earnings had collapsed to $¥1.7 billion, a level not seen since the 1st quarter of 1992. Reduced

exports, heightened import competition, and the conversion into dollars from operations abroad have had a major impact. Foreign operations, especially in Europe,

represent a sizable proportion of global sales and profits for many large American

firms. As foreign earnings are converted into dollars and have had to be marked

down 30 percent or more because of the shift in currency values, the impact on total

corporate profits has been huge. Corporate releases in recent weeks have been

replete with reports of reduced earnings because of the overvalued dollar.

How Individual Companies Have Been Affected

To understand the real extent of the injury being caused to U.S. manufacturers

it is necessary to look at the effect dollar overvaluation is actually having on individual companies and their employees. Many NAM member companies have written

to the Treasury Department urging action to bring relief from the overvalued dollar.

Typically they relate that after having been competitive in world markets for

years, they are now losing their foreign business. Many tell of export decreases of

25 percent, and some have lost almost all their export business.

Some letters are from large companies that are world industry leaders. Others are

from small companies, many of them family-owned. They tell a story of being unable

to compete not because of a decline in product quality or productivity and not because of any price increases in dollar terms—but only because of the rise in the dollar’s value relative to other currencies. All of them are losing sales overseas or find

they can no longer compete against imports into the U.S. market. Many of them are

having to reduce their workforces. Others say they have no choice but to close their

U.S. plant and start production overseas. This is the cost of having an overvalued

currency.

These are not poorly-managed companies. They are not ‘‘whiners.’’ They are

among the best U.S. manufacturers, and many had built large export markets, won

Government export awards, installed the latest machinery and technology, and

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proudly sold their American-made products around the world. I have appended

about a dozen of these stories to my testimony.

Correcting the Currency Misalignment

Currency values should—and over the longer term do—reflect economic fundamentals. However, the normal market adjustment mechanisms appear to have been

thwarted in the case of the dollar’s recent rise. While about one-fourth of the dollar

appreciation since 1997 took place during 1997–1998 as capital fled to the safety

of the U.S. economy in the wake of the Asian financial crisis, three-quarters of the

rise in the dollar took place after 1998 in spite of, not because of, the economic fundamentals of the United States. In the face of slowing economic growth, declining

interest rates, and rising manufacturing unemployment, the dollar has remained

high.

Interest rate differentials are one of the key factors normally expected to affect

exchange rates. In June 1999, the U.S. Federal Funds rate stood at 5 percent,

roughly 2 percentage points above the European Central Bank’s key lending rate.

This was certainly a factor contributing to dollar strength. However, repeated interest rate cuts have now put the Federal Funds rate fully 11⁄2 percentage points below

European rates. Why hasn’t the dollar fallen relative to the Euro?

Economic growth differentials are another important factor. In the late 1990’s,

U.S. economic growth averaged more than 4 percent, outpacing our major trading

partners. However, U.S. economic growth slowed substantially beginning in the second half of 2000. By comparison, while economic growth in Europe and the Pacific

Rim has also slowed, most analysts now expect economic growth to favor our trading partners overseas after the 1st quarter of 2002. Clearly, the impressive growth

disparity between the United States and economies abroad in the late 1990’s has

shifted. Why hasn’t this been reflected in exchange rates?

Trade and current account balances are important as well. The U.S. trade deficit

now stands at more than $400 billion, or 4.4 percent of real GDP—up significantly

from just 1.4 percent in 1997. During the late 1990’s the outflow of U.S. dollars,

which is the flip side of a large trade deficit, was largely used to acquire U.S. assets—primarily U.S. plant and equipment in the form of direct investment. However, business investment demand in the United States has been negative for 5

quarters running. Combined with continuing large trade deficits, this translates into

an oversupply of dollars in the world financial system which should put downward

pressure on the value of the dollar. Why hasn’t that happened?

Unless economic theory is to be rewritten, clearly there are market imperfections

at work. By far the most important factor interfering with the market is the Treasury’s maintenance of a ‘‘strong dollar no matter what’’ policy, a carryover from the

Clinton Administration. This rhetoric is artificially propping up the dollar—and

causing severe economic dislocation especially for manufacturing.

The Treasury’s statements are inherently contradictory. On the one hand it says

that a strong dollar policy is necessary in order to continue to attract the capital

needed to finance the trade deficit (which is caused by the strong dollar). On the

other hand, its says that the dollar is strong because the United States is the best

place to invest, and rapid foreign capital inflows are driving up the dollar through

the free operation of the marketplace.

But if the latter were true—that the dollar remains strong because of market

forces—then it wouldn’t matter if the Treasury said the United States had a strong

dollar policy, a weak dollar policy, or even no dollar policy at all. Markets would

only care about the economic fundamentals of U.S. growth, productivity, and returns

to capital.

But what would really happen if the Treasury announced it no longer had a

strong dollar policy and was adopting a policy of benign neglect—letting the markets set the dollar wherever they thought it should be?

Larry Kantor, Global Head of Currency Strategy for J.P. Morgan Chase, answered

that on National Public Radio recently, when he said that if markets, ‘‘hear even

a slight change in the rhetoric, it does risk a pretty sharp fall in the dollar.’’ Why?

Because the dollar is very high compared to its economic fundamentals. It should

have been adjusting for some time now, but has not.

If markets no longer believed the Treasury would keep the dollar at its present

levels, market expectations would change overnight, realism would take hold, and

the dollar’s correction would begin immediately. As Morgan Stanley told Fortune

Magazine, ‘‘the dollar is overvalued, and everybody knows it.’’ Thus, we believe the

Treasury’s policy is in effect distorting the market and preventing market forces

from working. It is time to end this policy and to allow the market to correct the

valuation of the dollar.

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Accordingly, we believe the Administration should stop and take the following

steps:

1. Announce clearly that exchange rates are not reflecting economic fundamentals,

that the Treasury is adopting a sound dollar policy of benign neglect, and that the

United States will not intervene in exchange markets to maintain the value of the

dollar.

2. Seek cooperation with other major economies in obtaining common agreement

and public statements that their currencies need to appreciate against the dollar.

3. Make clear that the United States will resist, and take offsetting action as necessary, foreign country interventions designed to retard movement of currencies toward equilibrium.

4. Seek agreement that the G–8 countries should state their intention to work together, as they stated in 1985 when the dollar was badly overvalued, and to make

a clear and unambiguous announcement at their next meeting, in June, that:

• external imbalances have become too great and are contributing to protectionist

pressures which, if not resisted, could lead to serious damage to the world economy; and

• exchange rates should play a role in adjusting external imbalances and in order

to do this exchange rates should better reflect fundamental economic conditions

than has been the case.

Should currencies begin adjusting too rapidly, coordinated intervention in the

market can assure an orderly movement. When countries coordinate intervention

and clearly state their intentions, markets react. The experience of the 1985 Plaza

Accord is instructive. This Accord restored currency stability and broke the back of

the rising protectionism. The preponderance of economic research, meticulously reviewed in the September 2001 issue of the American Economic Association’s highly

respected Review of Economic Literature, makes it plain that highly visible coordinated action, including intervention, does work.

The Treasury’s Report on Exchange Rate Policy

In concluding my remarks, Mr. Chairman, I would like to offer some views on the

Treasury’s Annual Report on International Economic and Exchange Rate Policy.

Section 3005 of the Omnibus Trade and Competitiveness Act of 1988 requires the

Secretary of the Treasury to provide Congress with periodic reports on exchange

rates and economic policies.

Of particular interest to the NAM is the requirement (Section 3005(b)(4)) that the

Treasury’s report include an assessment of the impact of the exchange rate of the

dollar on production and employment in the United States and on the international

competitive performance of U.S. industries. We have been disappointed consistently

that the Treasury’s reports have not, and do not, contain such an assessment. The

reports have contained no discussion at all of the effect the appreciation of the dollar has had on trade in U.S. manufactured goods or in farm commodities.

More transparency and visibility is desirable here, both for policymakers and for

the public. The NAM, therefore, recommends that the Commerce Department and

the Agriculture Department be required by the Congress to begin preparing semiannual reports directly analyzing the effect of exchange rates on U.S. trade, production, and employment. These reports would be separate from the Treasury’s

macroeconomic reports, and would be produced independently by the Commerce and

Agriculture Departments. Moreover, as part of their reports, they should be required

to survey what private sector economists are saying about the effect of exchange

rates on trade and production.

Mr. Chairman, I appreciate the opportunity of appearing before this Committee;

and we look forward to working with you to persuade the Administration to drop

its pegging of the dollar through its ‘‘strong dollar’’ policy and to adopt a ‘‘sound dollar’’ policy in which markets set currency rates based on economic fundamentals.

The longer this change is delayed, the worse matters will get.

Thank you, Mr. Chairman.

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PREPARED STATEMENT OF BOB STALLMAN

PRESIDENT, AMERICAN FARM BUREAU FEDERATION

MAY 1, 2002

Mr. Chairman, Members of the Committee, I am Bob Stallman, President of the

American Farm Bureau Federation and a rice and cattle producer from Columbus,

Texas. AFBF represents more than 5.1 million member families in all 50 States and

Puerto Rico. Our members produce nearly every type of farm commodity grown in

America and depend on access to foreign markets for our economic viability.

We appreciate the opportunity to testify on the importance of the exchange rate

to U.S. agriculture. Over-valuation of the dollar is one of the most pressing international economic problems facing America’s agriculture and manufacturing sectors.

U.S. farmers and ranchers have been losing export sales for the past 3 years because the dollar is pricing our products out of the market—both at home and

abroad. In addition, the higher exchange rate of the U.S. dollar has resulted in rising agricultural imports due to increased purchasing power. The purchasing power

of the dollar grew 21 percent from 1995 to 2000 in comparison to the exchange rate

value of those nations that supply food to our country.

Agriculture is one of the most trade dependent sectors of our economy. Our sector

has maintained a trade surplus for over two decades, but that surplus is shrinking.

One of the primary factors affecting our declining trade balance is the strong value

of the dollar.

In addition, the value of the dollar has significantly impacted agricultural employment. According to a recent USDA study, agricultural employment lost 87,000 jobs

between fiscal years 1997 and 2000, a period in which the real agricultural exchange rate was rising rapidly and U.S. agricultural exports were stagnant.

The sharp rise of the dollar since 1995 has reduced our ability to compete in foreign markets. In 1996, U.S. agricultural exports reached a record $60 billion, but

declined sharply to a low of $49 billion in 1999. This decline came as the U.S. dollar

strengthened. USDA estimates that 14,300 jobs are lost for every $1 billion decline

in agricultural exports. The short-term outlook for agricultural exports is not expected to improve significantly. Slow United States and global economic growth in

2001–2002 and a strong U.S. dollar will result in weak prices for the agricultural

sector, according to USDA. The continued strength of the U.S. dollar will be a primary constraint on agricultural export growth.

We are deeply concerned about countries that engage in currency devaluations in

order to gain an export advantage for their producers. The real trade-weighted exchange rates for agricultural exports from all of the major competitor countries, including Canada, Australia, Argentina, China, and Malaysia, have exhibited a longterm trend of depreciation against the dollar, contrary to market fundamentals. This

trend has persisted over several decades, leaving it hard to conclude that this is not

a deliberate monetary policy of these and other governments.

U.S. agriculture relies on exports for one-quarter of its income. In addition, about

25 percent of agricultural production in the United States is destined for a foreign

market. A number of our commodities are highly dependent on trade for a sizable

portion of their production. Some crops, like walnuts and wheat, about one out of

two acres is exported. Exports now account for nearly one-quarter of our apple, beef

and corn production and more than one-third of grapefruit and soybean production.

As productivity growth of U.S. farms and ranches continues to exceed the growth

in U.S. population, our dependence on trade will increase. Only 4 percent of the

world’s consumers live in the United States. It is estimated that 99 percent of the

growth in the global demand for food over the next 25 years will be in foreign

markets.

Our country is also a major importer of food and fiber. The aggregate import

share of U.S. food consumption has been rising steadily, along with the strength of

the U.S. dollar. For nearly 20 years, imports accounted for 7.5 percent of total U.S.

food consumption. The share of imports climbed to 8.6 percent in 1996 and 9.3 percent in 1999. These jumps in import share coincided with the strong value of the

dollar and U.S. economic growth.

With a strong dollar, we have the double challenge of our products being less competitive in other markets while products from other countries are more competitive

in U.S. markets.

In addition, there is a strong relationship between the value of the dollar and the

domestic price of our commodities. As the value of the dollar rises, foreign buyers

must spend more of their currency to purchase our exports. This causes foreign buyers to decrease their consumption of U.S. commodities or buy from our competitors

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instead. The resulting drop in consumption drives U.S. commodity prices down even

further.

