The dollar's shrinking value could correct some imbalances arising from huge US trade deficits and the decline may have further to go, the International Monetary Fund's chief economist said on Tuesday.
Raghuram Rajan, who leaves his post at year-end to return to teaching at the University of Chicago, said in an interview that under the global lender's auspices progress was being made in reducing imbalances that are a risk to the global economy.
"In the medium term, some depreciation of the dollar could be consistent (with), or facilitate the process of adjustment of the imbalances," Rajan said, adding "The question is what is the medium term that the markets have in mind."
He said leading economic powers must stay focused on their task of keeping the global economy growing and not be swayed by short-term fluctuations. "We should keep a steady focus on this and not just worry when the dollar gets volatile," Rajan said. The dollar tumbled in the past two weeks before regaining its footing on Monday. It lost about 3 percent of its value against the euro in the two weeks.
That happened despite Treasury Secretary Henry Paulson's statement in London a week ago that "a strong dollar is clearly in our nation's interest." Paulson added that he felt "very good" about the US economy's health.
The dollar's recent drop seemed to stem from a mixed batch of indicators about economic prospects as well as queasiness about the persistent US deficits. But Rajan said trends should not be gauged from short-term movements, which can be affected by market vagaries.
There is a potentially positive side. A cheaper dollar makes imports more costly, leading to hope that it might help reduce the US trade deficit. The US trade deficit topped $700 billion last year and is headed higher this year, heightening pressure on Paulson to make sure key trade partners like China play fair and making dollar depreciation a virtue if it means fewer imports. The deficit with China alone last year was over $200 billion.
Paulson is leading a high-level delegation to Beijing for meetings with Chinese officials December 14-15 to try to persuade them to buy more US goods and to let their yuan currency rise in value - which might make Chinese-made goods less attractive to American shoppers.
Rajan, the IMF's top economist since mid-2003, said progress was being made in efforts to have the United States, China, Japan, the euro zone and Saudi Arabia focus on steps they could take to reduce some of the imbalances. He said participants in global imbalance talks know what they need to do and that, at a minimum, the imbalances were not growing as they did in the past.
"I don't think we are in the situation by any means where we were, maybe two or three years ago, when there wasn't this shared understanding of what needed to be done," he said.
A concern cited in markets during the dollar's recent weakness was that countries left with a hoard of US dollars - like China - might grow nervous about the size of their holdings and decide to sell some off, putting pressure on banks and the global financial system.
Rajan doubted that was likely. If China, for example, sold US dollar-denominated assets in big volumes, that might push the dollar's value down and the yuan up so that Chinese-made exports became less competitive. It would also erode the value of the dollar assets that China still held.
"It doesn't seem to me clear that they have a free hand in deciding how much diversification they want without, in the process, also affecting the value of their currency against the dollar," he said. "This notion that they are going to diversify out of the blue without any other consequences is a little far-fetched."
"I think that diversification, as and when it takes place, is going to be a more measured process," he added, "rather than something that roils the market overnight."
A principal argument for China to take steps to boost domestic demand and to slow the growth in its dollar reserves is that it would help Beijing get control over its own monetary policy, Rajan noted. Chinese officials have acknowledged they are moving toward a market-based exchange system eventually and Rajan said the IMF takes some credit for that.
"I think the argument that exchange rate flexibility is critical for China to regain more monetary control is an argument that emanated from here....it was a central part of our argument," he said.
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