[Senate Hearing 107-881]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 107-881


                   U.S. DEPARTMENT OF THE TREASURY'S
                         REPORT TO CONGRESS ON
                       INTERNATIONAL ECONOMIC AND
                          EXCHANGE RATE POLICY

=======================================================================

                                HEARING

                               before the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                      ONE HUNDRED SEVENTH CONGRESS

                             SECOND SESSION

                                   ON

      THE U.S. DEPARTMENT OF THE TREASURY'S REPORT TO CONGRESS ON 
            INTERNATIONAL ECONOMIC AND EXCHANGE RATE POLICY

                               __________

                              MAY 1, 2002

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs


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                            WASHINGTON : 2003
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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  PAUL S. SARBANES, Maryland, Chairman

CHRISTOPHER J. DODD, Connecticut     PHIL GRAMM, Texas
TIM JOHNSON, South Dakota            RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island              ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York         WAYNE ALLARD, Colorado
EVAN BAYH, Indiana                   MICHAEL B. ENZI, Wyoming
ZELL MILLER, Georgia                 CHUCK HAGEL, Nebraska
THOMAS R. CARPER, Delaware           RICK SANTORUM, Pennsylvania
DEBBIE STABENOW, Michigan            JIM BUNNING, Kentucky
JON S. CORZINE, New Jersey           MIKE CRAPO, Idaho
DANIEL K. AKAKA, Hawaii              JOHN ENSIGN, Nevada

           Steven B. Harris, Staff Director and Chief Counsel

             Wayne A. Abernathy, Republican Staff Director

                  Martin J. Gruenberg, Senior Counsel

                Thomas Loo, Republican Senior Economist

   Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator

                       George E. Whittle, Editor

                                  (ii)


                            C O N T E N T S

                              ----------                              

                         WEDNESDAY, MAY 1, 2002

                                                                   Page

Opening statement of Chairman Sarbanes...........................     1

Opening statements, comments, or prepared statements of:
    Senator Bunning..............................................     2
    Senator Johnson..............................................     2
    Senator Miller...............................................     3
    Senator Corzine..............................................     4
    Senator Akaka................................................     4
    Senator Gramm................................................    12
    Senator Stabenow.............................................    51
    Senator Hagel................................................    51

                               WITNESSES

Paul H. O'Neill, Secretary, U.S. Department of the Treasury......     4
    Prepared statement...........................................    52
        Report to Congress.......................................    57
        Response to written question of Senator Akaka............   137
Richard L. Trumka, Secretary-Treasurer, American Federation of 
  Labor and Congress of Industrial Organizations.................    25
    Prepared statement...........................................    66
        Report submitted.........................................    68
        Response to written questions of Senator Bunning.........   137
Jerry J. Jasinowski, President, National Association of 
  Manufacturers..................................................    27
    Prepared statement...........................................   101
        Response to written questions of Senator Bunning.........   138
Bob Stallman, President, American Farm Bureau Federation.........    29
    Prepared statement...........................................   115
        Response to written questions of Senator Bunning.........   139
C. Fred Bergsten, Director, Institute for International Economics    31
    Prepared statement...........................................   123
Ernest H. Preeg, Senior Fellow in Trade and Productivity, 
  Manufacturers Alliance/MAPI, Inc...............................    35
    Prepared statement...........................................   127
        Response to written questions of Senator Bunning.........   140
Steve H. Hanke, Professor of Applied Economics, Johns Hopkins 
  University.....................................................    37
    Prepared statement...........................................   130
        Response to written questions of Senator Bunning.........   141

              Additional Material Supplied for the Record

Prepared statement of the American Forest and Paper Association..   142
Prepared statement of the American Textile Manufacturers 
  Institute, (ATMI)..............................................   154
Prepared statement of the Coalition for a Sound Dollar...........   156
Miscellaneous letters submitted for the record by Senator Paul 
  Sarbanes.......................................................   159

                                 (iii)

 
                   U.S. DEPARTMENT OF THE TREASURY'S
                         REPORT TO CONGRESS ON
                       INTERNATIONAL ECONOMIC AND
                          EXCHANGE RATE POLICY

                              ----------                              


                         WEDNESDAY, MAY 1, 2002

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.

    The Committee met at 10:02 a.m. in room SD-538 of the 
Dirksen Senate Office Building, Senator Paul S. Sarbanes 
(Chairman of the Committee) presiding.

         OPENING STATEMENT OF CHAIRMAN PAUL S. SARBANES

    Chairman Sarbanes. The hearing will come to order.
    We are very pleased to welcome Treasury Secretary O'Neill 
to the Committee this morning to testify on the Treasury 
Department's Report to Congress on International Economic and 
Exchange Rate Policy.
    He will be followed by a panel of representatives of 
American manufacturers, workers, farmers, and academics, who 
will comment on the impact of the exchange rate of the dollar 
on U.S. trade, employment, and long-term economic stability.
    Mr. Secretary, we apologize. We had a vote and we had no 
alternative in terms of when to start. And I understand that 
you have some time pressures and we are mindful of those. So 
when the time comes that you have to leave, we will certainly 
recognize that.
    The Omnibus Trade and Competitiveness Act of 1988 requires 
the Treasury Department to submit a report to Congress annually 
in October, with an update after 6 months, on international 
economic policy, including exchange rate policy.
    The Banking Committee originally planned to hold this 
hearing last October, at the time of the submission of the 
annual report, but delayed it because of the events following 
September 11.
    This morning's hearing is technically on the 6 month update 
of that annual report, but obviously, will encompass the report 
as well. It is important to just take a moment, and I will be 
very brief here because I know we want to move along, to 
understand the 
origin of this reporting requirement, so we can understand its 
purpose.
    The report required in the 1988 Act was a response to the 
experience in the early 1980's when the exchange rate of the 
dollar rose to very high levels and there was a sharp 
deterioration in the U.S. trade and current account balance.
    Initially, there was a denial that there was any issue, any 
concern. But the Treasury Department--this is in the Reagan 
years, Secretary Baker--shifted positions and organized an 
effort by the Group of 7 industrial countries in 1985, known as 
the Plaza Accord, to address lowering the value of the dollar 
and begin to ease the deterioration in the U.S. current 
account.
    In the aftermath of that experience, the Congress realized 
that it did not have a mechanism by which the Treasury 
Department would regularly report or testify on the conduct of 
international economic policy. There was a recognition that 
this was a critical area of economic policy and that a 
mechanism similar to the requirement that the Federal Reserve 
report to Congress semiannually on the conduct of monetary 
policy, was needed. This report was the result of that 
rationale. We regard this report as a serious matter. We intend 
for the Committee to conduct regular oversight on this 
important issue.
    I want to commend Secretary O'Neill and the Treasury 
Department for the timely submission of the report and its 6 
month update since the current Administration took office. In 
this regard, they have been quite responsive to the 
requirements of the statute. I am not going to go through the 
different requirements of that statute, many of which have been 
met specifically in the reporting requirement. There are some 
that were not addressed and I may make reference to those in 
the question session.
    The purpose of the report is for Treasury to present its 
views in writing to the Congress and the reasoning behind these 
views, and we look forward to hearing from the Secretary this 
morning.
    Senator Bunning.

                COMMENTS OF SENATOR JIM BUNNING

    Senator Bunning. Thank you, Mr. Chairman. First of all, 
thank you for holding this hearing and thank you, Secretary 
O'Neill, and all our other witnesses for being here. This is an 
important hearing and I would like to thank everyone here for 
testifying.
    I am entering this hearing with an open mind. There is a 
divergent opinion on this issue and we need to hear from 
everyone who is affected by this. I believe our economy, though 
growing, is still rather fragile and we could slide into what 
is known as a double-dip recession if we are not careful. We 
need to make sure that we make the right decisions so we do not 
jeopardize this recovery.
    I believe your testimony today can help us figure out how 
to keep the recovery going. I look forward to hearing from you 
and all the other witnesses, and I thank you, Mr. Chairman, for 
holding the hearing.
    Chairman Sarbanes. Thank you, Senator Bunning.
    Senator Johnson.