Net farm income is not directly tied to the rise and fall of the U.S. exchange rate;

rather it is the exchange rate that affects the price competitiveness of our exports.

The resulting change in the volume of trade—increased exports when exchange

rates are low and decreased exports when exchange rates are high—directly impacts

farm income. As you know, U.S. agricultural commodity prices are the lowest they

have been in over two decades. Further price depressions stemming from the strong

value of the dollar are exacerbating an already dire situation.

The exchange rate is the single most important determinant of the competitiveness of our exports. Other important determinants of U.S. agricultural export values

include income growth rates in developing countries, the growth and productivity

of the foreign agricultural sectors against which we compete, export subsidies use

by our competitors and weather conditions.

USDA’s Economic Research Service estimates that movements in exchange rates

have historically accounted for 25 percent of the change in U.S. agricultural exports.

The elasticity of export demand for all agricultural products with respect to the

value of the dollar is 1.38. This means that a 1 percent increase in the value of the

dollar is associated with a 1.38 percent reduction in the value of U.S. agricultural

exports.

The elasticity of export demand for individual agricultural commodities is 1.77,

thus resulting in a 1.77 percent decline in the export value of specific commodities

when the U.S. dollar appreciates 1 percent. The export dependency of U.S. agriculture, combined with the highly elastic response of U.S. agricultural export values

to changes in the exchange rate underscore the need to maintain a stable exchange

rate policy without overstating the value of the dollar.

The increasing strength of the dollar, and steady depreciation of the currencies

of our major export competitors, has had a profound impact on our ability to export.

In fact, the rising appreciation of the dollar is one of the primary reasons why the

agricultural economy did not experience the economic prosperity that most other

sectors of the U.S. economy enjoyed between 1995 and 1999. The dollar’s increased

purchasing power, and rising U.S. disposable income encouraged Americans to buy

more imported products, while high prices of U.S. food and agricultural exports, in

foreign currency terms, discouraged demand for our goods. As a result of the rapidly

appreciating dollar, our competitors gained an advantage in third-country markets

over our exports without even adjusting their sales price.

It is abundantly clear that the strong dollar is severely handicapping our ability

to compete. Agricultural analysts note that macroeconomic fundamentals point to

continued weak export performance in the near future.

For some commodities, the rising value of the dollar has directly contributed to

the export competitiveness of our foreign rivals. Sharply depreciating currencies

such as the Canadian and Australian dollars, the European Euro, the Brazilian real

and the Korean won have enabled our competitors to out-compete us in a number

of third-country markets.

The strong dollar is enabling our competitors to expand their production and gain

market share at our expense. Recent USDA estimates note that U.S. corn export

sales have fallen 3 percent and wheat shipments 10.5 percent as a result of the appreciation of the dollar.

Meats

Since 1995, the dollar has appreciated 42 percent against the currencies of beef

producing countries. The rise in red meat imports from 6.4 percent in 1996 to 8.9

percent in 2000 is explained in part by the strength of the dollar. In addition, the

recent announcement by McDonald’s to buy imported beef was largely driven by the

price advantage it faced vis-a`-vis its competitors, other U.S. fast food chains that

have historically used imported beef trimmings. Imported trimmings are cheaper

than U.S. trimmings due to the strong U.S. dollar.

Horticultural Products

During the period 1995–2000, U.S. imports of fruits and nuts jumped 33 percent,

largely due to the dollar’s 18 percent gain with respect to the currencies of foreign

suppliers of these commodities to the United States. The dollar rose only 3 percent

against currencies of foreign vegetable importers to the United States. The appreciation of the Mexican peso in price adjusted terms helped to mitigate the strength of

the dollar against the currency of Mexico, the country that supplies the majority of

U.S. vegetable imports.

A Farm Bureau-commissioned study documented the impact of the exchange rate

on corn, wheat, soybeans, and melons.

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1Kapombe, C.M. and D. Coyler. ‘‘A Structural Time Series Analysis of U.S. Broiler Exports.’’

American Journal of Agricultural Economics, 21 (December 1999): 295–307. 2 Espinosa-Arellano, J.J., S. Fuller and J. Malaga. ‘‘Analysis of Forces Affecting Competitiveness of Mexico in Supplying U.S. Winter Melon Market.’’ International Food and Agribusiness

Management Review 1, No. 4 (1998): 495–507.

Corn

United States corn prices in Japan have been affected by adverse exchange rate

movements. The U.S. landed corn price decreased from $3.64/bu in 1995 to $3.31/

bu in 1998. The United States dollar appreciated 39 percent relative to the Japanese

yen, from ¥94.23/$ to ¥130.81/$. The yen price of U.S. corn increased from ¥343/bu

to ¥4331bu, an increase of 26 percent even though the U.S. dollar price had declined

9.1 percent. United States exports of corn to Japan fell 11.3 percent, from 16 mmt

to 14.2 mmt.

Wheat

Exchange rates had similar impacts on the Mexican wheat market. Between 1995

and 1999, the price of United States wheat delivered to Mexico declined from $3.95/

bu to $3.20/bu. The United States dollar appreciated 48 percent relative to the Mexican peso (NP) during this period from NP6.45/$ to NP9.58/$. This appreciation led

to a 20 percent increase in the peso price of U.S. wheat from NP25.46/bu to

NP30.64/bu, though the U.S. dollar price of wheat declined 19 percent. However,

even with higher prices in peso terms, the volume of United States wheat exports

to Mexico rose significantly during this time, from 791,000 mt to 1.8 mmt (130 percent). This contrasts with the Japanese results for two main reasons. First, Japan

is a mature market with an established demand, extremely sensitive to price and

geographically distant from major grain suppliers. Second, the growth of the Mexican market, coupled with its proximity to United States suppliers, has more than

compensated for the increase in peso wheat prices.

Soybeans

Between 1996 and 1998 the U.S. average annual farm price for soybeans declined

from $7.27/bushel (bu) to $5.93/bu, an 18.5 percent drop. Over the same period, the

United States dollar appreciated 20 percent relative to the Japanese yen, going from

¥108.81/$ to ¥130.82/$. When the yen price of United States soybeans landed in

Japan is compared over this period of time it is important to note that the price

of U.S. soybeans in dollars fell from $9.09/bu to $8.16/bu, but in yen the landed

price actually increased from ¥989/bu to ¥1,068/bu, an increase of 8 percent. The cost

of United States soybeans to Japanese buyers increased primarily due to the appreciation of the United States dollar even though United States prices had fallen significantly. The result was higher priced United States soybeans in Japan when compared to soybeans from Brazil, which fell from ¥986/bu to ¥958/bu, allowing Brazilian soybeans to be sold in Japan for about $1.00/bu less than United States soybeans. United States soybean exports to Japan declined during this period from 3.9

million metric tons (mmt) to 3.7 mmt (200,000 mt, or 5 percent), while exports from

Brazil increased from 379,000 mt to 524,000 mt (145,000 mt, or 38 percent).

Poultry

Recent empirical evidence supports the strong relationship between exchange

rates and agricultural trade. Kapombe and Colyer 1 found that a 1 percent increase

in the Japanese yen–United States dollar exchange rate led to a .96 reduction in

Japanese demand for United States broilers. In addition, they also found that a

1 percent increase in the Hong Kong–United States exchange rate resulted in a .56

percent decline in Hong Kong demand for United States broilers, while a similar

change in the Mexican peso–-United States dollar exchange rate led to a .58 drop

in Mexican demand.

Melons

Other empirical studies have also documented the importance of the Mexican

peso–United States dollar exchange rate in influencing United States imports of

melons (Espinosa-Arellano, Fuller, and Malaga).2 Their results suggest that the

1994–1995 Mexican peso devaluation increased United States imports of watermelon, honeydew, and cantaloupe by 36, 18 and 4 percent, respectively in the short

run. In fact, a survey of historical empirical literature since the early 1970’s has revealed that in 32 separate studies of the role of exchange rates on U.S. agricultural

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3Kristinek, Jennifer. ‘‘The Impact of Exchange Rates of Beef and Cattle Trade in North America.’’ Texas A&M University, 2001.

trade, the exchange rate was found to be an important explanatory variable in 24

of the studies (Kristinek).3

Conclusion

American farmers are the most productive in the world. However, the comparative

advantages that our producers generally enjoy, abundant, fertile natural resources,

access to high-quality inputs and technology, for example, are mitigated by the rising appreciation of the dollar. The strong value of the dollar has, in many instances,

shut our exports out of foreign markets and increased import competition in the

U.S. market.

In short, U.S. agriculture is part of a worldwide food production system. We do

not advocate isolation as a means to shield our sector from the economic forces that

shape world trade. However, we cannot effectively plan our farming and ranching

enterprises in a world where exchange rates suddenly depreciate by 50 percent, as

happened with the Mexican peso in late 1994, or shift more slowly, such as the 50

percent decline in the Brazilian real from 1995 to 2000.

Exchange rate issues are certain to increase in importance as U.S. agriculture

produces more for export markets and U.S. food and fiber markets become more

open to imports. If these issues are not resolved by macroeconomic policies, there

will be continued pressure to find solutions in traditional farm policies.

Effective long-range financial planning at the farm and ranch level and the overall economic health of U.S. agriculture depends on more stable exchange rates that

do not overvalue the U.S. dollar against our competitors’ currencies.

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1William R. Cline, American Trade Adjustment: The Global Impact, Policy Analyses in International Economics 26, Washington: Institute for International Economics, 1989. 2See Catherine L. Mann, Is the U.S. Trade Deficit Sustainable?, Washington: Institute for

International Economics, September 1999, especially pp. 156–57, and Caroline Freund ‘‘Current

Account Adjustment in Industrial Countries’’ International Finance Discussion Papers 692: Federal Reserve Board of Governors, December 2001. 3 Catherine L. Mann, ‘‘How Long the Strong Dollar?’’ Institute for International Economics,

March 2002. 4Simon Wren-Lewis, Exchange Rates for the Dollar, Yen and Euro, International Economics

Policy Brief 98–3, Institute for International Economics, Washington, July 1998. The International Monetary Fund has publicly expressed a similar view, e.g., in its World Economic Outlook of May 2001.

PREPARED STATEMENT OF C. FRED BERGSTEN

DIRECTOR, INSTITUTE OF INTERNATIONAL ECONOMICS

MAY 1, 2002

The Rise of the Dollar

Since hitting its all-time lows in early 1995, the dollar has risen by a tradeweighted average of 40–50 percent in real terms against larger and smaller baskets

of currencies of its trading partners. It has climbed by well over 50 percent against

the yen and the European currencies. It could rise considerably further over the

next year if the United States continues to recover more quickly and more robustly

than Europe and Japan (or anybody else) from last year’s worldwide slowdown, as

is quite likely. Every rise of 1 percent in the trade-weighted dollar produces a rise of at least $10

billion in the U.S. current account deficit.1 Hence the currency’s appreciation over

the past 7 years accounts for a large share of the total external imbalance, which

will probably approximate $500 billion this year and be close to 5 percent of GDP,

entering the traditional ‘‘danger zone’’ where the United States and other OECD

countries have traditionally experienced correction of their external deficits.2 The

deficits rose at an average rate of $100 billion (or over 50 percent) per year during

the late 1990’s, an explosive and obviously unsustainable path that may now have resumed. They dropped back to annual rates closer to $400 billion during 2001, with

the drop in U.S. economic growth and hence import levels, but rose again sharply

in the first quarter of this year (and in fact subtracted 1.2 percentage points from

our economic growth in that period).

Our latest projections at the Institute for International Economics suggest that,

absent any corrective action, the U.S. current account deficit will rise to 7 percent

of GDP by 2006 (about $800 billion).3 The previous sharp falls in the dollar, which

have occurred about once per decade since the early 1970’s, were triggered by external imbalances that never even reached 4 percent of GDP. Our latest calculation

is that the dollar is overvalued in trade terms by 20–25 percent, i.e., a depreciation

of that magnitude would reduce the current account deficit to the level of around

2–21⁄2 percent of GDP that is likely to prove sustainable over the longer run.4

These annual imbalances add to the negative net international investment position of the United States, which reached $2.2 trillion at the end of 2000 as a cumulative result of the deficits of the past 20 years. As recently as 1980, the United

States was the world’s largest creditor country. It has now been the world’s largest

debtor for some time. Its negative international investment position is rising by 20–

25 percent per year. This trajectory too is clearly unsustainable.

The Impact of the Strong Dollar

These external deficits and debts levy several significant costs on the United

States:

• Over the longer run, they mean that we will pay rising annual amounts of debt

service to the rest of the world with a consequent decline in our national income.

