commentary

(Pittsburgh Post-Gazette)

May 8, 2005

The Falling Dollar: A Silver Lining for Pittsburgh

by Barry Balmat and Keith Crane

With the dollar falling, inflation accelerating, interest rates rising and growth slowing, the U.S. economy is in the midst of what could be a painful economic adjustment, triggered by historically high trade and budget deficits. But there is a silver lining in this cloud because corporations in Pittsburgh and around the United States can benefit from a more competitive dollar.

The good news about the falling value of the dollar is that it is creating a rising demand for U.S. exports. Over the past 24 months, U.S. manufacturers have had a respite from hammering by foreign competition, especially European manufacturers of machinery and equipment.

Manufacturing costs are still under control, and with an ample supply of high quality products U.S. exporters have regained ground against European competitors. Such Pittsburgh-based corporations as U.S. Steel and Alcoa are already benefiting from the more competitive dollar.

American steel exports have risen by 49 percent in the past year. However, there is still a long way to go. U.S. exports would have to rise by $620 billion — or by more than half — to close the trade gap. Traditional Pittsburgh products and services will play a role in restoring balance.

While in the past the dollar was king, the new European currency called the euro is beginning to play the role of upstart prince. In the future, contracts, trade credits and invoices are as likely to be denominated in euros as dollars. Although U.S. exporters are benefiting from the decline of the dollar, they will also need to adapt to the new global role of the euro in business and trade.

A number of leading U.S. corporations have already adjusted their accounting, financial management and European operations to adapt to the expanding role of the euro. Successful strategies will be discussed at a conference sponsored by the Rand Corp. and the European Commission of the European Union, "Doing Business with the Euro," in Pittsburgh on May 18. (See www.rand.org/events/doing_business_with_the_euro.html for details).

Speakers will include former U.S. Treasury Secretary and Alcoa Chairman Paul O'Neill, PNC Financial Services Group Chairman and CEO James Rohr, Rand Corp. President and CEO James Thomson, U.S. Chamber of Commerce Vice President Gary Litman, Bayer Corp. President and CEO Atilla Molnar, and Allegheny Technologies President and CEO L. Patrick Hassey. European speakers include European Commission Ambassador John Bruton, European Commission Minister of Financial Affairs Herve Carre, and Representative of the European Central Bank to the International Monetary Fund J. Onno de Beaufort Wijnholds.

The conference will focus on how corporations and financial institutions in the Pittsburgh region and throughout the United States can boost exports and profits by taking advantage of opportunities created by the falling value of the dollar compared with the rising euro.

Since 2001, the U.S. government has supplanted the private sector by sucking in foreign capital to finance burgeoning budget deficits. Over the course of the last quarter century, the United States has become the world's largest debtor. The value of the foreign loans to and foreign investments in the United States now roughly equal U.S. output.

To rectify these imbalances, the United States will have to export more and import less. The adjustment process is already under way. Private foreign investors, eyeing the soaring budget and trade deficits, have been dumping the dollar. Over the past three years, the dollar has fallen by as much as a third against the euro, the yen, the peso, the pound, and the ruble. Interest rates have had to rise to keep foreign investors interested in U.S. debt.

The falling dollar has pushed up the cost of imports, contributing to the recent acceleration in inflation from 1.8 percent in March 2004 to 3.2 percent in March 2005. OPEC has pushed for higher oil prices to offset the fall in the value of the world's currency. Interest rates have risen, as investors have demanded higher rates of return.

The rise in interest rates bodes ill for the U.S. construction industry, one of the brightest spots in the U.S. economy over the past three years. Higher interest rates may soon explode the bubble in housing prices, especially in the hottest markets. More rapid inflation and rising interest payments already slowed U.S. economic growth in the first quarter.

Sources of foreign financing of the U.S. budget deficit are becoming increasingly concentrated. East Asian central banks, especially the People's Bank of China and the Bank of Japan, are purchasing most of the dollars needed to finance the deficit. But East Asian central bankers are taking an increasingly jaundiced view of continued purchases of dollar assets, giving serious consideration to diversifying their assets.

In the past, some believed foreign central banks and foreign investors would continue to provide low-cost capital to the United States indefinitely despite the falling dollar because there were no alternatives. But since the birth of the euro on January 1, 1999, the U.S. dollar is facing a more muscular competitor than in the past. Investors now have a widely traded, increasingly valuable alternative to the dollar.

The adjustment process may be delayed, but cannot be avoided. Foreign central banks and investors will not finance large U.S. budget deficits at current interest rates indefinitely. U.S. savings will have to rise and growth in consumption slow as our own savings supplant funds provided by foreign investors.

By better understanding the post-euro economy and the opportunities and risks it has created, business executives in Pittsburgh and elsewhere in the United States will be better able to compete in the changed world economy.


Barry Balmat is director of the Rand Corp.'s Pittsburgh office. Keith Crane is a senior economist at the think tank, which seeks solutions to problems worldwide.

This commentary originally appeared in Pittsburgh Post-Gazette on May 8, 2005. Commentary gives RAND researchers a platform to convey insights based on their professional expertise and often on their peer-reviewed research and analysis.