The major global economic issue at the outset of the new millennium is likely to be a gradual decline in the exchange rate of the dollar. There are at least three reasons for this prospect.
First, the US's current account deficit will rise to about $300 billion (€283 billion). This equates to about 3.5 per cent of the country's GDP, roughly the same level reached at the previous peak in the middle 1980s - after which the dollar fell by more than 50 per cent against both the deutschmark and yen. The deficits are already at record levels in dollar terms. The net foreign debt of the US will rise to almost $2 trillion.
Second, the rise in the US deficit will intensify a wide range of protectionist trade pressures there. The steel industry is already seeking comprehensive relief. Machine tools, semiconductors, shipbuilding, textiles and several agricultural sectors may not be far behind.
If US economic growth slows enough to push unemployment up by even a modest amount, as seems likely, the trade deficit will be blamed for "exporting jobs" and the pressure on trade policy will become intense.
The likelihood of a sympathetic reaction by the Clinton Administration is highlighted by its acknowledged debt to organised labour, for delivering the money and votes that helped the Democrats to two Presidential victories, and for supporting Vice-President Gore's presidential campaign for 2000. These protectionist pressures will focus media and public attention on the trade deficit, as will the Clinton Administration's effort to win Congressional approval for new "fast-track" trade negotiating authority.
Particular concern will be expressed about Japan and China, with which the US's bilateral imbalances are soaring to record levels. Market attention to the external deficit will escalate sharply as a result.
Previous US efforts to reduce its deficits via dollar depreciation will be recalled. This series of events will add to the prospect of a gradual dollar fall.
Third, the strengthening of the euro could be the proximate trigger for the next phase of the dollar's decline. It is now widely agreed that the euro is a major global currency, perhaps eventually challenging the dollar for global financial supremacy.
The US will either have to adjust to this new reality or conduct a series of rear-guard defensive actions that will be increasingly futile and costly - like the British did for many decades as their leadership role declined.
The EU and US therefore need to devise new strategies and institutional arrangements to manage both their bilateral economic relations and global economic issues. Such strategies can be constructed with or without a "common European foreign policy" that embraces traditional security issues; the EU itself has integrated far faster economically than it has politically. The US trade deficit and the likely worldwide shifts of capital into the euro will push the euro up against the dollar during the next 12 months. In turn, a stronger euro will hurt Europe's competitive position and seriously exacerbate its unemployment problem, while the weaker dollar would push US prices and interest rates upward adding to tensions between the EU and US. The European Monetary Union (EMU) project is in the interest of the US. Monetary union will equip the European Union to extend economic and political stability to the central and eastern Europe region in which the US would otherwise be called upon to play a stronger role. The euro will also benefit US firms and customers economically, through the reduction in transactions costs and a solid European single market.
In the area of international finance the European Union in the form of the EMU/euro will pose ongoing challenges to the US policy elite.
Although the EU/US relationship in trade looks like it's in trouble, the financial dimension could prove even more disruptive as the euro becomes the major global currency. The euro now represents an economy almost as large as the US and will be even larger when all 15 EU states become members. It enjoys considerably larger trade flows and monetary reserves and can boast a far stronger external financial position as a sizeable creditor area.
In contrast, the US's net foreign debt now approaches $2 trillion. As soon as the European Central Bank establishes its credibility, the euro will become a global financial asset and produce a portfolio diversification from dollars into euros by private investors and central banks that could ultimately reach $1 trillion.
The official US position states that the creation of the euro is good for the US if it is good for Europe. This is correct but banal, given the strong impact that the euro could have on the fundamental economic variables on both sides of the Atlantic. At a minimum, the two sides need to agree on a dollar-euro range that would reflect their respective domestic economic conditions.
Economist Dr John Ryan is a euro specialist with PA Consulting Dublin.