These payouts are surprisingly small so far, amounting to only about $14 billion

in 2001, because foreign investment by Americans yields a substantially higher

return than foreigners’ investments here. However, the numbers are clearly negative and will become substantially larger over time.

• In the short run, any increases in the deficit subtract from our gross domestic

product. Export output falls and domestic demand that could be met by domestic

output is instead satisfied by higher imports. U.S. output and employment suffer

as a result and must be of concern unless the economy is at full employment because of booming domestic demand, as in the late 1990’s (on which, see more

below) but not now. Since most of our goods trade is in manufactured products,

the deterioration of the trade balance has contributed substantially to the large,

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5 Howard Lewis, III and J. David Richardson, Why Global Commitment Really Matters! Institute for International Economics, October 2001. 6For a more optimistic view, see Richard N. Cooper, Is the U.S. Current Account Deficit Sustainable? Will It Be Sustained? Brookings Papers on Economic Activity 2001:1, pp. 217–26. 7 C. Fred Bergsten, ‘‘The Need for A TransAtlantic G–2,’’ The Washington Post, April 2002. 8 C. Fred Bergsten, ‘‘Strong Dollar, Weak Policy,’’ The International Economy, July/August

2001 and ‘‘Ducking a Dollar Crisis,’’ The International Economy, September/October 2001.

and perhaps permanent, loss of employment in that high-paying sector—whose

wages average 13 percent higher and benefits average close to 40 percent higher

than for the manufacturing sector as a whole.5

• At almost any time, markets could decide that the deficits and debt are

unsustainable and reduce their new investments in dollars sufficiently to drive

the exchange rate down sharply. The United States must attract about $2 billion

of net capital inflow every working day to finance the deficits at their current

level. Since gross U.S. capital outflows have been running about as large as the

current account deficit, our gross capital inflows must average about $4 billion per

working day—and totaled about $1 trillion in 2000. Any decline in the level of these inflows, let alone their reversal via a selloff from the $10 trillion of outstanding dollar holdings of foreigners, would produce increases in the U.S. price

level and higher interest rates (and almost certainly a fall in the stock market

as well). This ‘‘triple whammy’’ would severely hurt the U.S. economy.6

• In terms of domestic policy, large external deficits and the overvalued dollar that

produces them have been the most accurate leading indicator of resistance to trade

liberalization throughout the postwar period. Paul Volcker has recently noted, for

example, the correlation between the roughly 30 percent tariffs on steel just imposed by President Bush and the decline of roughly 30 percent in the value of the

Euro since its creation in 1999. The deficits generated relatively little concern in

the late 1990’s, because growth was so strong and unemployment so low, but are

clearly doing so now as indicated by the other statements to the Committee this

morning. Antitrade pressures will almost certainly rise again if the economy fails

to resume rapid growth on a sustained basis and especially if unemployment fails

to fall much from its current levels. • It should also be noted that a disorderly correction of the dollar’s overvaluation

would produce major foreign policy problems, especially with Europe. A decline of

20–25 percent in the average value of the dollar would require a much larger decline against the Euro because the currencies of many of our closest trading partners (such as Canada and Mexico) would fall at least part of the way with the

dollar itself. A complete dollar correction would in fact require the Euro to rise

well beyond its initial starting point in 1999 and more than 30 percent above current levels. This would sharply reduce Europe’s competitive position and trigger

major complaints there, deeply exacerbating the transatlantic trade conflict that

is already so severe.7

At the same time, it must be recognized that the external deficits and dollar appreciation provided important benefits to the U.S. economy during the boom period

of the late 1990’s. With growth at 5–6 percent in those years, and unemployment

falling to a 30 year low of 4 percent, the sharp rise in net imports and the climb

in the dollar itself helped to dampen inflationary pressures. The capital inflows that

financed the deficit funded part of our investment boom and held interest rates in

check, permitting monetary policy to accommodate the rapid growth. Under such

circumstances, the ‘‘strong dollar’’ policy enunciated by the Clinton Administration

(though never defined nor made operational) was defensible.8

No such defense is possible under current circumstances, however. The economic

slowdown and rise in unemployment in 2000–2001 underlined the costs of the external deficit. The absence of inflationary pressure obviates the chief benefit of large

net imports. The sharp reduction in interest rates over the past year reduces the

need for large capital inflows. Investment is now limited by excess capacity and lagging demand, rather than by any shortage of capital, so that particular benefit of

the earlier inflows has largely disappeared.

It is thus stunning that Secretary O’Neill, in an interview published on March 15,

suggested that the current account deficit is ‘‘a meaningless concept’’ and that ‘‘the

only reason I pay attention to it at all is because there are so many people who

mistakenly do’’—a very different view that he expressed as CEO of International

Paper in the middle 1980’s when the dollar was also hugely overvalued and he could

observe its impact directly. Similar statements of ‘‘benign neglect’’ by his predecessor Secretary Donald Regan (and especially Under Secretary Beryl Sprinkle) in

the first Reagan Administration turned out to be so wrong, and so costly for the

economy, that they had to be totally reversed by the second Reagan Administration

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9 Adam Posen, Restoring Japan’s Economic Growth, Washington: Institute for International

Economics, 1998. 10 C. Fred Bergsten, Marcus Noland and Takatoshi Ito, No More Bashing: Building a New

Japan—United States Economic Relationship, Washington: Institute for International Economics, 2001.

via the Plaza Accord in 1985 to drive the dollar down by 50 percent over the succeeding 2 years.

A New Dollar Policy

It is thus time for a change in the dollar policy of the United States. There is no

basis for maintaining the ‘‘strong dollar’’ mantra of the prior boom period. At a minimum, the United States and its G–7 partners should ‘‘lean against the wind’’ of any

renewed dollar appreciation to keep the problem from getting worse. Indeed, they

should now begin easing the dollar down toward its long-run equilibrium level

through a combination of altered rhetoric and direct intervention to support other

currencies, especially the Euro.

The new policy should also make clear to other countries that the United States

will not accept any efforts to competitively depreciate their currencies against the dollar. This dimension is particularly needed because Japan intervened massively last

fall, once again, to keep the yen from rising as documented in the Treasury’s latest

Report to Congress on International Economic and Exchange Rate Policy. After halting the yen’s rise, at about 116:1 against the dollar, the Japanese then actively

talked it down to about 135:1. This latest episode of competitive depreciation of the

yen apparently ended in January but it clearly had a major impact in the currency’s

level that persists today.

The Japanese characterized this intervention as part of an effort to combat deflation by pumping more yen into their economy. However, there are many other assets that the Bank of Japan could buy to expand domestic liquidity—even if one

thought that doing so could be effective when demand for money is so low due to

the depressed state of the Japanese economy. Moreover, it appears that the Bank

of Japan sterilized the monetary effects of the currency intervention (as usual) so

it made little or no contribution toward easing monetary conditions anyway.

The more plausible explanation of the intervention is that Japan was once again

seeking to export its domestic economic problems to the rest of the world, as it has

done on numerous occasions in the past. One can readily sympathize with Japan’s

plight, in light of its economy’s ‘‘decade of decline’’ and the failure of so many of

its efforts to use traditional monetary and fiscal instruments to restore growth.9

One might even countenance a temporary decline in the yen that resulted from

implementation of needed reforms in Japan, as suggested by the Administration

during its early days.

But the renewed rise of Japan’s trade surplus that is already evident will ease

pressure on the country to take the decisive steps needed to deal with the huge

problems of its banking system—the fundamental requirement to get its economy

back on track—and cannot be accepted as an alternative to such reforms. Moreover,

especially in the context of last year’s global economic slowdown, any such exporting

of Japan’s problems to other countries is highly inappropriate and must be resisted—through all the relevant multilateral forums, notably the IMF and G–7, as

well as bilaterally by the United States.10 It is thus disturbing that the new Treasury Report ignores the problem even after identifying and acknowledging the existence of the massive intervention last fall, and indeed implies that it was somehow

related to the terrorist attacks of September 11 and thus excusable.

On the broader issue of U.S. currency policy, it is encouraging that neither Secretary O’Neill nor any other Administration official has repeated the ‘‘strong dollar’’

rhetoric since September 11, or even for some time before. Though the Treasury denies that there has been any change in policy, the absence of ‘‘strong dollar’’ language is promising. The Administration should now substitute advocacy of a ‘‘sound

dollar,’’ or some equivalent, to signal a substantive change in attitude.

The presumed reason for the Administration’s reluctance to embrace such a shift

is a fear that the dollar could then shift course abruptly and go into a sharp decline

that would trigger some of the deleterious consequences cited above. There is little

risk of any such ‘‘free fall’’ for the foreseeable future, however, in light of the far

stronger fundamentals of the United States economy (vis-a`-vis both Europe and

Japan) that have in fact held the dollar so high for so long. The dollar in fact remained quite strong during 2000–2001 despite the sharp falls in U.S. economic

growth, interest rates, and equity prices—all of which would have traditionally been

expected to produce a depreciation of the exchange rate. At the same time, there

are no foreseeable sharp pickups in Europe or Japan (or anywhere else) that would

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11 C. Fred Bergsten, ‘‘The Dollar and the Euro,’’ Foreign Affairs, July/August 1997. 12The sharp reduction in the U.S. budget surplus, resulting from the tax cuts of early 2001

and the post-September 11 stimulus package, further enhances the prospect of larger trade deficits via a strong dollar. The fall in the surplus means that Government saving will decline

sharply, by perhaps 2–3 percent of GDP, and that an equivalent amount of additional foreign

capital will have to be imported—implying a similar jump in the trade deficit—unless private

saving were to rise by a like amount, which is not only unlikely but also undesirable since the

goal of the stimulus efforts is to promote increased consumer demand and thus a restoration

of rapid economic growth. See C. Fred Bergsten, ‘‘Can the United States Afford the Tax Cuts

of 2001?’’ American Economic Association, January 5, 2002.

pull large amounts of investment away from the United States. Hence this is an excellent time to start easing the dollar down toward its sustainable equilibrium level,

especially as it has already fallen by 3–4 percent over the past few months and that

‘‘leaning with the wind’’ is most likely to be effective.

The worst policy course is to wait until the inevitable change in economic fortunes,

whenever it comes, triggers a shift in market sentiment against the dollar. Coming

on top of the huge underlying imbalance, such an alteration of investor views could

indeed trigger a very sharp fall in our currency and a ‘‘hard landing’’ for the economy. There is in fact a third factor that could then also kick in and make the ensuing adjustment even nastier: The likely structural portfolio shift into Euros that will

almost certainly occur at some point due to the likelihood that that currency, based

on an economy as large as the United States and with even greater trade, will move

up alongside the dollar as a global key currency.11

The risk of maintaining the Administration’s policy of ‘‘benign neglect’’ would be

substantially increased if the likely strong recovery of our economy over the next year

or so were to trigger a renewed appreciation of the currency that, in combination

with the growth pickup itself, would send our external deficits soaring even further.12 Under such circumstances, continuation of the ‘‘strong dollar’’ rhetoric would

be particularly inappropriate because it would encourage an even greater rise in the

currency’s overvaluation. It would be a huge mistake to let the dollar rise to levels

from which it would be even more certain to come crashing down.

Such a situation would be reminiscent of what actually occurred in 1984–1985.

Even after the ‘‘Reagan dollar’’ had risen by about 25 percent in 1981–1983, and

already shifted the U.S. current account from balance in 1980 toward a deficit of

over $100 billion, the dollar rose by another 25 percent or so in what all subsequent

analysts have characterized as a purely ‘‘speculative bubble.’’ The Reagan Administration itself was then forced to engineer the Plaza Accord in September 1985 to

drive the dollar down by more than 50 percent against the other main currencies

by the end of 1987.

There are of course those who doubt the effectiveness of sterilized intervention in

the currency markets. Such a view ignores the fact that all three cases of intervention by the Rubin–Summers Treasury worked in textbook fashion. Joint United

States–Japan intervention stopped and reversed the excessive strengthening of the

yen in 1995. Similar intervention stopped and sharply reversed the excessive weakening of the yen in 1998. Joint U.S.–EU intervention in late 2000 stopped the slide

of the Euro and prompted a 10 percent rebound. But the best evidence comes from

the Administration itself: Why is it so afraid to alter the ‘‘strong dollar’’ mantra if

it believes there would be no impact from doing so? Does anyone really think that

the dollar would fail to decline toward a more desirable level if Secretary O’Neill

and his G–7 colleagues were to start calling for such a correction? An effective alternative policy is clearly available.

We also know that currency depreciation, supported by sound domestic policies,

produces the desired changes in current account balances with a lag of 2 or 3 years.