                STATEMENT OF SENATOR TIM JOHNSON

    Senator Johnson. Thank you, Chairman Sarbanes, and thank 
you, Secretary O'Neill, for joining us here today.
    This is an important hearing to discuss international 
economic conditions and exchange rate policy. Monetary policy 
and the strength of the dollar relative to foreign currencies 
play a critical role in America's ability to compete in a free 
trade environment.
    I think it is fair to say that in my home State of South 
Dakota, that the appreciating value of the dollar, the 
differential that increasingly occurs, is significantly 
undermining support for free trade negotiations, as our farmers 
and ranchers in particular find increasingly that the problem 
that they have that results in an unlevel playing field in 
their perspective is not so much the issue of tariffs and other 
nontrade barriers, as it is currency differentials.
    I want to focus a bit today on the local economic impact 
that the strong U.S. dollar has in my State. I am concerned 
that, in the face of cheaper meat imports, cattle and sheep 
prices continue to fall and exports stagnate. I am also 
concerned about small manufacturing firms as well that are 
unable to compete effectively against foreign competitors due 
to the sustained appreciation of the dollar against other 
currencies.
    This past year, my State saw an 11.6 percent decline in 
manufacturing employment and a 27 percent increase in personal 
bankruptcy filings. Some of this, of course, is due to the 
business cycle and the recent recession. But the depreciation 
of the dollar and the consequent depression in commodity prices 
appears to be a principal reason why the ag economy did not 
share in the economic prosperity that most sectors enjoyed 
between 1995 and 1999.
    Last year, I requested the USDA to complete a study on the 
U.S. sheep industry, its future and the factors that have led 
to its decline. The study focused on the rapid increase in lamb 
imports in the mid-1990's that resulted from price manipulation 
by New Zealand and Australia. As a result of arbitration, the 
United States 
established a 3 year tariff rate quota, TRQ, on lamb imports 
from these countries in July 1999.
    Despite implementation of the TRQ, imports did not slow 
because the effects of the tariff were almost entirely offset 
by the strong United States dollar and unusually weak 
Australian and New Zealand currencies, in 1998, when the United 
States dollar appreciated against the Australian and New 
Zealand currencies by more than 18 percent and 24 percent, 
respectively.
    In light of these developments and the impact that it has 
on U.S. trade, and the impact it has on the willingness of the 
American people to pursue trade agreements that do not take 
into consideration currency differentials, I think it is very 
important that we take a hard look at this, and I welcome, 
Secretary O'Neill, your report and your willingness to testify 
to this Committee today.
    Chairman Sarbanes. Thank you very much, Senator Johnson.
    Senator Miller.

                COMMENTS OF SENATOR ZELL MILLER

    Senator Miller. Thank you, Mr. Chairman, for holding this 
hearing. I will pass on a statement. But I do want the 
Secretary to know how glad we are to have him with us and thank 
him for his service.
    Chairman Sarbanes. Senator Corzine.

               COMMENTS OF SENATOR JON S. CORZINE

    Senator Corzine. Mr. Chairman, I thank you for holding this 
hearing, and it is always good to see the Secretary.
    This is an important topic that really has a true impact on 
our economy and I look forward to his remarks and the other 
witnesses' remarks as well.
    Thank you.
    Chairman Sarbanes. Good.
    Senator Akaka.

              COMMENTS OF SENATOR DANIEL K. AKAKA

    Senator Akaka. Thank you very much, Mr. Chairman. I will 
also be brief.
    I want to welcome the Secretary and I look forward to your 
report to us on International Economic and Exchange Rate 
Policy. I also welcome the other witnesses.
    During today's discussion, Mr. Chairman, I am particularly 
interested in the current account deficit and the potential 
problems that it may cause.
    Given the divergence of opinion on the significance of the 
current account deficit, I look forward to an examination of 
the consequences of the deficit on our economy. Secretary 
O'Neill, you have stated that the current account deficit is a 
meaningless concept. The International Monetary Fund's chief 
economist has called the U.S. current account deficit, and the 
possibility of a correction, a significant risk to the global 
economy.
    The Wall Street Journal described the nightmare scenario 
involving the reversal in account deficit and the possibility 
of foreign investors withdrawing their money out of the U.S. 
economy. This could lead to a weakening of the dollar and stock 
markets, and higher interest rates.
    I welcome, Mr. Chairman, the witnesses' assessments of the 
potential adverse impact of the current account deficit on the 
global economic outlook and the consequences of account 
reversal.
    Mr. Chairman, I thank you very much for holding this 
hearing.
    Chairman Sarbanes. Thank you, Senator Akaka.
    Secretary O'Neill, we would be happy to hear from you.

            STATEMENT OF PAUL H. O'NEILL, SECRETARY

                U.S. DEPARTMENT OF THE TREASURY

    Secretary O'Neill. Chairman Sarbanes, Ranking Member Gramm, 
Members of the Committee, thank you for this opportunity to 
appear before you to discuss our international economic policy. 
With the Committee's permission, I will submit my full 
testimony for the record and make an abbreviated oral statement 
to allow more time for questions.
    Chairman Sarbanes. Thank you very much, that will be fine. 
We appreciate that.
    Secretary O'Neill. Thank you, Mr. Chairman.
    At the outset, I think maybe it is important for me to say, 
because I want to have an opportunity to have a full and clear 
engagement with the Chairman and Members of the Committee, that 
whatever one might try to imply from what I say today, there is 
no intent in anything that I say that should give comfort to 
those who think we are going to change our policy today. I say 
that to you because, as I read the wire clips from around the 
world this morning, there is apparently some breathless 
anticipation that I am going to say something to intentionally 
indicate a change in policy position or direction.
    I want to assure you at the outset that whatever I may say, 
that is not the intent. And again, I want to make it really 
clear because the people who benefit from roiling the world 
currency markets are speculators. And as far as I am concerned, 
they provide not much useful value to the furtherance of 
advancing the cause of improving living standards around the 
world. So, I do not want to give them any ammunition to say 
that there is a basis for roiling the world currency markets 
out of our conversation here this morning.
    I would like to touch on several of the Administration's 
policy initiatives for increasing economic growth and reducing 
economic instability abroad. They are of vital interests to the 
United States.
    First, we are working to reduce barriers to international 
trade. Total U.S. trade amounts to about one quarter of our 
domestic product, and trade touches every part of our economy 
and creates millions of American jobs, paying above-average 
wages.
    To bolster growth and create new exports and job 
opportunities for America, the Senate should pass trade 
promotion authority so that President Bush can work with 
nations around the world to reduce trade barriers and open 
markets to U.S. exports.
    Second, we are also working with the International Monetary 
Fund to give emphasis to their role in crisis prevention. When 
crises do occur, we need a more orderly process for resolving 
them so that capital continues to flow to emerging markets. We 
are working with others in the official sector to implement a 
market-oriented approach to the sovereign debt restructuring 
process. We also support continued work on the Fund's statutory 
approach to sovereign debt restructuring.
    Regarding the multilateral development banks, we believe 
they can deliver better results by investing in high-impact, 
productivity-enhancing activities.
    President Bush has proposed that we transform the World 
Bank and other development bank funds for the poorest countries 
into grants rather than loans. Investments in crucial social 
sectors, such as health, education, water supplies, and 
sanitation, are crucial to private enterprise-led growth and a 
necessary basis for development. But they do not directly 
generate the revenues that service new debt. As a result, the 
recipient government is forced to repay the loan by taking 
resources from citizens subsisting on less than a dollar a day. 
By piling loans on these nations, we are simply generating the 
next generation's debt-forgiveness program. We ought to 
recognize that projects that do not generate economic returns 
should be funded by grants and not loans.
    President Bush recently announced his new compact for 
development, a major new initiative for development based on 
the shared interests of developed and developing nations in 
peace, security, and prosperity.
    The compact creates a new development assistance fund 
called the Millennium Challenge Account. To access account 
funds, developing countries would have to commit to policies 
that promote growth and development, including governing 
justly, investing in people, and promoting economic freedom. We 
intend to put our development assistance funds into 
environments where they can make a difference. Another 
important aspect of our international economic agenda is the 
financial war on terrorism.
    Since September 11, the Treasury Department has thwarted 
supporters of Al Quaeda and other terrorist organizations by 
freezing $34 million in assets directly and assisting our 
allies to freeze 
another $70 million. Recent joint discussions with our allies 
mark 
a new level of coordination in the fight against international 
terrorism.
    I would like to now turn briefly to global economic 
conditions. The world economy is still in the early stage of 
recovery. The GDP figures released last week confirm that we 
are on the path back to sustainable growth of 3 to 3\1/2\ 
percent per year.
    I also want to reiterate my feelings on the U.S. current 
account deficit. The current account represents the gap between 
domestic savings and investment. It is financed by 
international capital flows which have risen because of foreign 
interest in investing in the United States. As long as we 
continue to have the best investment climate in the world, 
people in other nations will send their savings here, where 
those resources fuel our economic growth and job creation.
    I believe we should strive in both the private and public 
sectors to always be the best place on earth to invest. As long 
as we are the most productive economy in the world, our Nation 
will continue to be prosperous.
    I thank you again for this opportunity to testify and I 
would be delighted to take your questions.
    Chairman Sarbanes. Well, thank you very much, Mr. 
Secretary.
    I want to focus on the current account deficit. I am really 
seeking a better understanding of your views. The current 
account deficit now as a percent of GDP is higher today than it 
was at its peak during the 1980's. In fact, we have some charts 
that show a really dramatic deterioration in the current 
account deficit as a percent of the gross domestic product.
    This is back in the 1980's and then this is what has 
happened in the 1990's (indicating).
    You have been quoted as saying--``I do not know.'' I will 
let you address the quote--that you view the current account 
deficit as meaningless or irrelevant. Would you explain to us 
the rationale behind this view?
    Secretary O'Neill. I am sure I must have said that some 
place. I am not sure what the context was of when I might have 
said something that fits between those quote marks. My view of 
the current account deficit is this. I think, first of all, one 
needs to examine what the origins of the idea of the current 
account deficit are.
    I think the answer to that question is, it is a derivative 
part of the notions that were put in place in the late 1930's 
and early 1940's about how we should assemble data to look at 
how the world works, and to try to draw from the data in these 
various conventions that we have adopted correlations with good 
and bad economic activity in the world. When I look at it, I, 
first of all, ask myself, is the world the way it was in 1939 
or 1940, when Simon Kuznets and his associates put it together? 
My own answer to that is that it is not. And it is not in these 
important ways.
    I think in the 1930's and 1940's and, in fact, I think one 
could argue maybe even through the 1950's, that the world in 
fact was relatively aligned with the ideas that suggested that 
the world is run on a nation-state basis, and that nations are 
basically independent of each other in an economic sense, and 
that in fact, it is possible for one nation to substantially 
change its economic position by playing off of other nations 
because of the separateness.
    I do not find that to be the way the world is any more. 
Having run a corporation with operations in 36 nations, I will 
tell you what--I never spent a minute thinking that somehow, I 
could go to some of these, any of these other countries, and 
act as though that country were independent of the rest of the 
world.
    I did not find that it was possible to do that here in the 
United States. In fact, I do not think it is possible for 
anyone to do it. It is possible for people to continue to think 
it, but it is not real world in terms of the way world economic 
activities work any more. So, I have a problem with the 
construct before I ever get to what the implications of adding 
up all of these numbers are? And then I would submit this--that 
it is said that the current account deficit is a U.S. current 
account deficit.
    Now my question is, what does that mean? Does the U.S. 
Government have a deficit with other countries? That is to say, 
have we in the Federal Government gone out and borrowed money 
from other countries that they can jerk out from under us?
    The answer to that is no.
    Who owns the so-called current account deficit? Millions, 
or maybe even billions of individual investors who have made 
decisions around the world to own these investments. Again, in 
my brief oral statement, I made the point that the reason money 
comes here is because it is treated better than any place in 
the world, as measured by the risk-adjusted rate of return on 
investments that are made in the United States.
    I have a lot of trouble with the construct that, if you 
accepted at face value that somehow this is a deliberate 
decision of the United States to do something, this is an 
analogy to an individual deciding to borrow too much money. I 
find it is a false analogy. So, when I have said these words 
about my problem with the current account deficit, it is this 
stream of thinking that I had in mind.
    It does not mean that I do not think there is some 
legitimate value in thinking about relative capital flows 
around the world and the implications that has for interest 
rates and other important determinants of where money goes. But 
it does mean that I do not think the simple correlations that 
are made are not meaningful or useful and, in fact, I think are 
a dangerous basis for making policy prescriptions.
    Chairman Sarbanes. Let's just sharpen the debate for a 
minute. I know you are a man who likes to engage in vigorous 
intellectual debate. I want to quote to you from The Economist 
just a week ago, an editorial. This is what they say:

    The International Monetary Fund says that America's current 
account deficit poses one of the biggest risks to the world 
economy. Paul O'Neill, America's Treasury Secretary, reckons 
that the Fund's economists do not know what they are talking 
about. He says the current account deficit is a meaningless 
concept. Policymakers should pay no attention to it.
    Mr. O'Neill's views fly in the face of experience. A 
deficit that will require America to borrow from abroad almost 
$2 billion a day by 2003 can hardly be ignored. The 
consequences for the dollar if foreigners' appetite for 
American assets even wanes would give a Treasury Secretary who 
knew what he was talking about sleepless nights.

    Now, I put that out there because this is one serious 
commentary and I would be interested in your response to it.
    Secretary O'Neill. If you do not mind, I have two different 
things I would like to say about that.
    First of all, last November, the International Monetary 
Fund--we got the World Bank and the International Monetary 
Fund, the G-7, together--made a public pronouncement that 
growth in the United States in 2002 would be 0.7 percent.
    And on the spot, I said to the managing director of the 
IMF, I am going to bet you a dinner in a restaurant of your 
choice that we are going to far exceed that number. They have 
now decided that the number is going to be 2.4 percent. So, at 
the time, I was saying we were going to be some place like 
where, in fact, we are on the glidepath. And so, maybe you 
would prefer their economic judgment to mine. So far, they have 
not been right.
    Now to a different point on this. It is not that I think we 
should pay no attention to this issue. But I would ask the 
question, if you do not like the current account deficit, what 
policy instruments would one use to change the current account 
deficit? And then, what is the most meaningful question--are 
you willing to suffer the consequences of treating the current 
account deficit as the objective variable in the equation?
    What I mean by that is this. One way to fix the current 
account deficit is to reduce imports. I do not know anyone who 
wants to do that because the implications of reducing imports 
is we become a more isolated and insulated society. Our 
citizens pay more money for goods. The reason goods are coming 
here is because they are valued by consumers at the prices they 
are offered at, as compared to alternatives.
    So if you do not like the current account deficit, we could 
say, bugger them, the U.S. citizens. We here in Washington know 
better. They should not be buying so much stuff from outside 
the country. That would fix the current account deficit. That 
does not seem like a brilliant thing to me to do.
    If you look at the academic work, what I consider to be the 
best academic work on this subject, there is a report I would 
submit to you by Allan Sinai that was done in December 2000, 
that basically says, if you run all the econometric equations 
and treat the current account deficit as the dependent variable 
and you seek to reduce the current account deficit, every 
single intervention hurts the U.S. economy, as compared to 
leaving the current account deficit alone.
    I have not seen academic work that suggests itself to me 
that produces a different answer. And so, it is part of the 
reason why I am mystified that there seem to be so many people 
that want to treat the current account deficit as the objective 
function for our society, when doing so. This is not a partisan 
report from Sinai. This is an academically solid, legitimate 
report. I do not know of something to counter Alan's findings.
    Chairman Sarbanes. Well, we could go on at great length, 
but my time has expired, and I am going to yield.
    I would just note that the panel that is coming along 
behind you feels pretty strongly, at least a number of them do, 
that the currency is manipulated by some of our trading 
partners, very much to the U.S. disadvantage, and that is 
affecting the balance of trade in a very substantial way. And, 
of course, that is one of the things that we are trying to get 
at in these reports.
    Senator Bunning.
    Senator Bunning. Thank you, Mr. Chairman.
    Secretary O'Neill, the Treasury Report said there was no 
current manipulation by our major trading partners last year. 
How does this jibe with the reports saying China purchased $50 
billion, Japan bought $39 billion, and South Korea bought $9 
billion last year? In other words, if there is no importance to 
that fact, how does that jibe with your report?
    Secretary O'Neill. By the definitions of law, as we 
understand it, the individual actions that have been taken do 
not amount to manipulation under the statute. And I think, in a 
broader sense, if you look at the Chinese currency against 
world currencies, they are running kind of a soft peg.
    I do think this. The markets are grinding so finely, and 
they are so interlaced any more, that it is not possible any 
more to actually fool the market for very long. That is to say, 
to create an artificial situation that is not in line with the 
judgment of the market about the discounted present value of 
productivity improvements relative to other countries.
    Senator Bunning. Currently, I do not disagree with you.
    What happens with China having that large a reserve of U.S. 
dollars--what happens in a time of crisis, such as a 
confrontation at the Taiwan Straits that the Chinese could dump 
dollars onto the world market in an attempt to destabilize our 
economy?
    Secretary O'Neill. First of all, it presumes that the 
dollars are held by an authority that has the ability----
    Senator Bunning. The Chinese government.
    Secretary O'Neill. But the Chinese government I think does 
not actually hold that money. I think if you go look at how 
that money is held, you are looking at first-order effects. 
Look at the second-order effects. What did the Chinese do with 
that money?
    I will tell you one thing that they did with it. They built 
new factories. Now where do they get the technology for the new 
factories? They bought it in the UK or they bought it here, or 
they bought it--you know, it is in German hands or it is in 
Brazilian hands. It is in somebody else's hands.
    It is another problem that I have with the current account 
deficit. It assumes the world is static and that first-order 
effects never become second-order effects.
    Senator Bunning. I do not consider it static. But I 
understand that if they do use that currency as hard dollars to 
do other things, that they are replacing them with hard 
dollars. And we are talking about a fixed period of time where 
they measured the amount of dollars that the Chinese had under 
their control. Are you telling me that that is not important?
    Secretary O'Neill. I do not think so.
    Senator Bunning. You do not think so? In other words, if 
they got up to $100 billion, you would not think so? Or $200 
billion, it would have no effect?
    Secretary O'Neill. No, I do not think it is a material 
amount, in an economy that is a $10 or $11 trillion economy. 
$100 billion--I am trying to think about it.
    Senator Bunning. As long as the situation in the world is 
like it is, I do not disagree with you. But if we have a 
confrontation, I think it would have a serious effect on the 
dumping and devaluing in our economy of the U.S. dollar, if 
they dumped that on the world market.
    Secretary O'Neill. I think if it is true that one sovereign 
had the ability to make an instantaneous decision, you might be 
right. I do not think that is the case.
    Senator Bunning. In the mid-1980's, our Government worked 
on a similar problem through the Plaza Accord. In what 
circumstances would you have considered to take a similar 
action?
    Secretary O'Neill. Well, first, you are going to hear from 
panel members and I am sure they will have their own and 
probably different views.
    Senator Bunning. I want yours. I do not want the panel's.
    Secretary O'Neill. I just wanted to say, it is not clear to 
me that the implication of your question about the Plaza Accord 
has substance behind it, in this sense: I think it is a real 
speculation to know, in fact, whether conditions and trends 
were moving in the direction that the Plaza Accord simply 
hopped on the back of.
    What comes to mind is the metaphor of the caterpillar 
riding on a log down the stream and thinking they are steering. 
I think you have to be really careful in assigning causality to 
supposed political interventions. I am not sure that those 
causalities exist.
    Senator Bunning. In other words, our political intervention 
in Afghanistan----
    Secretary O'Neill. I did not say that.
    Senator Bunning. There is no consequences to Afghanistan?
    Secretary O'Neill. No, I did not say that.
    Senator Bunning. What are you saying, then?
    Secretary O'Neill. I am talking directly about intervention 
attempts in world financial markets. I am saying, I think there 
is a real doubt about the effectiveness of interventions or 
words about interventions--although I would grant you one 
thing. It is why I made my statement at the beginning--it was 
not my intent to roil the financial markets today. There is 
nothing the speculators like better than to roil the financial 
markets. And I think it is true, by changing rhetoric, you can 
roil or even maybe give direction to the financial markets over 
some limited period of time.
    But coming from the part of the economy that produces real 
tangible things you can take home and put on the table, I 
believe at the end of the day, while monetary affairs are not 
incidental, the real long-run economics of the world depends on 
the physical production of goods and services and therefore, 
you can have as much rhetoric as you want; eventually the world 
is going to stabilize around the real production of goods and 
services.
    Senator Bunning. You may believe that, but I will guarantee 
you, the Chairman of the Federal Reserve does not believe that.
    Thank you, Mr. Chairman.
    Chairman Sarbanes. Thank you very much, Senator Bunning.
    Before I yield to Senator Miller, Mr. Secretary, I am 
prompted to quote President O'Neill of the International Paper 
Company in 1985.

