The dollar is down sharply. Should we be writing about its collapse?

By Kenneth Rogoff

krogoff@harvard.edu

Q. Is there a real threat of a dollar collapse?

Q. If it does collapse, how far might it fall and what will it mean for most Americans?

Yes, the threat is real. The big problem is that the United States government has been borrowing record amounts from the rest of the world, $600 billion in 2004, almost 6 percent of US income (Gross National Product). 

The United States is soaking up 75 percent of the current surpluses of China, Japan, Germany, and of all the world’s other surplus countries. It is unprecedented and unlikely to continue, especially given that a large part of the deficit is due to government borrowing (federal, state and local), rather than real investment that might lead to future growth to help pay off the debts.

Fed chairman Alan Greenspan argues that the fall will be easily absorbed thanks to today’s highly developed financial markets. But this will not be the case if the dollar decline takes place in an adverse global environment, a high probability given the terrorism and the open-ended security costs the United States is facing, oil price pressures, and the need to rebalance today’s extraordinarily expansionary monetary and fiscal policies.

Ordinary Americans may not be hurt much at first. But eventually prices of imported goods will rise proportionately to the dollar’s decline, so that even Wal-Mart will not seem so cheap. Europeans and Asians, on the other hand, will view the US as a giant discount store. They will likely go on a spending spree that includes not only US goods and services, but US companies and real estate.

Conversely Americans, who are already finding it more and more expensive to go abroad, will really notice the difference. Countries such as Switzerland will become prohibitive. Even countries in Latin America, where tourism is reasonably priced today, will seem expensive. US income, which today constitutes 22 percent of world output, will shrink to 18 percent of world output (at market exchange rates). An exchange rate collapse will significantly raise the cost to the United States of maintaining a large military presence abroad.

Kenneth Rogoff is Thomas D. Cabot Professor of Public Policy and Professor of Economics at Harvard University, as well as Director of the Harvard Center for International Development. E-mail: krogoff@harvard.edu

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