The large dollar decline of 1985–1987, for example, led to virtual elimination of the

U.S. current account deficit in the early 1990’s. The sharp appreciation of the yen

produced a similar correction in the Japanese surplus.

Hence there is a strong case for a new U.S. policy toward the dollar. Virtually

every sector of the economy is now calling for such a change, as indicated at this

hearing: The business community through the National Association of Manufacturers, labor through the AFL–CIO, agriculture through the American Farm Bureau.

Important parts of Wall Street, including former Fed Chairman Paul Volcker and

the chief economist of Goldman Sachs, have issued similar calls. It is time for the

Administration to change its policy toward the dollar, to improve the prospects for

the U.S. economy and U.S. trade policy, and to reduce the risks of the much more

severe adjustment that will inevitably hammer us later if it continues to ignore the

problem.

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1 Actually, about 80 percent consumption and 20 percent investment. For a full explanation

of this important yet often misunderstood relationship, see Ernest H. Preeg, The Trade Deficit,

the Dollar, and the U.S. National Interest (Hudson Institute, 2000), Chapter 4; a briefer explanation by the author is in ‘‘A rose-tinted view of the deficit,’’ Financial Times, June 22, 2000.

PREPARED STATEMENT OF ERNEST H. PREEG

SENIOR FELLOW IN TRADE AND PRODUCTIVITY

MANUFACTURERS ALLIANCE/MAPI, INC.

MAY 1, 2002

Thank you, Mr. Chairman, for this opportunity to appear before your Committee

to address the impact of the dollar on the U.S. balance of trade, economic growth,

and long-term economic stability. I will focus my presentation heavily on one particularly disturbing aspect of the trade deficit, namely currency manipulation to

commercial advantage by some trading partners, and in particular by China, the nation with whom we have the largest and most lopsided trade deficit. To put this

issue in broader context, however, I begin with brief comments on three basic concerns I have about the chronic and very large overall U.S. trade deficit.

Three Basic Concerns About the Trade Deficit

The first, most immediate concern, is the impact of a larger trade deficit on U.S.

economic recovery this year and next. The U.S. trade deficit was $345 billion in

2001, and could rise sharply to $400 billion or more this year, as a result of a faster

initial rate of economic recovery in the United States compared with our major trading partners and the time-lagged adverse trade impact of the strengthening of the

dollar over the past 2 years. More than 80 percent of the deficit—in the order of

$350 billion this year—will fall on the manufacturing sector, which has been hardest hit by the economic slump of the past 18 months. U.S. manufacturing industry,

through new product innovation and capital investment, is the engine for overall

growth in the U.S. economy, and a major increase in the trade deficit for manufactures could be the Achilles’ heel for the hoped-for strong rebound in such productivity-enhancing investment and sustained overall growth.

The second, somewhat longer term concern, is that the longer we maintain a trade

deficit—or more precisely current account deficit—in the prospective order of 5–6

percent of GDP, the larger becomes the U.S. international debtor position, and the

greater becomes the likelihood of a more disruptive ‘‘hard landing’’ for the dollar and

the U.S. economy when the inevitable downward adjustment on trade account finally occurs. The chronic trade deficit has transformed the United States from the

largest net creditor nation in the mid-1980’s to the unprecedented largest net debtor

nation approaching $3 trillion of net foreign debt today, projected to $5 trillion by

mid-decade. There is near consensus that this foreign debt accumulation course is

unsustainable and the question is rather how and when we will confront the point

of unsustainability. I believe an earlier downward adjustment in the trade deficit—

which would entail a depreciation of the dollar exchange rate by perhaps 10–20 percent—would be less disruptive and better for longer term economic stability, in the

United States and for the world economy, than a prolonged further debt buildup

until financial markets finally react against the dollar under the cloud of a $5 trillion U.S. foreign debt.

My third and even longer term—but no less important—concern about the trade

deficit and the consequent buildup of foreign debt is the social inequity we are imposing on our children and grandchildren. A current account deficit of $500 billion per year means we are living beyond our means by roughly 5 percent of GDP,

mostly for immediate personal consumption and to a lesser extent for investment.1

This consumer binge is being paid for through foreign borrowing comparable to the

current account deficit, and the resulting $3–$5 trillion buildup of foreign debt is

being left to our children and grandchildren to service indefinitely or to pay off fully

in principal. With a younger generation of Americans already concerned about paying rising Social Security and Medicare commitments to the current older generation, the foreign debt buildup is one more intergenerational income transfer being

undertaken essentially by stealth.

These are my three principal concerns about the trade deficit. As to what we can

or should do to reduce the deficit, there are two principal remedies. The first is to

increase domestic savings, thereby reducing the need to borrow abroad, about which

there is more in the concluding section of this presentation. The second and more

immediate way to reduce the trade deficit is to restrain others from ‘‘manipulating’’

their exchange rates to commercial advantage.

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2See the Financial Times, January 16, 2002, ‘‘Banker’s fall throws spotlight on China’s missing billions.’’

U.S. Benign Neglect of Currency Manipulation by Others

We currently have a predominantly floating exchange rate international financial

system. The United States has a basically free float policy, with official market

intervention rare and in only token amounts. The EU, Canada, and Mexico have

similarly followed a free float during the past several years. Others, however,

particularly in East Asia, implement a heavily managed float through large scale

official purchases of foreign exchange, principally dollars, in order to keep their

exchange rates lower than they would be subject to market forces alone, and

consequently to push the dollar higher. This managed approach is ‘‘mercantilist’’ in

that the objective is to maintain a large trade surplus as a matter of national policy,

and the result for the United States is a trade deficit larger than it would be based

on market forces alone.

Article IV of the IMF Articles of Agreement states that members shall, ‘‘avoid manipulating exchange rates to gain an unfair competitive advantage,’’ and, under IMF

surveillance procedures, a principal indicator of such manipulation is ‘‘protracted

large scale intervention in one direction in the exchange market.’’ Protracted purchases of dollars by certain East Asian central banks would thus clearly qualify as

currency manipulation, under the IMF definition, but the U.S. Treasury has rarely

raised the issue, preferring a policy of benign neglect.

Japan, the largest trade surplus nation in the world, is an outstanding example

of such currency manipulation, with $250 billion of official foreign exchange purchases (almost all dollars) since 1995, including $33 billion in September and October 2001 alone when market forces were putting upward pressure on the yen. The

yen, meanwhile, declined by 15 percent vis-a`-vis the dollar during 2001. South

Korea is another more recent example of such currency manipulation. The Korean

central bank bought $9 billion of foreign exchange during 2001 while the nation

recorded a $9 billion trade surplus. In effect, the central bank purchases entirely

offset any upward pressure on the won from the trade surplus, and the Korean

currency, in fact, depreciated 5 percent against the dollar during the year.

This form of currency manipulation does not, of course, explain all of the strengthening of the dollar vis-a`-vis these currencies in recent years, but currency traders

know that the central banks involved will not let their currencies strengthen significantly, and therefore they hold back speculative purchases even when market conditions would otherwise indicate a currency appreciation. It is also noteworthy that

the relevant indicators involved are net figures, whether for central bank intervention, trade flows, or capital market transactions, and on this basis the net purchases

of foreign exchange by the Bank of Japan in recent years have probably held the

yen at a significantly lower level than would have prevailed based on market forces

alone. And consequently, Japan has likewise maintained a significantly larger trade

surplus with the United States, especially in price-sensitive industries such as the

automotive sector.

The Uniquely Powerful Chinese Currency Manipulation

Chinese exchange rate policy is an important special case which spells currency

manipulation in a different way. The Chinese currency has a fixed rate to the dollar

but is nonconvertible on capital account. Over the past year, there has been a $25

billion trade surplus, a $45 billion net inflow of foreign direct investment—which

also puts upward market pressures on the exchange rate—and over $50 billion of

central bank purchases of foreign exchange. In this case, the central bank purchases

offset almost three-quarters of market-generated upward pressure on the yuan from

the trade surplus and the FDI inflow combined. Moreover, these official foreign

exchange purchases may have been even larger except for an unfolding financial

scandal involving billions of dollars of missing reserves.2

Based on the IMF definition, China has clearly been manipulating its currency

for mercantilist purposes. The Bank of China has made protracted large scale purchases of foreign exchange—$150 billion since 1995—in order to maintain a large

trade surplus as an offset to poor growth performance in the domestic economy. A

direct measure of the manipulation is not possible because of the nonconvertible

fixed exchange rate. There is no doubt, however, that if the central bank had not

purchased $50 billion in 2001, there would have been strong upward pressures on

the yuan in formal and informal markets. The bottom line is that the Chinese yuan

is substantially undervalued and should certainly not be devalued as the Chinese

government occasionally threatens to do.

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3The World Bank rule of thumb for adequate reserves is 25 percent of annual imports; China

and Japan now have foreign exchange reserves of approximately 100 percent of annual imports.

The Benefits and Costs of Chinese Currency Manipulation

The unique form of Chinese currency manipulation provides a mix of benefits and

costs for China and for the United States. The most direct result is a larger trade

surplus for China, which means more export-oriented jobs in the Chinese economy.

From the United States point of view, of course, it means a larger trade deficit with

China and the loss of export-oriented and import-competing jobs. In 2001, United

States imports from China were $102 billion, or more than five times larger than

the $19 billion of United States exports to China.

One problem for China in implementing currency manipulation through a fixed

but nonconvertible exchange rate is that it creates breathtaking opportunities for

official corruption, as noted above. A floating rate, however heavily managed, would

do the manipulation job more efficiently, as it does for Japan, and China will, for

this and other reasons, likely move in this direction as its economy becomes progressively more open to international trade and investment.

Additional benefits to China from its cumulative purchase of foreign exchange accrue in other areas of foreign policy. With $220 billion of ready cash in the central bank—far greater than any measure of ‘‘adequate’’ reserves for commercial

purposes 3—Chinese purchases of weapons and other military equipment abroad,

as regularly received from Russia, in particular, can be made without financial

constraint.

A similar conclusion can and should be drawn about China as an economic aid ‘‘graduate.’’ There is no longer any justification for China to receive several billion

dollars per year in long-term loans on favorable terms from the World Bank, the

Asian Development Bank, and some bilateral donors, when there are $220 billion

of unutilized funds stashed away in the Central Bank. And yet the development

banks continue to lend large sums to China!

Another geo-economic advantage to China from its large reserves is the ability to

offer concessionary trade and investment finance to other Asian nations, particularly in Southeast Asia, as a means of strengthening Chinese economic engagement

in the region at the expense of the United States. Some first steps along these lines

have been taken together with Japan, to weaken ‘‘United States economic hegemony,’’ and such trade-related incentives will likely be expanded in support of the recent Chinese initiative for a free trade arrangement with the Association of Southeast Asian Nations (ASEAN).

Finally, and more speculatively, China at some future point could use its official

dollar holdings as foreign policy leverage against the United States by threatening

to sell large quantities of dollars on the market, or merely shift its reserves away

from dollars and into Euros and yen. This will not happen anytime soon because

the result would be a decline in the dollar and an adverse impact on Chinese

exports. At some future point, however, if China were to become less dependent

on exports to the United States for economic growth, such a threat could become

credible. For example, the threat of substantial Chinese sales of dollars, with its implications for a disruptive decline in the dollar and the U.S. stock market, especially

during a downward phase in the U.S. economy and/or an election year, could influence the course of U.S. policy toward Taiwan. Chinese military officers, in fact, in

their studies of nonconventional defense strategies, include reference to George

Soros and his attack on the British pound in 1992 as a template for disrupting a

rival’s (i.e., the United States) economic system.

Thus, the Chinese currency manipulation is very real and substantial, with wideranging implications, and it deserves, as a policy response, something more than the

total official neglect it has received up to this point.

A Long Overdue Policy Response

The United States should adopt a clear and forceful strategy for reducing its

chronically large external deficit. Indeed, such an initiative is long overdue.

The first step in such a strategy would be to have frank discussions with major

trading partners as to why it is a mutual interest to reduce current imbalances on

current account. These consultations could take place within the G–7 finance ministers’ framework and with key trading partners, including China, Mexico, and

South Korea.

The substance of the strategy should begin with a joint commitment to a free or

very lightly managed floating exchange rate relationship, except for those nations

engaged in full monetary union. Within this international financial framework, the

macroeconomic response would be for the United States to take steps to increase

its domestic savings while other, large trade surplus countries would take corVerDate 11-MAY-2000 11:02 Mar 31, 2003 Jkt 000000 PO 00000 Frm 00133 Fmt 6633 Sfmt 6621 85735.TXT SBANK4 PsN: SBANK4
130

responding steps to increase domestic consumption. These domestic steps would

force adjustment in the trade imbalances, in large part through downward movement of the dollar exchange rate.