    The strong dollar has turned the world on its head. We have 
suffered a major loss in competition position because of the 
loss in exchange rates. And then O'Neill explained that in the 
last few years, a strong dollar has dramatically eroded the 
U.S. forest products industry's natural advantage in world 
trade.

    This is what we are hearing from all of your former 
colleagues, or people who currently hold comparable positions 
in the business world. And of course, that is what you were 
saying in 1985.
    Secretary O'Neill. Do you have the rest of what I said 
then?
    Chairman Sarbanes. Well, what else did you say then?
    Secretary O'Neill. What else I said then was, ``what we in 
the industry need to do is we need to take matters in our own 
hands and we need to create conditions in the goodness of what 
we do, the exceptional excellence of what we do, so that we can 
pros-
per no matter what is happening with exchange rates. We need to 

use our brain power to figure out how to create goods in the 
cur-
rency that we sell them. And we need to take this 
responsibility 
on ourself.''
    I do not think you will be able to find any place where I 
called on the Government to intervene in the financial markets. 
I was 
basically calling attention to the fact that, indeed, currency 
rela-
tions had changed and those who were going to prosper were go-
ing to have to assume the responsibility for their own 
individual 
companies and industries to fix the problem, not look to 
Govern-
ment to make a temporary intervention that would make life 
sweeter for us.
    Chairman Sarbanes. Well, Paul H. O'Neill, Los Angeles 
Times, International's President, doubts that paper prices will 
rise in step with the dollar's decline. But he definitely sees 
happier days ahead. ``Exchange rates moving back to normal 
levels would be very good news for our industry, he says. We 
would recoup most, if not all, of our export volume.''
    Secretary O'Neill. That is a statement of fact. It is not a 
prescription for the Government to intervene.
    And if you go look at the record, which you will find both 
at IP and Alcoa, there is a performance. Let me remind you of 
rate spread. The Japanese yen-United States dollar rate, as I 
recall, in 1985, was 240 or something on that order of 
magnitude. We reached a low relationship of 80 yen to the 
dollar, I think, a couple of years ago.
    Through that whole time, the companies I was associated 
with prospered, became leaders in the world. And we did not do 
it by coming down here asking somebody to fix the world, to 
make it easier for us. We did it with our fingernails in 36 
different countries around the world.
    Chairman Sarbanes. Well, it doesn't square. You have the 
Plaza Accord and that helped you tremendously, you and other 
export-
ers, and John Gorges, who was with you at International Paper. 
Correct?
    Secretary O'Neill. He was the Chairman.
    Chairman Sarbanes. Yes. One of the toughest problems we 
face is the very strong dollar, which impacts our export 
products and prices a good deal. There are major uncertainties. 
If the dollar weakened, we could compete better. And it is not 
just us. It is other exporters, too.
    Senator Miller.
    Senator Miller. Mr. Secretary, I guess I am going to 
continue along that same kind of questioning. I want to say 
that I understand how you have to look at the really big 
picture. I appreciate that and I respect that.
    As a Senator from Georgia, though, I have to be a little 
bit more parochial. I have to look at those 8 million people in 
Georgia. There are some industries in our State, forestry is 
one of the key ones, agriculture, textiles. They all have 
complained to me pretty loudly that the dollar is making it 
difficult for them to export profitably, and making it easier 
for imports to take the market share here in the United States.
    Continuing on this line the paper industry which the 
Chairman mentioned, has seen more than 90 percent of the growth 
in their U.S. markets captured by imports, they tell me. I 
guess my question is, and I know you have to look at it from a 
different angle, but how would you respond to my constituent 
industries that are so very concerned about this matter?
    Secretary O'Neill. You know, when I come around and I sit 
on your side of the table, I understand the pressure that not 
just you, but you are reflecting what your constituents are 
telling you. I understand the pressure that creates.
    I said that while I was at Alcoa, we prospered. But it does 
not mean that we did not have dislocations. In fact, we did 
have dislocations because not in every place were we able to 
push our costs down enough to compete in the whole world on a 
competitive basis with changes in exchange rate positions over 
time.
    I know these are issues where your heart breaks for the 
people that are directly affected by these things. And I 
suppose it is no solace at all to the individuals who are 
directly affected. But I think it is demonstrably clear that in 
fact we in the United States, the U.S. citizens as a body, and 
the world as a body, are better off if we let competition and 
best value products lead the world.
    It is not an easy thing to follow in practice and that is 
why we have lots of people coming to Washington to tell us how 
they are hurting. And I think we have to be sympathetic with 
that. But I think at the same time we are better off to help 
the casualties if it produces a better economic outcome for the 
whole society than to let the casualties become the control on 
our ability to succeed as a total country.
    Senator Miller. Thank you. I do not have any other 
questions.
    Chairman Sarbanes. Senator Gramm.

