The free fall of the dollar in the late 1970s forced the US to tighten monetary policy and address its budget deficits, commencing the correction of double-digit inflation.
In the mid-1980s, large current account deficits and a sharp dollar decline helped produce initial cuts in budget deficits.
Most importantly, the recent crash came after record imbalances had seen huge capital inflows into the US, keeping monetary conditions loose and interest rates low.
Fred Bergsten, FT February 15 2011
Now America can terminate its reliance on debt-financed consumer demand, and sustain recovery, only by a big improvement in its trade balance and supportive investment. This requires a substantial decline of the dollar, primarily against the renminbi and a few other undervalued Asian currencies, which the dollar’s role impedes.
How to solve the problem of the dollar
The world economy faces an acute policy dilemma that, if mishandled, could bring on the mother of all monetary crises.
Fred Bergsten, FT December 10 2007
The risks ahead for the world economy
Fred Bergsten The Economist print edition Sep 9th 2004
Fred Bergsten is director of the Institute for International Economics in Washington, DC.
His book, “The United States and the World Economy: Foreign Economic Policy for the Next Administration” is forthcoming.
Very Important Article
Five major risks threaten the world economy.
Three centre on the United States:
renewed sharp increases in the current-account deficit leading to a crash of the dollar;
a budget profile that is out of control; and
an outbreak of trade protectionism.
A fourth relates to China, which faces a possible hard landing from its recent overheating.
The fifth is that oil prices could rise to $60-70 per barrel even without a major political or terrorist disruption, and much higher with one.
Most of these risks reinforce each other. A further oil shock, a dollar collapse and a soaring American budget deficit would all generate much higher inflation and interest rates. A sharp dollar decline would increase the likelihood of further oil price rises. Larger budget deficits will produce larger American trade deficits, and thus more protectionism and dollar vulnerability.
Realisation of any one of the five risks could substantially reduce world growth. If two or three, let alone all five, were to occur in combination then they would radically reverse the global outlook.
Fears of a hard landing for the dollar and the world economy are of course not new. The situation is much more ominous today, however, because of the record current-account deficits and international debt, and the high probability of further rapid increases in both. The potential escalation of oil prices suggests a parallel with the dollar declines of the 1970s, which were associated with stagflation, rather than the 1980s when a sharp fall in energy costs and inflation cushioned dollar depreciation (but still produced higher interest rates and Black Monday for the stockmarket).
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