The U.S. policy objective for the exchange rate would consequently change from

current categoric support for a strong dollar to a neutral reliance on market forces

to establish the rate, with the expectation of some downward adjustment of the

dollar in parallel with a declining trade deficit. Such a United States stated objective, in conjunction with complementary statements by major trading partners,

would, in itself, likely lead to some decline in the dollar and the beginning of the

trade adjustment process.

Another immediate objective should be to restrain others from further currency

manipulation to competitive advantage. This could be done through G–7 and bilateral discussions and, in parallel, more formal consultations within the IMF. The

point of departure would be that nations with persistently large trade surpluses—

and even more so if they have large FDI inflows as well—should cease official purchases of foreign exchange or any other actions that would maintain their currencies

below market-determined levels. A joint announcement to this effect should further

influence financial market behavior, with upward pressures on floating currencies

that have recently been subject to substantial manipulation, such as the yen and

the Korean won, and corresponding downward movement of the dollar.

China, once again, is an important special case in view of its nonconvertible fixed

rate to the dollar, and should thus be given a very high priority for bilateral consultations. The mutual interest in reducing the extremely lopsided bilateral trade

account should be assessed in detail, starting with the question as to why China

has such a large trade surplus with the United States and moderate trade deficits

with most other trading partners. A United States request to China to cease official

foreign exchange purchases and to adjust its fixed rate upward would define the immediate United States objectives. The longer term transition of China toward a fully

convertible, floating rate relationship with the dollar should also be examined seriously, as a mutual interest, and as the best way to avoid trade conflict resulting

from further unjustified Chinese currency manipulation.

—————

PREPARED STATEMENT OF STEVE H. HANKE

PROFESSOR OF APPLIED ECONOMICS

JOHNS HOPKINS UNIVERSITY

MAY 1, 2002

Mr. Chairman, thank you for this opportunity to express my views on exchange

rate policies. Commentary about exchange rate policies often originates in polemical,

and more or less political, attempts at self-justification. In consequence, the discourse is often confused and confusing. In an attempt to bring some clarity to the

topic, I will begin by presenting some principles and characteristics of exchange rate

regimes.

Exchange Rate Regimes

There are three types of exchange rate regimes: Floating, fixed, and pegged rates.

Each type has different characteristics and generates different results. Although

floating and fixed rates appear to be dissimilar, they are members of the same family. Both are ‘‘automatic’’ free-market mechanisms for international payments. With

a ‘‘clean’’ floating rate, a monetary authority sets a monetary policy, but has no exchange rate policy—the exchange rate is on autopilot. In consequence, the monetary

base is determined domestically by a monetary authority. In other words, when a

central bank purchases bonds or bills and increases its net domestic assets, the

monetary base increases and vice versa. Whereas, with a fixed rate, a monetary

authority sets the exchange rate, but has no monetary policy—monetary policy is

on autopilot. In consequence, under a fixed-rate regime, the monetary base is determined by the balance of payments. In other words, when a country’s official net foreign reserves increase, its monetary base increases and vice versa. With both of

these free-market exchange rate mechanisms, there cannot be conflicts between

exchange rate and monetary policies, and balance-of-payments crises cannot rear

their ugly heads. Market forces automatically rebalance financial flows and avert

balance-of-payments crises.

Floating- and fixed-rate regimes are equally desirable in principle. However, floating rates, unlike fixed rates, have rarely performed well in developing countries

because these countries lack (in varying degrees) strong independent institutions,

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1 Contrary to the popular impression, Argentina’s convertibility system was not an orthodox

currency board. Some students of currency board systems pointed this out almost a decade ago.

They anticipated that Argentina’s convertibility system would eventually degenerate into a

pegged exchange rate system and that it would blow up. See Steve H. Hanke, Lars Jonung and

Kurt Schuler, Russian Currency and Finance: A Currency Board Approach to Reform. London:

Routledge, 1993, pp. 72–77.

coherent and predictable systems of governance and the rule of law. Accordingly,

they cannot establish confidence in their currencies. Indeed, they usually lack either

a sound past performance or credible guarantees for future monetary stability. In

consequence, a floating currency usually becomes a sinking currency in a developing

country.

Fixed and pegged rates appear to be the same. However, they are fundamentally

different. Pegged rates are not free-market mechanisms for international payments.

Pegged rates (adjustable pegs, bands, crawling pegs, managed floats, etc.), require

the monetary authority to manage the exchange rate and monetary policy simultaneously. With a pegged rate, the monetary base contains both domestic (domestic

assets) and foreign (foreign reserves) components. Unlike floating and fixed rates,

pegged rates almost always result in conflicts between exchange rate and monetary

policies. For example, when capital inflows become ‘‘excessive’’ under a pegged system, a monetary authority often attempts to sterilize the ensuing increase in the

foreign component of the monetary base by reducing the domestic component of the

monetary base. And when outflows become ‘‘excessive,’’ an authority attempts to

offset the decrease in the foreign component of the base with an increase in the

domestic component of the monetary base. Balance-of-payments crises erupt as a

monetary authority begins to offset more and more of the reduction in the foreign

component of the monetary base with domestically created base money. When this

occurs in a country with free capital mobility, it is only a matter of time before market participants spot the contradictions between exchange rate and monetary policies and force a devaluation. Table 1 summarizes the main characteristics and results anticipated with floating, fixed, and pegged exchange rates, when free capital

mobility is allowed.

The Evolution of U.S. Exchange Rate Regime Policies

If a country adopts a fixed exchange rate regime (either an orthodox currency

board 1 or official ‘‘dollarization’’) and allows free capital mobility, it must give up

monetary autonomy. Alternatively, if a country wants monetary autonomy and free

capital mobility, it must adopt a floating exchange rate. If a country has a pegged

exchange rate, it must restrict capital mobility to avoid balance of payments and

currency crises.

Over the past decade, the advantages of free capital mobility have become clear,

and restrictions of capital mobility have been dramatically reduced. However, most

developing countries have continued to employ some variant of pegged exchange

rates. And not surprisingly, major balance of payments and currency crises have

occurred frequently in the 1990’s.

In a world of increasing capital mobility, the U.S. Government had no coherent

policy on exchange rates until the late 1990’s. Motivated by criticism from a small

group of economists (including myself), Former Senator Connie Mack’s campaign for

official dollarization in countries with low quality currencies, and the fallout from

the currency crises that engulfed Mexico, Asia, and Russia, the U.S. Treasury finally

produced a clear policy statement on exchange rate regimes. Given that the U.S.

embraces free capital mobility, Treasury Secretary Robert Rubin correctly concluded, in a speech made at The Johns Hopkins University on April 21, 1999, that

either floating or fixed exchange rates were acceptable, but that pegged rates were

not. And shortly after Lawrence Summers became Treasury Secretary, he presented

the same policy conclusions at an address he delivered at Yale University on September 22, 1999. Stanley Fischer, the Former Deputy Managing Director of the

International Monetary Fund, weighed in with the same message, when he delivered the Distinguished Lecture on Economics in Government at the annual meeting

of the American Economic Association in New Orleans on January 6, 2001.

With these policy pronouncements, the U.S. Treasury’s (and the IMF’s) position

on exchange rates became clear. In principle, the position was correct. In practice,

it was (and continues to be) applied correctly in the case of the U.S. dollar, where

a floating exchange rate regime continues to be embraced. In developing countries,

however, the United States and the IMF have not adhered to the position with any

rigor. For example, Brazil and Turkey were both given the green light to continue

or establish pegged exchange rate regimes shortly after U.S. officials indicated that

these set-ups were, in principle, unacceptable.

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2 I thank Fred Bergsten for reminding me of de Gaulle’s astute observation.

The Bush Administration has not yet articulated a clear policy on exchange rate

regimes. Secretary O’Neill would do well to clear the air and make a statement

along the same lines as Messrs. Rubin and Summers. Indeed, since the United

States espouses free capital mobility, the only logical course is for U.S. policy to embrace floating rates or fixed rates (orthodox currency boards or official dollarization),

and to reject pegged rates. With the departure of Stanley Fischer, the IMF’s position

on exchange rate regimes has become fuzzy. Anne Krueger, Fischer’s successor,

would do well to follow his lead and reaffirm Fischer’s conclusions.

The ‘‘Strong’’ Dollar Mantra

The exchange rate—the nominal exchange rate quoted in the market—is a price.

With a floating exchange rate policy, the price freely adjusts to changes in individuals’ and business’ expectations about conditions here and abroad. The dollar

broadly strengthened against other currencies after the mid-1990’s because market

participants expected to receive higher rates of return on their investments in the

United States than abroad. For example, consider for a moment the fate of the Euro

versus the dollar since the Euro’s launch on January 1, 1999. Then, the exchange

rate was 1.17 dollars per Euro; today it’s about 0.90. The dollar strengthened by

30 percent against the Euro primarily because market participants anticipated

brighter prospects and higher rates of return in the United States than in Euroland,

and capital flowed out of Euro-denominated assets into equities, bonds, and other

U.S. investments.

This brings me to the ‘‘strong dollar’’ mantra. This rhetorical phrase, which was

prompted by the dollar’s broad strength in the markets, is unfortunate and confusing, at best. The combination of a floating exchange rate and the pursuit of low

inflation, which the United States has had for many years now, is a policy. The

‘‘strong dollar’’ is not. Indeed, given a floating exchange rate regime, it is impossible

to know what a so-called strong dollar policy is because the price of the dollar on

foreign-exchange markets is on autopilot. The price is (or should be) determined by

buyers and sellers, and U.S. Government officials should refrain from trying to influence it by ‘‘open-mouth operations.’’ As long as the United States embraces a

floating exchange rate policy, the Treasury Secretary should strike the term ‘‘strong

dollar’’ from his lexicon when engaging in discourses about exchange rate policies.

The phrase ‘‘strong dollar’’ is meaningless and leads to no end of confusion.

The Dollar’s Dominance

So under a floating-rate policy, one in which the dollar’s price is on autopilot,

what can be said about the dollar? We can say that the dollar is the world’s dominant currency, more so with each passing year.

Consider some facts about the U.S. dollar and its role in the world’s monetary affairs. Thanks to its stability, liquidity and low transactions costs, the dollar occupies

a commanding role. It is the world’s dominant international currency, a unique feature that gives the United States an edge in attracting capital inflows to finance

current account deficits at a relatively low cost. This prompted Charles de Gaulle,

when he was President of France, to characterize the benefits derived from the

dollar’s dominant position as an ‘‘exorbitant privilege.’’ 2

• Ninety percent of all internationally-traded commodities are invoiced and priced

in dollars. • The invoicing and pricing of manufactured goods in international trade presents

a much more complicated picture. The dollar, however, dominates. For example,

37 percent of the United Kingdom’s exports to Germany are invoiced in dollars,

not Euros or Sterling. • The dollar is employed on one side of 90 percent of all foreign exchange transactions. • Over 66 percent of all central bank reserves are denominated in dollars, and that

percentage has been steadily increasing since 1990. • The second most popular hand-to-hand currency used by foreigners is the dollar,

with their own domestic currencies in first place. That explains why an estimated

50–70 percent of all dollar notes circulate overseas.

• The dollar is the second most popular denomination used by foreigners for onshore bank accounts, with their domestic unit of account usually in first place.

According to the IMF, the average ratio of dollar-denominated bank accounts to

broad money in highly dollarized countries is 0.59, and for moderated dollarized

countries, the ratio is 0.18. Not surprisingly, the dollar is the king of off-shore

bank accounts.

• Fifty percent of the internationally-traded bonds are denominated in U.S. dollars.

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3The ABN–AMRO index is based on the Fed ‘broad’ index weighting system. To avoid creating

an unwieldy index and to reduce susceptibility to potential distortions from sharp fluctuations

in nominal values in developing economies, the ABN–AMRO index does not explicitly include

weights for minor U.S. trading partners. It does, however, include weights for medium-sized

trading partners such as the UK, Mexico, China, Hong Kong, and Malaysia.

• The dollar also dominates the world’s equity markets, with 60 percent of the capitalized value of all traded companies in the world denominated in dollars. And

that is not all. Capital markets throughout the world are rapidly shifting into dollars. To lower their cost of capital, foreign companies are beating a path to the

New York Stock Exchange and Nasdaq, which of course both trade in dollars.