                STATEMENT OF SENATOR PHIL GRAMM

    Senator Gramm. Well, Mr. Chairman, I was over trying to 
participate in the negotiations to bring our trade promotion 
authority bill to the floor, and so I missed our opening 
statements. So, I would like to take my time to make a 
statement.
    First of all, every day on the world currency market, as I 
understand it, there are about $1.2 trillion worth of dollar 
transactions. This is the purest market in the world in that it 
has the most participants and it has the largest volumes.
    My own belief is that even a country as rich as the United 
States of America could affect currency values, could affect 
the value of the dollar, only for a very short period of time, 
just as I could lower real estate values in my neighborhood if 
I were mad at everybody else and wanted to hurt them, by 
selling my house for $100. But once the house is sold, then 
real estate values are basically back as they were.
    I not only believe we cannot affect the value of the 
dollar, except by changing policy that would affect people's 
perception and the reality of the American economy, but also 
that currency intervention is a nonfeasible policy, even if it 
were desirable, would be my first thesis.
    Second, this is a perfect market, for all practical 
purposes, where every day people are buying and selling 
dollars. Why do they buy dollars? They buy dollars to buy 
American goods and they buy dollars to invest in America. And 
they sell dollars and buy foreign currency to invest abroad or 
to buy foreign goods.
    So when we say we have a current account surplus, by 
definition, we have a capital account. We have a huge inflow of 
capital. Were that not the case, the value of the dollar would 
change and the surplus would be eliminated. What you are seeing 
is a mirror image of capital inflow versus a current account 
deficit. Now is the capital inflow bad? Who's against 
investment? Every once in a while people say, well, my God, 
foreigners own some building in New York. I have found 
ownership is not what it is cracked up to be.
    [Laughter.]
    First, try moving that building back to Japan. Second, I do 
not think anybody is willing to come out here and say: 
Investment is a bad thing and we want less of it. Then what 
about loans? Aren't you a debtor when you get a loan?
    Well, it depends on what you do with the loan. If you 
invest it productively, it is an avenue to riches. If you 
invest it poorly, it is a path to poverty. The only kind of 
loan I would be concerned about is if our Government were 
borrowing money to invest in Government and they expected value 
of the investment would be far less than the service cost 
alone. And exactly the opposite is true.
    This idea about what you said about forest products in my 
mind is totally consistent with what you are saying today. 
There is no doubt that at any given time there are many 
industries that would benefit if the dollar was cheaper. There 
are industries that would benefit if the dollar were more 
valuable. But the question--you are not here today representing 
the forestry industry.
    Secretary O'Neill. That is right.
    Senator Gramm. You are here today representing the American 
economy. And the point is that if you could snap your fingers 
and make the dollar cheaper, there would be some people who 
would gain. There would be some people who would lose. So, I do 
not see an inconsistency there.
    Finally, I, quite frankly, do not have a problem with what 
The Economist says. For the world economy, looking at the world 
now, is it good that all this investment is coming to America?
    If you just look at the world economy now, maybe you would 
want to redistribute this investment differently. It may be 
risky for the world that America gets richer and more 
prosperous and our real wages rise and we become more dominant 
in the world, depending on your perspective. But our question 
is not the world. Our question is the United States of America. 
It seems to me that when we look at American interest, that it 
is very clear that we want investment, that we want to have 
open markets, and that we are succeeding economically as a 
result of it.
    So, I do not disagree with my colleague from Georgia. We 
have 60,000 jobs in Texas in the forestry industry. A lower 
value for 
the dollar, if you could just wish it and have it, would be 
beneficial 
to them.
    But for everybody going to Wal-Mart, it would be a bad 
thing. And in this case, there is nothing that we could really 
do to change it, other than we could have our Navy blockade our 
ports. That would improve our situation. The enemy would do it 
in war, but we could do it in peacetime. Or we could stop 
foreign investment. I would submit, we do not want to do either 
one of those things.
    I think we need to keep our eye on current account deficit. 
If it becomes clear that it is a Government policy that is 
driving it, such as we are getting foreign loans to finance 
Government or foreign investment--if something artificial is 
happening, then I think it is something that we should be 
concerned about.
    But the thing I am never concerned about is that somehow, 
somebody is going to manipulate a market where there is $1.2 
trillion worth of transactions every day. Even as much money as 
you control, you would be a bit player in this market. And 
foreign countries that try to manipulate the value of the 
dollar are trying to get water to run up a rope. It just cannot 
be done.
    The only final point I would make is that we could have a 
dollar for exports and a dollar for imports. You could have one 
that was valuable and you could have one that was cheap.
    The problem is that then you would have to have an exchange 
rate between the two dollars. And in the end, I think this is a 
thing where individual industries can say, I wish markets were 
different. But, A, I do not think there is anything you can do 
about it and, B, even if you could do something about it, you 
might want to do it if you were in the paper industry. But if 
you are Secretary of the Treasury, you do not want to.
    I would say that we have been blessed with Rubin and 
Summers and with you, Secretary O'Neill, that on this one 
issue, that there has never been an equivocation. There has 
never been any politics involved in it. I think that the 
country has benefited a great deal, even though individual 
parts of the economy might benefit, but at a great expense to 
everybody else. I guess that is my view. I worry about this. 
But by the time I get to it on my list, every night I am 
asleep.
    [Laughter.]
    Chairman Sarbanes. Senator Corzine.
    Senator Corzine. Well, I do not fall asleep thinking about 
the dollar, either, in that particular category of concerns.
    But I do wonder when you think about the current account, 
which I basically think is reflective of the underlying trade 
imbalances that we have, and it has some other elements in it, 
that a lot of the financing that goes on in the world, these 
flows which are covered by this $1.2 trillion, which you say is 
a lot of--I am a little more comfortable with speculators based 
on where I came from than maybe you are.
    [Laughter.]
    In the sense that it allows for the transition of the flow 
of dollars from one place to another, or assets. But it strikes 
me that while managing the dollar is not necessarily the issue, 
worrying about that underlying trade deficit is a real issue.
    And if it were to change our views with respect to how 
people look at the capital markets in the United States because 
they do not feel they are as secure as they might have thought 
they were at another point in time, which can happen for 
political reasons or it can happen for underlying economic 
conditions, the kind of deficits that Senator Gramm is 
concerned about, which, by the way, seemed to be reappearing in 
relatively substantial amounts.
    You can then have a completely serious series of events, 
like changing price levels and higher interest rates. I think 
we will hear Mr. Bergsten talk about that kind of scenario.
    Those things do happen. They have happened in history, that 
other countries ran large trade deficits. I think that there 
are reasons to be concerned about underlying trade conditions 
that work against our Nation, even at a macrolevel. Get away 
from the forestry because, cumulatively, these things end up 
setting a vulnerability that is actually more serious than the 
Chinese reserves building up $50 billion, which I think is a 
drop in the bucket.
    But if the investors in American stocks and bonds decide to 
get out, that is a lot easier to do than selling that building. 
Only one holder of those is the central banks or the reserve 
holders. And that is a serious concern. It is a serious concern 
if we see an erosion in our stock market because people do not 
have confidence in our accounting systems or our financial 
policies.
    That to me is a bigger worry than where the dollar is at a 
given point in time. And that is why it concerns me when you 
say it is irrelevant because it is relevant to the underlying 
economic conditions, which I agree with you, ultimately, are 
what determine where people want to put their money.
    There are issues here that could change people's 
perceptions about the United States, our fiscal policy, the 
management of our internal structures that surround our 
markets, the accounting issue being one that I am concerned 
about. And so, isn't that shock issue a real concern for anyone 
who is responsible for policy, and shouldn't we do things that 
try to advance more security with regard to those in the long 
run?
    Secretary O'Neill. Indeed, I think I am very sympathetic to 
your notion that we should look at underlying trade 
relationships. I also am frankly much more interested in what 
we can do to advance the cause of more exports from the United 
States. And with that, the development of the world.
    I am sure you all know this, there is still 1.2 billion 
people in the world living on less than a dollar a day. And if 
you can imagine raising their standard of living so that they 
could demand plywood from the United States and plumbing 
fixtures and the other things that we all take for granted, we 
would quickly get rid of the worry about current account 
deficit because we would be exporting goods and we would be 
creating well-paying jobs for people here in the United States 
that are demanded by people who are growing into something 
approaching our standard of living.
    So, I see this in a fuller sense because I am not really 
infatuated with finance as the prism for thinking about 
everything. For me, it is a derivative question. Finance is a 
derivative question, not a primary question.
    I am very interested in your notion that, yes, we should be 
worried about this and we should be working on passing the 
trade promotion authority so we can get on with opening up 
markets to U.S. goods. And we can be helping people to realize 
a decent life instead of the misery so many of them are living 
in today.
    On your other question about the concern that investors 
would make what I would characterize as a cliff decision to 
withdraw from the U.S. market, indeed, I do think that we have 
to be very careful about the mix of monetary and fiscal policy 
so that investors outside of the United States look at what we 
are doing and take comfort in what we are doing, that we are 
not running unsustainable excesses that would weaken their 
claim on U.S. goods and services because we are running policy 
that is a folly.
    So, I think, indeed, we have to pay a lot of attention at 
the Government level to running sensible, sustainable fiscal 
and monetary policies and giving every bit of encouragement we 
can to the continuation of the extraordinary level of 
productivity growth that we are seeing now.
    We are expecting when the final numbers are completed, that 
the first quarter rate of productivity growth in the United 
States is 
better than the 5.2 percent that we saw in the fourth quarter, 
which is truly extraordinary and I think should give lots of 
comfort 
to investors around the world, that the differential rate 
between 
productivity growth in the United States and every place else 
is just phenomenal.
    And when I sit down and talk with the chancellor of the UK 
and Eddie George, the Governor of the Bank of England, they 
just cannot figure out how we can be doing so extraordinarily 
well in productivity growth while they are still limping along 
in the 2 percent range, and have been for a very long time. It 
is not even a subject in Continental Europe. They just cannot 
imagine how their productivity growth could begin to approach 
what we have demonstrated we can do.
    Senator Corzine. Two observations.
    First, these shocks do occasionally happen. We had one in 
1987 that was pretty clear when people evacuated markets at a 
given point in time. And it has real impact on the underlying 
economy. I know you are aware of that.
    Second, if you are concerned about the underdeveloped 
world, the United States--and I think investment is great for 
the United States. But the idea that we are sucking up most of 
the capital that is freely formed is an issue that I think can 
be a concern for the development of a lot of the underdeveloped 
world.
    Frankly, I do not know that that relates to TPA. I think it 
has a lot to do with those internal structures and viabilities 
and political stability of a lot of the countries. So one has 
to figure out what is the most important ingredient to actually 
change what those conditions involve.
    Secretary O'Neill. I believe, these things are very much 
related to each other. And it probably escaped your notice 
because it did not get much attention, but when the G-7 was 
here 10 days ago, we did something which I think is profoundly 
important.
    We resolved that we are going to work with the developing 
world to move them all toward a condition of investment grade 
sovereign debt. And you will understand and you have indicated 
by what you just said, in order to do that, there has to be a 
real rule of law and there has to be enforceable contracts, and 
there has to be an attack on corruption. And with those 
conditions, we can begin to help them create a basis for better 
competing for capital flows.
    Now, I also believe this. I do not believe economics is a 
zero-sum game. I think the amount of money that is available 
for capital formation and capital investment is not limited to 
the amount that we are now producing.
    If we can grow our own economy at 3\1/2\, or maybe even a 
little better than that percent of annual growth, we will throw 
off more capital and that capital in turn, if it is properly 
invested, will produce more economic growth and more economic 
growth will throw off the capital that is required to bring 
others along.
    I really do believe the idea that capitalism at its best is 
a perpetual motion machine, or as close as the mind of man has 
been able to come, and that we are not doomed to live with the 
amount of capital that is now available as a limit for the 
whole world's growth.
    Senator Corzine. Thank you. Mr. Chairman.
    Chairman Sarbanes. Mr. Secretary, I want to come back to 
this basic point. I am really taken aback that we have a 
Secretary of the Treasury who does not perceive any problems 
associated with this large current account deficit. Now that 
flies directly contrary to what virtually every other economic 
observer is telling us.
    Business Week recently ran an article: ``U.S. Debt Overseas 
Stirs Up Trouble At Home.'' The growing current account deficit 
might set the United States up for a fall. And they say the 
following:

    The United States mounting external debt is clearly the 
most crucial structural problem facing the economy. And unlike 
other recent economic troubles, there may be no easy way out.
    The January and February increase in imported goods was the 
largest 2 month rise in two decades. Last year's current 
account gap hit 4.1 percent of gross domestic product and it 
could reach 5 percent by the end of 2002. That would be the 
largest rate in the industrialized world and larger than in 
many emerging market nations.

    Now, we asked Chairman Greenspan about this at the Joint 
Economic Committee, the consequences to the U.S. economy of a 
growing current account deficit. This is what he responded.

    The current account deficit is also a measure of the 
increase in the level of net claims, primarily debt claims, 
that foreigners have on our assets. As the stock of such claims 
grows, an even larger flow of interest payments must be 
provided to the foreign suppliers of this capital.
    Countries that have gone down this path have invariably run 
into trouble. And so would we. Eventually, the current account 
deficit will have to be restrained.

    Do you differ with that?
    Secretary O'Neill. That is all he said? He did not say at 
what level he thinks we have to do restraint or how he would 
restrain the current account deficit?
    Chairman Sarbanes. Are you prepared to concede that at some 
level it would need to be restrained? At some point is it a 
problem? Are you saying to me, it is not a problem right now, 
but it could be a problem? Or, are you saying to me, look, this 
is a meaningless concept. It is really irrelevant. It is not 
something we should worry about now or in the future or at any 
time. Forget this kind of thinking. That is the approach you 
originally took, I think. Is that your position?
    Secretary O'Neill. Well, I would want to look at the 
composition of where the money is and the circumstances that 
exist in the rest of the world.
    The implication of saying, yes, we should constrain the 
current account deficit is, as I said, as I have looked at the 
best academic work I know of, all the interventions that have 
been modeled would do damage to the U.S. economy if we decided 
to reduce the size of the current account deficit.
    I do not find it very appealing to say that we are going to 
cut off our arm because some day we might get a disease in it, 
and this is an anticipatory move. I just do not understand the 
thinking that treats what I consider to be an artificial, 
intellectually useful construct, and then take it to a policy 
conclusion that does damage, that we decide to do damage to our 
own economy because of this artificial construct. I do not find 
that appealing, no.
    Chairman Sarbanes. Let me go to another line of 
questioning. This issue leaves me very concerned because we 
have a Secretary of the Treasury who just says there is no 
problem. Everyone else is telling us there is a problem in 
varying degrees, and they have different approaches as to how 
to deal with it. But they are not saying, look, just forget 
about it. Just go on about your business.
    On the currency manipulation, and the Treasury found that 
there wasn't any, but there is a general view that the net 
purchases of foreign exchange by the Bank of Japan in recent 
years probably held the yen at a significantly lower level than 
would have prevailed based on market forces alone.
    China, which has had a running current account surplus of 
about 2 percent of GDP, so they are running a very large trade 
surplus, they have also had an enormous inflow of foreign 
direct investment. In fact, the Treasury found that their 
bilateral trade surplus with the United States was $46 billion, 
just for the second half of 2001.
    Ordinarily, with a sizable trade and current account 
surplus, and a large inflow of foreign direct investment, your 
currency would appreciate. But that has not happened in China. 
They have avoided that by acquiring huge amounts of foreign 
assets, in effect, doing what the Japanese are doing. In fact, 
your own report says that they expanded foreign reserves by $32 
billion in just the second half of 2001.
    Now why doesn't this represent a concerted policy on the 
part of China, to get the trade surplus, to get the foreign 
direct investment and sustain that position by making the 
purchases, huge purchases of foreign assets, in order to hold 
their currency in place, all to their advantage? That is not 
the workings of the market forces. They are intervening in the 
workings of the market forces in order to sustain an advantage, 
are they not?
    Secretary O'Neill. I do not know. What would you prescribe 
as a policy intervention? Which one of those things would you 
see us changing somehow?
    Chairman Sarbanes. I think you have to look at something 
like the Plaza Accord again. You have to address, in effect, 
the overvalue of the U.S. dollar in relationship to that. If 
they won't, in effect, allow their currency to depreciate, if 
they seek to sustain it in this way, then you have to do it on 
the American side.
    You are putting our manufacturers in an incredible 
position, it seems to me. They may be quite competitive. You 
talked about the productivity improvements. It is a real 
tribute to labor and to management that have been doing that. 
But they are coming and they are saying to us, look, we are 
just at a 25, 30, 35 percent handicap because of the currency. 
Not because of the underlying economic 
realities.
    Then you say, well, the currency value is going to be set 
by the market. But then we look at what some of these major 
trading partners are doing who are running these very large 
trade surpluses with us and it looks as though, pretty clearly 
to me, that they are intervening in ways to affect the currency 
relationship in order to sustain a very substantial and 
significant trade advantage.
    I will concede to you, on many of these problems, just as 
you said earlier about the current account deficit, it is a 
very difficult call to figure out what to do. I do not gainsay 
you on that. But that is different than saying there is no 
problem here. That is different than saying, it is all 
irrelevant. It really dosn't matter. The whole concept is 
faulty and we are just not paying any attention to it.
    Secretary O'Neill. I think, just as you said, it makes a 
lot of sense to pay attention to this issue, but at the level 
of detail that we are talking about it now.
    When you mentioned the elements of what China is doing, I 
would submit to you, at least for myself, looking at this data, 
it is not at all clear to me that China has been able to change 
the relation of its currency to the dollar because of the 
combination of policies that they are running. In fact, it is 
not clear to me that any nation has enough reserves any more to 
run even an intermediate length intervention program that the 
market does not believe is associated pretty directly with the 
expectations for discounted productivity expectations as 
between countries.
    It is true that I think it is clear on the face of it, I 
have been to China and sat down with the Governor of the Bank 
of China and talked with them about their currency regime and 
their intentions toward the rest of the world. And it is true 
that they are running what I would characterize as a semisoft 
peg. But I do not think, however much of their reserves may be, 
that they can get away very long with, in effect, defeating the 
market or producing a different relationship between their 
currency and the other major currencies in the world by using 
reserves to do it. And I think if it were true, then Argentina 
would not be where it is today.
    Chairman Sarbanes. First, I think the Chinese and Japanese 
are very skillful about this.
    Second, if the United States is not resisting what they are 
doing, but, in effect, is going along with it, which is 
essentially what would flow out of an attitude that says, this 
is an irrelevant concept and there is no problem here, it makes 
it easier for them to work this game to their advantage. That 
is what is happening.
    The figures just will not sustain, it seems to me, the 
position you are coming from. I think there is a problem. You 
keep saying, no problem. Manufacturers say that there is a 
problem. Economic commentators say there is a problem. You say, 
no problem. Well, look, as long as you say no problem, then 
their ability to have an impact is enhanced, not diminished, in 
my view.
    Secretary O'Neill. Senator, may I say just one word to 
that?
    Chairman Sarbanes. Sure.
    Secretary O'Neill. Again, I look at the objective evidence 
and I hear Japan. And I noticed this. In the last 12 years, the 
