San Diego Union-Tribune, January 10, 1999
Knight-Ridder/Tribune Media Services, January 4, 1999
Economists seem to have a special talent for conjuring up new and exotic threats to our future well-being, much like Calvin (in the cartoon strip Calvin and Hobbes) was always finding new monsters under his bed. The ones that seem to get the most play are generally about as dangerous, in reality, as Calvin’s monsters.
First there was the federal budget deficit, which seems to have disappeared of its own accord– not that it makes any measurable difference to our economy. Then there were the scare stories about Social Security and how entitlements for the elderly would bankrupt the economy some three decades from now. And the “savings” shortage. And so on.
Now we have the Euro, which is great for scaring people, since most people already feel a little nervous when the conversation turns to subjects like exchange rates and “monetary union.” Or sleepy. Why should Americans care about the Europeans adopting a new, single currency for eleven countries? (It went into effect with the new year).
Well, certainly not for the reasons that are presently being tossed around. Here‘s the number one scare story: the United States dollar is currently the world‘s supreme “reserve currency”– about sixty percent of the world‘s foreign exchange reserves are in dollars. The fear is that the European Union has now created an alternative currency that can rival the dollar as a reserve currency. Central banks, as well as multinational banks and investors, will now have a new place to park their money, and might sell a lot of their dollars to do just that.
Those who are still awake at this point might reply, so what? A lower dollar means that our exports become cheaper, and imports more expensive. This is good for any U.S. industry that has to compete internationally, helps reduce our trade deficit, and stimulates the American economy generally.
The worst side effect of the scare story is that we now have economists, even liberal ones, saying we might have to have higher interest rates in order keep the dollar from falling too much. What a rotten idea! It has taken more than twenty-five years for the Federal Reserve to allow unemployment to sink below 4.5 percent. Now, on the basis of some very bad economic logic, these people would give the Fed an excuse to revert to its previous, high-unemployment policies.
Some background will help to explain what‘s at stake here. In the United States, the Federal Reserve is able to pretty much determine the rate of unemployment, and the rate of growth of the economy, through its control over short-term interest rates. Until four years ago, the Fed held to the theory that six percent unemployment was about “as good as it gets,” without stoking the fires of inflation.
The economic growth of the last four years swept that theory into the trash heap, as unemployment fell steadily to its present 4.3 percent, while inflation actually declined, rather than rising. Although most people don‘t realize it, this is probably the most important change in economic policy in the past twenty years. We have some $300 billion in additional income, and at least three million more people employed today, as a result of that change.
But the Fed never announced any formal change in policy. In fact its last three interest rate cuts were driven by crisis management: the fear was that the effects of global financial turmoil would spread to the United States and set off a recession here. So what the Fed giveth, it can easily taketh away– if the storm clouds hovering over the international financial system should ever subside.
There is of course a coalition of powerful interests that sees a strong dollar as more important than creating jobs or stimulating economic growth in the United States. This includes the big bondholders favored by the Fed, for whom inflation is the only enemy; as well as some multinational corporations for whom an overvalued dollar means better bargains for hiring labor or buying factories overseas.
But there is no reason for anyone else to believe that the introduction of the Euro, or any other development overseas, should constrain American interest rate policy. We can set our own economic priorities, and the first priority of monetary policy should be full employment– even though we are still a long way from getting the Fed to agree.