Many traditional foreign companies now issue American Depositary Receipts in

New York. These ADR’s, representing claims on shares in foreign companies, are

traded in dollars, and dividends are paid in dollars. For example, 58.7 percent of

the total capitalization of all traded Latin American companies is denominated in

dollars, and for the two largest Latin economies, Brazil and Mexico, the dollarized

percentages are 69.9 percent and 42 percent, respectively.

All this boils down to a simple fact: The world is already highly and unofficially

dollarized. And unless the quality of the dollar deteriorates, that is the way things

will stay. If more countries with low-quality currencies would officially replace

their domestic currencies with the dollar, the competitive devaluations that so many

fret about would come to an abrupt halt. And exchange rate crises that frequently

engulf countries with half-baked currencies would be a thing of the past. After all,

countries that are officially dollarized do not have an exchange rate vis-a`-vis the

dollar.

The Dollar’s Price

The dollar’s strength against major currencies since 1995 and particularly since

the start of 2000 has persuaded many, particularly the dollar bears, that the dollar’s price is too ‘‘high’’ and unsustainable. The dollar’s ‘‘high’’ price has also generated

predictable howls from those who assert that the ‘‘strong dollar’’ has made their

businesses uncompetitive and squeezed their margins.

Just how ‘‘high’’ is the dollar’s price? It depends on how you measure it. If we

use the Federal Reserve’s broad dollar index or IMF’s dollar index, it appears that

the dollar is at a ‘‘high’’ level and perhaps not sustainable (see Chart 1). However,

if we use ABN–AMRO’s trade-weighted dollar index, the dollar does not appear to

be as ‘‘strong’’ as many believe. The weighting used by ABN–AMRO is more representative of the realities (see Table 2). Indeed, ABN–AMRO’s dollar index more

accurately reflects the dollar’s trade weighted price than do either the IMF’s or the Fed’s dollar indexes.3 Perhaps that explains why the dollar bears have been

disappointed so often in the past few years: They have been looking at the wrong

indexes.

Yet another way to look at the dollar indexes, which are constructed by a few

experts, is through the lens of the Austrian School of Economics. As Friedrich von

Hayek, a leader of the Austrian School, observed, the most important function of

a market is to process widely dispersed bits of information from many market participants to generate an easily understood metric—a price. Not surprisingly, the

judgments of many market participants, who are putting real money at risk, are

deemed to be more important, as they should be, than artificial constructs produced

by a small group of experts. Accordingly, the dollar’s price is where buyers and sellers agree it should be. To the extent that the dollar’s price is too ‘‘high’’ simply

means that the consensus of the many market participants differs from the few who

are in the business of constructing artificial indexes.

Under a floating exchange rate regime, the future course of the dollar will be determined by expectations about prospective rates of return in the United States and

overseas, as well as the risks involved. Judgments about future returns and risks

are, of course, difficult and highly dependent on, as Lord Keynes put it, the state

of confidence. In this respect, all we know is that the United States engaged in a

new, long war against an elusive enemy which will consume meaningful real resources, eventually becoming a drag on productivity. This suggests that capital flows

to the United States (as evidenced by recent data), might not be as forthcoming in

the future as they were during the past few years. If that is the case, the floating

dollar will weaken in the markets and market forces will automatically cause those

‘‘troubling’’ U.S. current account deficits to shrink.

In closing, under floating rates, the less said in Washington, DC about the level

and course of the dollar’s price, the better. After all, under floating, the dollar’s ex- change rate is on autopilot. Alas, this is probably asking for too much. When it

134

comes to exchange rates and adjustments in the balance of payments, many of the

cognoscenti in Washington have a distaste for automaticity. For them, the consequences of a country’s balance of payments should not spread themselves out

inconspicuously in time and scope. Instead, they should remain concentrated and

visible as a signal for policy changes and as a pivot for expert consultations.

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136

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RESPONSE TO WRITTEN QUESTION OF SENATOR AKAKA

FROM PAUL H. O’NEILL

Q.1. This week the Associated Press reported that the Treasury De- partment would borrow one billion dollars instead of retiring $89

billion of the national debt, which had been projected in January.

This was the first time since 1995 that the Government needed to

borrow money in the April–June quarter. Three-quarters of the increase in borrowing was due to lower-than-expected tax revenue. In

the fourth quarter of last year, foreign investors purchased $33.3

billion in U.S. Treasury Securities. This debt adds to the current

account deficit. What are the impacts of the Federal budget deficit

and the tax cuts enacted last year on the current account deficit?

A.1. There is no direct connection between the Federal budget and

current account deficits. The current account reflects the balance

between savings and investment in the economy. This fiscal year’s

Federal deficit is related to the recent downturn in the U.S. economy and the spending requirements of the war on terrorism. The

deficit is not large by international standards. The decline in revenue that naturally occurs during cyclical downturns, and the

Administration’s tax cuts, were critical in stimulating the timely

recovery of the U.S. economy, and ensuring that the recent recession was among the mildest and shortest on record.

RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING

FROM RICHARD L. TRUMKA

Q.1. What happens if the Secretary decides to ‘‘talk down’’ the dollar, but foreign investors still look at our economy as the strongest

in the world and the best return for their investment? Won’t the

foreign investors still send their money here, and keep the dollar

at a high rate against other currencies?

A.1. That foreigners view the U.S. economy as the strongest in the

world is a strength and advantage to us. That said, it is still possible for the dollar to get out of alignment owing to speculative

pressures, and there are many empirical measures that show the

dollar is overvalued today.

Foreign investor attitudes toward the United States are one reason for the high value of the dollar. But equally important is Treasury’s policy toward the dollar. By constantly talking about a

‘‘strong dollar,’’ and by failing to speak out against the many countries who intervene to keep their currencies low in order to gain

competitive advantage, the Treasury has encouraged speculators to

think that they face a ‘‘one way bet.’’ That is, the dollar will remain

strong and other currencies will remain weak. This policy must

end, and ending it is fully consistent with the United States

remaining an attractive place for foreign investment.

Q.2. If the Treasury went to an aggressive policy to lower the dollar, it would raise import prices for the consumer. Would we not

risk increased inflation under such a scenario?

A.2. There are three reasons to discount the ‘‘inflation risk’’ scenario:

First, a lower dollar will cause import prices to rise slightly because foreign firms pass through part of the exchange rate change.

But that need not translate into damaging generalized price inflaVerDate 11-MAY-2000 11:02 Mar 31, 2003 Jkt 000000 PO 00000 Frm 00141 Fmt 6633 Sfmt 6601 85735.TXT SBANK4 PsN: SBANK4
138

tion. Most U.S. manufacturing firms have massive excess capacity

and stand ready to step into the breach and fill the gap left by importing firms. As a result of this substitution, the net impact on inflation and consumers stands to be quite moderate. Moreover, any

increase in import prices will be a one-off increase, and therefore

will not generate continuing inflation.

Second, the current environment is one of very low inflation, bordering on deflation. At these levels, even if a small increase in inflation were to materialize it might actually be a good thing by

pushing the economy away from a deflation—which is economically

disastrous in an environment where business and firms are heavily

indebted.

Finally, an important consideration is that the real issue is ‘‘dollar adjustment now’’ versus ‘‘dollar adjustment later.’’ It is widely

agreed that the dollar and the trade deficit are unsustainable at

current levels. Doing nothing risks a damaging and painful adjustment down the road, and in the meantime the overvalued dollar

will have hollowed out our manufacturing sector, destroyed good

manufacturing jobs, and undermined our economic recovery. A better strategy is to manage the adjustment, avoid the damaging economic effects of delay, and avoid a possible financial crash that

might occur when markets ultimately decide to correct.

RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING

FROM JERRY J. JASINOWSKI

Q.1. What happens if the Secretary decides to ‘‘talk down’’ the dollar, but foreign investors still look at our economy as the strongest

in the world and the best return for their investment? Won’t the

foreign investors still send their money here, and keep the dollar

at a high rate against other currencies?

A.1. The fundamental force which drives investment flows is access

to developed and thriving markets. And with the expectation that

productivity growth (the main driver behind a sustainable growth

and increased living standards) will continue to be robust in coming years, there is no doubt that the United States will continue

to be an attractive market for worldwide investment. While this

outlook does not support a weak dollar, it also does not support a

dollar 30 percent above its level in 1997—a level reach in February

2002. The record actually shows that investment inflows do not

react to changes in the dollar—but rather to changes in the outlook

for the economy.

Capital will continue to flow into the United States as the dollar

returns to normal, and, in fact, direct investment inflows may actually increase. That is what happened after the 1985 correction of

the dollar. During 1985–1987 the dollar fell 40 percent—returning

to normal levels prevailing prior to 1985. During the time the dollar was appreciating—up until mid-1985—foreign direct investment

into the United States averaged $4.5 billion per quarter. But after

the dollar started to fall, direct investment inflows nearly tripled,

to $12.3 billion per quarter. Why? Because the dollar’s return to

normalcy made the United States a better place to invest.

139

Q.2. If the Treasury went to an aggressive policy to lower the dollar, it would raise import prices for the consumer. Would we not

risk increased inflation under such a scenario?

A.2. Certainly a declining dollar will put some upward pressure on

prices, for we have been having a free ride for several years while

the dollar became increasingly overvalued. The adjustment, however, will be mild. According to NAM estimates based on the widely-used Washington University Macro Model, a 15 percent dollar

devaluation over the next year and a half would only result in a

one-time increase in the GDP deflator (the widest measure of

prices in the U.S. economy) of less than 1 percent.

This is because inflation has been held down principally by the

high productivity growth of U.S. industry—especially manufacturing. Declining import prices for consumer goods have actually

not had that much of an inflation-restraining impact. Bureau of

Labor Statistics data show that despite the 30 percent rise in the

dollar since 1997, consumer goods import prices have fallen only 6

percent. Part of the explanation for this is in the fact that a significant proportion of consumer goods imports come from China, whose

currency has remained pegged to the dollar. Additionally, a significant part of the consumer price index is related to energy imports,

and these are denominated in dollars—thus being impervious to

fluctuations in the value of the dollar.

Import prices for capital goods, however, have fallen 25 percent,

which has put U.S. capital goods industries at an enormous disadvantage. As the prices of these imports rise, we would anticipate

a shift back to U.S. production and a reduced rate of import

growth. Inflation will also be restrained by the huge capacity overhang in the U.S. economy. Federal Reserve Board data shows capacity utilization to be extremely low—less than 75 percent. This

makes it very difficult to raise prices, showing that this is actually

a good time for the dollar to decline to more normal levels. The

worst time for the dollar to decline would be during a period of

overheated boom.

A mild inflationary response to a dollar devaluation is supported

not only by econometric modeling, but also by history. After a

sharp appreciation in the early 1980’s, the dollar fell by 40 percent

in 2 years starting in mid-1985. While a strengthening dollar

played a role in bringing down inflation, which was running near

double digits in the early 1980’s to a more moderate 3.1 percent by

1985, no significant pickup in inflation accompanied the 1985–1987

correction. In fact, between 1986 and 1988, the inflation rate actually averaged 0.3 percentage points lower than the inflation rate at

the height of the dollar’s peak in 1985.

Thus, while a weak or devaluing dollar falling to abnormally low

levels may cause inflation, the evidence indicates that a dollar declining to normal levels has little inflationary impact.

RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING

FROM BOB STALLMAN

Q.1. What happens if the Secretary decides to ‘‘talk down’’ the dollar, but foreign investors still look at our economy as the strongest

in the world and the best return for their investment? Won’t the

140

foreign investors still send their money here and keep the dollar

at a high rate against other currencies?

A.1. The American Farm Bureau Federation (AFBF) does not favor

the Secretary either ‘‘talking up’’ or ‘‘talking down’’ the value of the

dollar. We also recognize the importance of maintaining a vibrant

economy, one that attracts ample foreign investment. It is equally

important to ensure that all sectors of the U.S. economy have the

opportunity to thrive in a manner that is not impaired by an overvalued dollar.

The strong dollar is severely affecting sectors, like agriculture,

that are highly dependent on exports. For this reason, we support

a Congressionally mandated study of the impact of the value of the

dollar on the U.S. economy. Such a study should take into account

the ability of the United States to attract foreign investment and

not only maintain, but also increase, exports.

Q.2. If the Treasury went to an aggressive policy to lower the dollar, it would raise import prices for the consumer. Would we not

risk increased inflation under such a scenario?

A.2. AFBF does not support pursuing an aggressive policy to lower

the dollar. Such a policy is not likely to be effective in today’s technology-based global economy wherein massive intervention would

be required, but would not have long lasting effects. We remain

concerned, however, with the actions taken by some U.S. trading

partners to intervene repeatedly in international exchange markets

in a concerted attempt to devalue their currencies vis-a`-vis the dollar and believe that the United States should respond to these currency manipulation attempts by other countries.