Japanese economy has performed dismally at something close to 
an average GDP growth of zero, as compared to a spectacular 
performance by historical measure for the U.S. economy over the 
same period of time. And we appear to be headed back toward our 
potential rate.
    The same facts pertain to Western Europe. I do not find a 
basis for deciding that what we have been doing is 
fundamentally wrong in the experience that we have had as an 
economy as compared to any other economy in the world.
    Chairman Sarbanes. We have heard you talk about short-term 
benefits and long-term vision and so forth in a different 
context in talking about the budget, having sort of self-
discipline and so forth. The fact of the matter is that we are 
building up these large obligations. We will have to pay or 
service those obligations into the future. So the gap between 
what we must produce and what we can reserve of that production 
for ourselves is growing because more and more of it is going 
to have to be committed to servicing these foreign claims that 
we have built up.
    You may say, well, the economy is going well. Everything's 
hunky dory, and so forth and so on. But, nevertheless, this 
burden continues to build. And it carries with it, it seems to 
me, potentially very severe problems in the future. And you are 
the only one I find who denies that. Alan Greenspan says, at 
some point, we have a problem. Most everybody says that. I 
cannot even get you to say here today that at some point, we 
would have a problem. It is still no problem.
    Senator Gramm.
    Secretary O'Neill. As you know, Senator, I am not reluctant 
to be alone.
    [Laughter.]
    Chairman Sarbanes. I understand that. That is pretty clear. 
But you worry when the Secretary of the Treasury of the leading 
economic power in the world is pursuing an attitude and a 
policy that no one else thinks is on all fours.
    Senator Gramm. First, I would like to say, Paul, that I 
appreciate what you said today. I think it is very important, 
it is very tempting in this world we live in, in politics, what 
I guess would be the politics of political correctness, for 
people to say, oh, yes, there is a problem.
    You fall in love with somebody and they fall in love with 
you. Well, there is a problem because something could happen to 
them. There is a problem at the bottom of every good thing. To 
me the problem with going around talking about the problem is 
that there are people who have a vested interest to create a 
problem for their own benefit. I do not blame them. I am not 
being critical of them.
    It seems to me that the cold reality is that even if you 
wanted to manipulate the value of the dollar, that you could 
manipulate it maybe for a week. And that is for our financial 
position, and it would be money completely squandered. I think 
that that is the first place I am coming from.
    Second, we are all accustomed from early age, neither a 
borrower, nor a lender be. The plain truth is our country was 
built with foreign money from the time the first Pilgrim 
stepped on Plymouth Rock. At least until a couple of years 
after World War I, we were far and away the greatest debtor 
nation in the world.
    The British built our railroads. They built our canals. 
They built post roads. They invested in our manufacturing. But 
all those were good investments. So it was true, we had to pay 
all this money to Britain, but we made more money. Maybe I am 
so poor because I have never been a debtor. But I was never 
confident enough that I would have known what to do with the 
money any way.
    The one thing we could do that would clearly lower the 
value of the dollar would be increase domestic savings rates, 
no question about it. If we could get Americans to save more 
money, we would depress real interest rates and we would change 
the flow of capital. And that would be a positive for the 
world, as well as for us. So trying to create incentives or an 
environment to encourage thrift, I think all those would be 
very positive things. But I think, in the end, when you get 
right down to it, obviously, there are a combination of 
circumstances whereby current account deficits could become a 
problem.
    Chairman Sarbanes. Were you nodding your head to that?
    Secretary O'Neill. I was. I agree with this formulation.
    [Laughter.]
    Senator Gramm. It depends on what is causing it.
    Secretary O'Neill. Right.
    Senator Gramm. That is the factor. Looking at the 
underlying things. And as I look at this trade deficit, I do 
not see anything right now we would want to change that is 
causing it. It is not as if it doesn't accrue benefit to some 
people.
    The other day, I had left a shovel I was using in a truck, 
the shovel was gone. I had a limited amount of time, so I went 
to Home Depot and I was going to buy a shovel. I bought a 
shovel for $4.52. Now, I would say that never in the history of 
the world, has a quality product sold for less than that. The 
plain truth is we live in a golden age. Now if I were 
manufacturing shovels, I would be damned unhappy about it.
    [Laughter.]
    I would be calling me up, if I were a manufacturer in 
Texas--I do not think we have any shovel manufacturers in 
Texas. But, 
I would be saying, we need to do something about it because I 
am going out of the shovel business. And if you are in the 
shovel 
business, it is a terrible thing. But if you are buying 
shovels, it 
is not a terrible thing. And Government has got to balance all 
these 
interests.
    The only way I know to balance them is do it in a way that 
in the long-term benefits the most people. And it seems the way 
to do that is freedom and trade and that in the long-term, that 
is what benefits people the most.
    So there is a dark side of it. If you are trying to sell 
products on the world market or compete against imports, this 
high-value dollar with this massive inflow of capital, which, 
God knows, we 
do not want to stop and we could use more of it in Texas. The 
dark side of it is it does hurt some people. But any change in 
any 
policy hurts somebody. The vacationer is hurt by rain. The 
farmer is helped by rain. Anything you do has advantages and 
disadvantages.
    I guess if you are going to worry about it, you can. But in 
the end, I do not know under the circumstances we face now, I 
guess my view, and I will stop, Mr. Chairman, is I do not know 
what we could do differently other than better Government 
policies that would encourage more thrift in the United States.
    I do not think we ought to be discouraging people from 
investing in America. I do not think we ought to blockade our 
ports or impose tariffs. In fact, I am not sure a tariff would 
do anything to this problem. If you put a tariff on everything, 
exchange rates would change and it would have no effect. Only 
if you put it on some things not on others, do you help 
anybody.
    So, I think it is so tempting to say under these 
circumstances, yes, there is a problem. And I do not know 
exactly what Chairman Greenspan was referring to, but I just 
think that it is important to have somebody, and this happens 
to be you today, who says, I do not see a problem as to where 
we are now with this that we would want to fix. I think that is 
right. And I agree with it. But I do not agree with you about 
speculators.
    Secretary O'Neill. You do not?
    Senator Gramm. No. I knew you were a manufacturer when you 
said that.
    [Laughter.]
    Speculators are public benefactors who make money by making 
markets work better. And God bless 'em.
    Secretary O'Neill. Let me substitute manipulator for 
speculator.
    Senator Gramm. Well, manipulators in a market like this 
lose their shirt.
    Secretary O'Neill. That is what I want.
    Senator Corzine. Senator Gramm, I have never loved you so 
much.
    [Laughter.]
    Senator Gramm. Well, I give credit where it is due.
    [Laughter.]
    Secretary O'Neill. May I make just two quick points?
    Senator Gramm. You did not get rich without providing 
value.
    Secretary O'Neill. Just two quick points, Senator. Thank 
you very much for your comments.
    First, on the issue of current account deficit. 
Economists--we did not know what this was back in the 1800's. 
But it turns out we had a huge, overwhelming current account 
deficit in the late 1800's. I guess it is a good thing that we 
did not know about it. We might have stopped the British 
investment.
    Chairman Sarbanes. Well, does the same thing work today? 
The world's most advanced economy, as opposed to a nation 
seeking to develop itself. You apply the same test.
    Senator Gramm. You develop it.
    Secretary O'Neill. One of the things that I find, frankly, 
a little disconcerting about the notion of a current account 
deficit, and, again, I think it is a static concept.