AFBF believes that the value of the dollar should be set by the

market without interference by either our Government or a foreign

government trying to manage the dollars value it to achieve a certain economic outcome.

Thank you very much for the opportunity to clarify our position

on this issue.

RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING

FROM ERNEST H. PREEG

Q.1. What happens if the Secretary decides to ‘‘talk down’’ the dollar, but foreign investors still look at our economy as the strongest

in the world and the best return for their investment? Won’t the

foreign investors still send their money here, and keep the dollar

at a high rate against other currencies?

A.1. The phrase ‘‘talk down’’ is ambiguous. If it implies follow-up

actions, such as large and persistent United States official financial

market intervention to bring the dollar rate down below a marketbased rate (as do Japan and China, for example), such a statement

would make foreign investors hesitate in anticipation of such a

‘‘manipulated’’ lower dollar. I oppose such a talk down/intervention

strategy, and I do not believe Secretary O’Neill has any intention

of doing so. If, in contrast, ‘‘talk down’’ simply means a personal

assessment by the Secretary that market forces are likely to lead

to a lower dollar, related to the unsustainability of the record trade

deficit, investors would likely maintain their existing assessment

141

as to whether the U.S. economy offered the best rate of return on

their investments.

Q.2. If the Treasury went to an aggressive policy to lower the dollar, it would raise import prices for the consumer. Would we not

risk increased inflation under such a scenario?

A.2. If the dollar declined for any reason, import prices would rise

for the consumer, and there would be some corresponding rise in

the overall rate of inflation. In the context of a 10–20 percent decline in the dollar, however, it would be a relatively small, one-time

upward blip in the inflation trend.

RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING

FROM STEVE H. HANKE

Q.1. What happens if the Secretary decides to ‘‘talk down’’ the dollar, but foreign investors still look at our economy as the strongest

in the world and the best return for their investment? Won’t the

foreign investors still send their money here, and keep the dollar

at a high rate against other currencies?

A.1. If the Secretary decides to ‘‘talk down’’ the dollar, which I believe would be imprudent, net financial flows that favor the United

States would be disrupted temporarily and the dollar would probably weaken temporarily. But if rates of return on capital, adjusted

for risk, are anticipated to be superior in the United States, net financial flows will continue to favor the United States. Given that

the United States has a floating exchange rate regime, the value

of the dollar is determined in the market. It is on autopilot. Accordingly, under the scenario sketched above, the current account deficit as a percent of GDP will continue to increase and so will the

dollar’s nominal exchange rate. This should not be cause for alarm.

It would simply be a reflection of the superior underlying economic

fundamentals in the United States vis-a`-vis those in the rest of the

world.

Q.2. If the Treasury went to an aggressive policy to lower the dollar, it would raise import prices for the consumer. Would we not

risk increased inflation under such a scenario?

A.2. On the assumption that the U.S. Treasury possesses the policy

levers to aggressively lower the value of the dollar—a highly questionable assumption—and that these bear fruit, the dollar would

weaken and import prices would rise for the consumer. And, yes,

inflation would be higher than would otherwise be the case. This

set of events would tend to motivate the Federal Reserve to attempt to fight inflation with higher short-term interest rates. This

would bring forth howls of protest from those who advocate an aggressive Treasury policy to lower the value of the dollar because

many of the ‘‘weak dollar’’ advocates also tend to embrace ‘‘low’’

interest rate policies.

142

PREPARED STATEMENT OF THE

AMERICAN FOREST & PAPER ASSOCIATION

MAY 1, 2002

The American Forest & Paper Association (AF&PA) appreciates the opportunity

to comment on how U.S. exchange rate policies are negatively impacting the forest

products industry. The wood and paper products business is highly sensitive to exchange rate fluctuations. The Committee’s long-term engagement on this issue has

been helpful in focusing attention on trade and exchange rate linkages and their

effect on the global competitiveness of the U.S. economy. Our statement today will

recommend additional measures which, we believe are necessary to correct

unsustainable trade and exchange rate imbalances—and restore the ability of American manufacturing to fuel U.S. economic growth.

AF&PA is the national trade association representing the forestry, pulp, paper,

paperboard and wood products industry in the United States. This industry accounts for approximately 7 percent of total U.S. manufacturing output and employs

approximately 1.5 million people in 42 States, with an annual estimated payroll of

$64 billion. Industry sales exceed $250 billion annually in the United States and

export markets. AF&PA’s membership encompasses the full spectrum of U.S. businesses ranging from small family owned manufacturing and tree farm businesses

to large integrated companies.

Many of the leading economists, including several represented at today’s hearing,

believe the U.S. dollar is currently overvalued relative to a basket of major currencies—and that the extent of the imbalance is somewhere around 25–30 percent.

We agree that it is substantial.

At these levels, U.S. industry is, in effect, paying a 30 percent ‘‘overvalued dollar

tax’’ on all shipments—whether they are going to foreign or domestic customers.

Few U.S.-based producers can compete for long under those circumstances. Just a

few of the devastating effects of this ‘‘tax’’ are described in the following examples:

• Our companies have had to exit export markets they have served for decades. For

example, United States kraft linerboard exports to Europe have plunged by 48

percent in the 1997–2001 period, to $207.6 million. At the same time, U.S. hardwood exporters have lost key European markets based solely on the price differential caused by the value of the dollar. The U.S. product is of a higher quality and

its delivery is more reliable than other competitors who are now taking market

share based on price alone. And, new Eastern European production facilities are

now being constructed to ensure that U.S. manufacturers do not retake that market share when the Euro-dollar exchange rate returns to balance.

• Simultaneously, competitors have been taking advantage of their relatively cheap

currencies to capture an ever-widening share of the U.S. domestic market. Over

the period 1997–2001, United States imports of European coated printing paper

soared by 50 percent, to $730.6 million. In the 1997–2000 period, imports took

more than 90 percent of the growth in the U.S. paper market. (Exhibit 1)

• Similarly, the wood products sector has also been battered by cheap imports,

which has resulted in a ripple effect across manufacturing interests. The domestic

furniture industry, one of the largest traditional users of hardwood lumber and

veneer, has been contracting rapidly as a result of substantial lower priced furniture imports. (Exhibit 2)

• As a result, the U.S. net imports of paper and of wood products have more than

doubled from a negative $6 billion in 1997 to a negative $13.6 billion last year.

(Exhibit 3)

During this period, none of the factors which shape the underlying competitiveness of the U.S. forest products industry have changed—except the value of the

dollar. On the contrary, our companies have scrapped uneconomic capacity and

upgraded technology to significantly improve competitive performance. Nevertheless,

a report by Salomon-Smith-Barney states that the exchange rate is robbing U.S.

paper companies of their long-held competitive advantage vis-a`-vis European producers. (Exhibit 4) The report further states that companies will not return to profitability unless and until exchange rates are adjusted to more appropriate levels.

The combined effect of weakening export markets and surging imports has put

unprecedented downward pressure on paper and wood product prices. Faced with

this kind of challenge, the only option available to many of our companies is to close

mills. Since 1997, American paper companies have had to close 72 mills or an average of 14 mills per year—compared to an average of less than four in the early

1990’s. (Exhibit 5) Employment at paper industry mills has declined by 32,000 jobs

since 1997. (Exhibit 6) In the last year alone, more than 20 wood processing faciliVerDate 11-MAY-2000 11:02 Mar 31, 2003 Jkt 000000 PO 00000 Frm 00146 Fmt 6633 Sfmt 6621 85735.TXT SBANK4 PsN: SBANK4
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ties with a capacity of 1.7 billion board feet were shutdown permanently. In the last

3 years, the wood sector has lost 51,000 jobs. (Exhibit 7) These were high paying

jobs in rural communities where wood and paper manufacturing mills serve as the

backbone of small-town economies.

Data prepared by the National Association of Manufacturers (NAM) shows an estimated 500,000 jobs lost since mid-2000 as a result of the drop in manufactured

goods exports. This job loss was principally due to the overvalued dollar and makes

clear that this pattern is not unique to the forest products industry but is repeated

in sectors as diverse as automobiles, aerospace, steel, textiles, and machine tools to

name a few.

Looking ahead, there are no signs of future improvement. U.S. producers of wood

and paper products are closing capacity here in the United States while foreign competitors—especially in Europe and East Asia—are rapidly building more, often with

their government’s financial support.

The real long-term danger is a hollowing out of American industry as a result of

the persistence of an overvalued dollar. This is what adds a compelling urgency to

our call for action today.

The American Forest & Paper Association supports policies that encourage exchange rates to be set by market fundamentals. But, when other countries are

purposely taking action to keep their currencies artificially low, the United States

must step in to ensure that the dollar is not overvalued as a result of these nonmarket actions by foreign governments. We believe U.S. exchange rate policy must

address two major sources of dysfunction in currency markets:

• A widespread perception in exchange rate markets that there is no upper boundary to United States support for the dollar.

• Manipulation of currencies by U.S. trading partners for competitive advantage.

In currency markets, rhetoric matters. The statements by U.S. Treasury officials

indicating a totally hands off attitude toward the value of the dollar have resulted

in a widespread belief that there is no point at which the U.S. Government will

consider taking any action to stop the rise. Signals from the U.S. Treasury that it

supports a sound dollar consistent with the competitive fundamentals of the U.S.

economy would go a long way toward erasing the current expectation that the dollar

will continue to rise in value.

Currency Manipulation

Ambassador Ernest Preeg has provided solid empirical evidence of currency manipulation by U.S. trading partners—and its effect on the U.S. economy. In a recent

12 month period, East Asian economies had a cumulative current account surplus

of $218 billion, while their central banks together added an aggregate $165 billion

in foreign exchange reserves. Japan alone has accumulated $95 billion in foreign

reserves. This means that about three-quarters of the net foreign exchange inflow

resulting from Asian current account surpluses was taken off the market through

central bank purchases, with the result of lower exchange rates and larger trade

surpluses than otherwise would have been the case. The dollar share of the aggregate foreign reserve accumulation was estimated at 80 to 90 percent.

Japanese officials also have been actively talking down the yen. In recent months,

China has become more outspoken in calling attention to the effect Japanese policies could have on the global economy, by triggering a race to the bottom among

key Asian countries that compete with Japan for export markets.

Provisions in the Trade Act of 1988 requiring surveillance of exchange rate policies by U.S. trading partners have undoubtedly had a positive effect in addressing

more egregious practices. However, the data cited above make it clear that further

action is needed. The Senate version of Trade Promotion Authority recognizes that

significant or unanticipated changes in exchange rates can negate U.S. market

access gains in trade agreements. The legislation provides for the establishment

of consultative mechanisms among parties to trade agreements to protect against

currency manipulation by foreign governments. We believe this step is necessary to

ensure that, in future trade agreements, the balance of benefits USTR negotiates—

and the U.S. Congress approves—cannot be upset by subsequent exchange rate

manipulation. We strongly support this provision of the bill.

G–8 Collaboration

Concerted action by major economies worked in 1985 with the Plaza Accord and

we believe it can work again today. The G–8 meeting in Canada next month offers

an opportunity for action to address the twin imbalances—the overvalued U.S. dollar and the U.S. trade deficit—which are widely recognized as posing a major threat

to global economic stability. Indeed, the just released IMF World Economic Outlook

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concluded that the overvaluation of the U.S. dollar and the large U.S. current account deficit pose significant risk to the sustainability and durability of the incipient

economic upturn, both in the United States and globally. There are also mounting

indications that some of our trading partners share this concern about trade and

currency imbalances, and might be prepared to work with us to ensure a ‘‘soft landing’’ which minimizes the real economic pain associated with an unmanaged or

‘‘hard landing’’ adjustment.

Such a concerted approach, combined with enhanced Trade Promotion Authority

provisions, would improve the prospects for long-term market-sustainable exchange

market rate equilibrium.

Agreement on a joint plan of action would represent a substantial, positive G–8

outcome. Alternatively, failure to deal with the issue at the G–8, in the face of the

clear warning signals, risks exposing the still fragile United States and the global

economic recovery to an unpredictable and potentially unmanageable market

adjustment.

The Time for Action is Now

There is a striking similarity between the situation in 1985 and today in terms

of the impact of the overvalued dollar on the U.S. economy and the forest products

industry’s trade balance. But there is also an important difference: Today, the U.S.

economy is more dependent on trade than ever before. An indication of this is that

U.S. trade exposure (i.e., total imports and exports) was 17 percent of GDP in 1985,

while today it accounts for 24 percent. The forest products industry reflects this

trend as well. In 1985, the trade exposure for paper was 23 percent, but reached

33 percent in 2001. (Exhibit 8)

Notwithstanding the challenges of the past year, the American economy is sound.

There are increasing signs that the economy is coming out of recession. The incipient recovery will not thrive without a robust and sustainable rebound in U.S.

manufacturing. For the U.S. forest products and other manufacturing industries,

this will require exchange rate policies which ensure that the value of the dollar

is consistent with the underlying economic fundamentals. It will also call for action

to prevent future currency misalignment, which rob our companies of the competitiveness they and their workers have built.

We appreciate the opportunity to present these views and look forward to working

with the Committee and the Administration in reaching solutions that will ensure

a strong and vibrant U.S. forest products industry.

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1We have attached a one-pager on the impact of the dollar on textiles for your review.

PREPARED STATEMENT OF THE

AMERICAN TEXTILE MANUFACTURERS INSTITUTE (ATMI)

MAY 1, 2002

The American Textile Manufacturers Institute (ATMI) submits this statement to

the Senate Committee on Banking in regards to the May 1 hearing on the release

of the Treasury Department’s Foreign Exchange Report. ATMI is the national trade

association of the U.S. textile industry, one of the largest manufacturing sectors in

the United States.

ATMI is writing to describe the devastating impact that the overvalued dollar,

now at a 16 year high, is having on the U.S. textile sector and to urge the Committee and the Administration to take immediate steps to bring the dollar back

down to normal, historic levels.

The U.S. textile industry is suffering its worst economic crisis since the Great Depression. Since the dollar began to surge in value in 1997, over 175,000 textile workers have lost their jobs and over 215 textile plants in the United States have closed.

The Asian currency devaluation in 1997–1998 and the ‘‘strong U.S. dollar’’ policy

instituted at that time are the root cause for this devastation. As of last year, the

dollar had increased in value by an average of 40 percent against the leading Asian

textile exporting countries. Prior to the dollar’s surge, the U.S. textile industry was

enjoying some of its best years in history and recording new highs for shipments,

profits, and exports.

Since that time, the strength of the dollar has allowed Asian exporters to cut their

prices by an average of 23 percent and caused Asian textile and apparel exports to

the United States to increase by an astonishing 6 billion square meters, an increase

of 65 percent.

As a result, U.S. textile profits have virtually disappeared, shipments have declined by 25 percent or $12 billion, exports have fallen by $2 billion and a swath

of misery has spread across the Southeast.1

This impact has hit not only domestic textile manufacturers but U.S. cotton and

wool growers, textile machinery suppliers and man-made fiber manufacturers. It

has also devastated small towns across the Southeast that have depended for generations on domestic textile manufacturing.

In addition, the problem of the overvalued dollar impacts virtually every manufacturing and agriculture sector in the United States. The National Association of Manufacturers estimates that half a million manufacturing jobs have been lost in the

last 18 months just from lost export orders. That figure does not include hundreds

of thousands of jobs lost because of a surge in artificially low-priced imports.

We also note that the International Monetary Fund (IMF), the Organization for

Economic Development (OECD), the European and Canadian Central Banks and

even members of the Federal Reserve in the United States have all expressed alarm

over the continuing rise in the dollar’s value.

In February, despite stagnant economic activity, rising imports and a dramatic

jump in the current accounts deficit, the Federal Reserve reported that the dollar

had hit a new high, with a 31 percent increase in value against the world’s major

currencies since 1997.

It is clear that economic fundamentals are being overridden by a belief in the

market that the U.S. Treasury will act to support a ‘‘strong dollar.’’ This policy is

now having a devastating impact on the textile sector.

The last time the dollar surged to such heights was in the mid-1980’s during the

Reagan Administration. At that time, Treasury Secretary Jim Baker took strong

action, in concert with other major trading nations, to restore the dollar to sound,

stable levels. That action set the stage for a decade of dollar stability and U.S.

export growth.

ATMI firmly believes that for the textile crisis to end and for the industry to return to health, the U.S. Government must act to return the dollar to its normal,

historic range. We strongly urge the Committee and the Administration to act

quickly to accomplish this.

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PREPARED STATEMENT OF THE COALITION FOR A SOUND DOLLAR

MAY 1, 2002

Mr. Chairman, we the undersigned organizations comprising the Coalition for a

Sound Dollar appreciate the opportunity to submit a statement for the record for

the Committee’s May 1, 2002 hearing on the release of the Treasury Department’s Foreign Exchange Report.

The Coalition represents a broad array of manufacturing and agricultural interests which employ millions of U.S. workers and which have been deeply impacted

by the overvaluation of the U.S. dollar over the past 5 years. As of this date, job

losses from the overvalued dollar are almost certainly in excess of three-quarters of

a million U.S. workers.

Indeed, the damage caused by the dollar’s prolonged surge has become so great

that U.S. manufacturing and agriculture, two fundamental legs of the U.S. economy,

are unlikely to rebound as a result of the economic recovery. Recent statistics show

that despite a surge in first quarter GDP, durable goods orders and business investment remain down and that the bump up caused by inventory restocking was a one

time event. In addition, despite increased economic growth overseas, both manufacturing and agricultural exports have continued to decline.

The Coalition members believe that a sound dollar is a fundamental prerequisite

for maintaining a healthy United States and global economy. A sound dollar is one

whose value relative to other major currencies is determined by market forces that

reflect fundamental economic trends, such as trade balances, interest rates, GDP

growth, and other objective indicators of a country’s performance.

The disturbing reality is that for several years the dollar has not been reflecting

economic fundamentals. In 1997, after 8 years of stability, the dollar began to appreciate sharply against other major currencies. The appreciation has continued despite

a U.S. economic downturn, a yawning current accounts deficit and, in many cases,

higher comparable GDP growth overseas. Today, the dollar stands 30 percent higher

than in 1997—its highest level in 16 years. The dollar is now approaching the

calamitous levels last seen in 1985, which provoked intervention on an international

scale.

As a result of the 30 percent dollar ‘‘tax,’’ many U.S. made goods have been literally priced out of markets at home and abroad. For example, U.S. manufacturing

exports have dropped by an annual rate of more than $140 billion over the past 18

months. The National Association of Manufacturers estimates that half a million

manufacturing jobs have disappeared simply as a result of the export decline, principally due to the fact that the dollar has taxed U.S. exporters, rightly proclaimed

by the U.S. Government as the most productive in the world, out of market after

market.

Indeed, the conventional wisdom that the U.S. advantage in high-technology products is a key to future U.S. economic growth has been gutted by the dollar’s impact.

U.S. Government statistics show that over the past 5 years, a healthy U.S. surplus

in these products has vanished into a deficit of $20 billion.

Winners of the President’s vaunted ‘‘E-awards’’ given to top U.S. exporters have

not been spared either. In letters sent to Secretary O’Neill, these E-award winners,

among many other top exporters, said:

• ‘‘The value of the U.S. dollar now makes us uncompetitive in almost all world

markets . . . The 30 percent change in currency value is making us uncompetitive

even in our own home market. We are a small business with our only manufacturing facility in South Dakota. We have been forced to make substantial layoffs

of production and support personnel to adjust to this catastrophic problem.’’

• ‘‘The strength of the dollar has had a profound effect upon our business, especially

in the area of employment. A year ago at this time we employed 1,625 people in

the Green Bay area. Today that number is down by over 500 people . . . As this

environment of a strong dollar has continued, we have been forced to consider relocating our manufacturing capabilities offshore.’’

U.S. agriculture, which suffers from the same ‘‘Made in the U.S.A.’’ dollar tax,

estimates that nearly 100,000 agricultural workers have been displaced because of

the overvalued dollar. From cotton to rice to wheat, the U.S. breadbasket is seeing

its major export markets dwindle and imports increase because of the dollar’s sustained rise.

The damage extends to industries where there have been significant import

surges with the overvalued dollar acting as an enormous import subsidy. Sectors

such as textiles, paper and forest products, automobiles, nonferrous castings, steel

and furniture have, in total, lost hundreds of thousands of workers as imports have

ridden the currency wave by cutting prices or increasing incentives. Many of these

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jobs have been lost in rural communities that often depend on local manufacturing

or agricultural as their major source of employment.

In particular, textiles have seen Asian prices drop by an average of 23 percent

since 1997—prior to 1997, Asian prices were showing moderate growth. Since the

dollar’s rise, job losses in the textile sector have totaled more than 175,000.

U.S. automakers are being forced by the dollar penalty to pay out billions of dollars in incentives in an expensive effort to slow a sharp decline in market share.

At the same time, they are being treated to reports of record profits by Japanese

automakers who have tacked billions of dollars in currency-generated profits to their

bottom lines.

Paper mills, many with state-of-the-art equipment, have been closed by the dozen

as dollar-cheapened imports now take 90 percent of the growth in the U.S. paper

market.

The truth is that the overvalued dollar is increasingly forcing manufacturing permanently off-shore as well as displacing increasing numbers of farmers. Jobs, not

goods, are now being exported as a result of the dollar tax.

Long term, a 30 percent dollar tax on goods produced in this country is simply

not by the majority of U.S. companies and farmers. A key policy question for this

Committee and the Government is whether shrinkage of the U.S. manufacturing

and agriculture base is an acceptable cost for supporting the out-of-kilter dollar.

The Coalition contends that the U.S. Treasury’s policy of a ‘‘strong dollar’’ regardless of economic fundamentals or the dollar’s cost to U.S. workers and their families

is not good or sound policy. Indeed, this policy has already led to an increase in the

current accounts deficit to new record highs, now almost 4.5 percent of U.S. real

GDP, more than triple the deficit’s level before the dollar began to rise in 1997.

The Coalition notes that Secretary O’Neill, in his previous incarnation as President of International Paper during the 1980’s run-up in the dollar’s value, complained that the dollar ‘‘had turned the world on its head.’’ Today, when the dollar

is now reaching the very heights it did during 1980’s, the Secretary calls U.S. manufacturers ‘‘whiners,’’ expressing ‘‘no sympathy’’ for the burdens the overvalued dollar

policy has created. This is not the message that hard-working American families

should be hearing.

We firmly believe that sound currency values can be restored and that manufacturing and agriculture can again thrive in this country. To do this, the Treasury

should:

• State publicly that the dollar is out of line with economic fundamentals.

• Firmly state that its policy is to seek a market-determined dollar that is consistent with underlying global economic fundamentals, including the competitiveness of America’s farms and industries.

• Seek cooperation with other major economies in obtaining common agreement and

public statements that their currencies need to appreciate against the dollar.

• Make clear that the United States will resist, and take offsetting action as necessary, foreign country interventions designed to retard movement of currencies

toward equilibrium.

The Coalition notes that when the Treasury faced a similar situation more than

15 years ago, it took decisive and successful action. In crafting the ‘‘Plaza Accord’’

of 1985, Treasury Secretary James Baker was able to restore currency equilibrium

and launched renewed global growth. It was possible then, and is possible now.

Sincerely,

Aerospace Industries Association

American Brush Manufacturers Association

American Cotton Shippers Association

American Fiber Manufacturers Association

American Forest & Paper Association

American Furniture Manufacturers Association

American Hardware Manufacturers Association

American Iron and Steel Institute

American Paper Machinery Association

American Pipe Fittings Association

American Textile Machinery Association

American Textile Manufacturers Institute

Associated Industries of Florida

The Association for Manufacturing Technology

Automotive Trade Policy Council

Business and Industry Association of New Hampshire

The Business Council of New York State

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The Business Roundtable

The Carpet and Rug Institute

Composite Can and Tube Institute

Copper and Brass Fabricators Council

Fiber Box Association

Industrial Fabrics Association International

IPC—Association Connecting Electronics Industries

Mississippi Manufacturers Association

Motor and Equipment Manufacturers Association

National Association of Manufacturers

National Cotton Council of America

National Marine Manufacturers Association

New Jersey Business and Industry Association

Non-ferrous Founders’ Society

North Carolina Citizens for Business and Industry

North Carolina Manufacturers Association

Ohio Manufacturers Association

Packaging Machinery Manufacturers Institute

Paperboard Packaging Council

Precision Machined Products Association

Process Equipment Manufacturers’ Association

Secondary Materials and Recycled Textiles Association

Southern Forest Products Association

Steel Manufacturers Association

Textile Distributors Association

Tooling and Manufacturing Association

USA Rice Federation

Utah Manufacturers Association

Virginia Manufacturers Association

Waste Treatment Technology Association

Wheat Export Trade Education Committee

Wood Component Manufacturers Association

Wood Machinery Manufacturers of America

For more information about the Coalition for a Sound Dollar, contact Frank Vargo

at 202–637–3182 or visit the Coalition’s website at www.sounddollar. org.

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