    I have to tell you what I was doing when I was running 
Alcoa. Yes, I was borrowing money and getting more equity 
investment. But I was taking it around the world. So the idea 
that it was stuck here, the fact that ownership here did not 
mean it was stuck here. It was helping to create economic 
development around the world.
    Second, the other point I wanted to make was about this 
issue of savings. Inherent in that is a sense that we here in 
Washington know better than what individuals are now doing 
collectively they ought to do. I think that if you really stop 
and think about it, you really believe we here in Washington 
know better what individuals ought to do about savings and how 
we measure savings.
    Many people think their home is a savings and in fact, the 
evidence has demonstrated that people are getting real savings 
and ascension into the middle class by homeownership, which is 
an important form of savings. The other face of that, of 
course, is that we have more savings and we have less 
consumption. So these are not questions without consequence.
    Chairman Sarbanes. Senator Bunning.
    Senator Bunning. Chairman Sarbanes, thank you. I have heard 
enough conversation. I pass.
    Chairman Sarbanes. Jon.
    Senator Corzine. Mr. Secretary, I want to go back.
    Chairman Sarbanes. I told the Secretary that we would have 
him out in short order. Go ahead.
    Senator Corzine. Okay. It strikes me that we have a risk by 
this current account cumulative element that has built up over 
the years. And that is a dynamic. It keeps growing and our 
trade issues are ones, and it is a problem at a microlevel for 
a lot of individuals. There is no trade adjustment kinds of 
facilities that are 
accompanying a lot of the problems that end up occurring as a 
function of exchange rates. And if they are sustained at 
relatively 
high levels, whatever that might be, then I think we have 
reason 
as public policymakers to wonder whether the system is working 
fairly.
    We have talked about China with the soft peg. And the fact 
is that that is an intervention into the market, not because of 
their purchases of dollars on the market, although, you know, 
at the margins some place, that increases the value. But if 
their currency depreciates versus the dollar, even within their 
pegged range, it undermines our manufacturers' ability to 
compete fairly in a marketplace, if one is talking about fair 
markets.
    So, I think that is a legitimate problem. And if you put 
that cumulatively across a lot of different countries in the 
world, and there are places where there are soft pegs in other 
areas--you look in a lot of the developing world, there are 
soft relationships on what currencies are.
    I do not know. I think that is the case in Korea. I think 
that is the case in Taiwan. I think that is the case in the 
Hong Kong manufacturing areas.
    And with smaller currencies, it is easier to manipulate and 
opposed to how it is with respect to the yen or the dollar or 
the Euro.
    I think that there are other structural elements of the 
marketplace which you are trying to address here. But I think 
our manufacturers and our workers end up on the short end of 
the stick with regard to how these systems work.
    I am not arguing that we ought to be in the manipulation of 
the currency markets. But I think we have a real policy 
responsibility to do something about changes in some of these 
structures that work to the disadvantage of American workers 
and American business. I do not think that all of those are not 
necessarily in the trade arena. They are in structural reforms 
that I think we have the impact to have real change brought to 
bear on how some of these markets work.
    A lot of these things do not even hit the radar screen of 
trade agreements. They are the regulations that slow down the 
flow of how people can participate in the markets. And that I 
think is a serious problem and I think it contributes to the 
long-term risk which has to do with what is the nature of the 
structure of American markets, whether people lose confidence 
in our markets because our accounting statements do not make 
sense or that we end up running huge deficits at the Federal 
Government that competes for that flow of inflow of capital. I 
think these things are serious and they are potentially riskier 
in a dynamic context because we build up these current account 
deficits over a period of time. I guess I am siding with the 
Chairman here that we have something to be concerned about.
    Senator Gramm. That is a smart thing to do. That is a very 
smart thing to do.
    [Laughter.]
    Chairman Sarbanes. Mr. Secretary, we promised you that we 
would have you out, actually a little sooner. This has been a 
very interesting session, as it invariably is when we have the 
opportunity to exchange views with you. As you depart, I want 
to leave you with one image in your mind. This is the real 
foreign exchange value of the dollar. This is 1980. This is 
2002.
    This was the Plaza Accord. And we have heard this morning 
that if you try to do something, it won't sustain itself. But 
it worked for quite a period of time. Now, we are back up here. 
My anticipation is that this is going to go, it will be above 
where we were at the time of the Plaza Accord. So, I leave that 
with you. The Treasury, in effect, brought others together and 
took an initiative to try to address that.
    Secretary O'Neill. May I make one observation about the 
basing point in the chart for 1980?
    Chairman Sarbanes. Sure.
    Secretary O'Neill. I would remind you, that around 1980, 
the interest rate in the United States was 20 percent and the 
unemployment rate was 11 percent.
    And so, if 1980 is a desirable position, that is not my 
notion of desirable economic circumstances. In fact, if you 
look at the period since--it is hard for me to see from here, 
but it looks like 1994, 1995, when the value started rising. We 
have arguably had among maybe the five best years in our 
economic performance in modern history.
    Chairman Sarbanes. Well, accepting all of that, we still 
have, it seems to me, a real problem here.
    Thank you very much.
    Secretary O'Neill. Thank you. I will read the transcript of 
what follows very carefully because I want you to know that I 
do not have a closed mind on these subjects. I am open to 
listen to information and insights that can help us advance 
policy in a constructive way. So, I do not want you to take 
from what I have said that I think I have the answer. No one 
else knows what they are talking about. I just have not seen 
compelling evidence that is connected to possible public policy 
levers that would advance the cause of our society.
    Chairman Sarbanes. We have some very good panelists coming, 
and I am encouraged to hear that you intend to look carefully 
at their testimony and the transcript.
    Thank you very much for being with us this morning.
    Secretary O'Neill. Sure.
    Chairman Sarbanes. If the panel would come forward and take 
their places, we will continue.
    [Pause.]
    Chairman Sarbanes. We are pleased to have a distinguished 
panel now to address this issue. I believe they were all here 
at least during part of the Secretary's testimony and exchange. 
So, we will proceed now, and I will introduce each as we move 
across the panel, instead of everyone at once.
    First, we will hear from Richard Trumka, the Secretary 
Treasurer of the AFL-CIO.

                 STATEMENT OF RICHARD L. TRUMKA

                      SECRETARY-TREASURER

                AMERICAN FEDERATION OF LABOR AND

              CONGRESS OF INDUSTRIAL ORGANIZATIONS

    Mr. Trumka. Thank you, Mr. Chairman, and Members of the 
Committee.
    Chairman Sarbanes. And I would say to the panel, your full 
statements will be included in the record, and if you can 
summarize them, we would appreciate that very much.
    Mr. Trumka. I will do just that, Mr. Chairman.
    I am glad to have the opportunity to talk with you today on 
behalf of the 13 million working men and women of the AFL-CIO, 
about the economic impacts of the overvalued dollar.
    As we struggle to escape the grip of recession, the 
overvalued dollar represents a serious problem. It is also 
causing long-term damage by destroying our manufacturing base. 
Failure to redress the problem risks undermining our fragile 
recovery and pushing us into a double-dip recession.
    Manufacturing is ground zero of the recession, and its 
troubles are intimately connected to the dollar. Since March 
2001, we have lost 1.4 million jobs, of which 1.3 million have 
been manufacturing jobs. Manufacturing has therefore accounted 
for 93 percent of all job losses despite being only 14 percent 
of total employment. Today, manufacturing employment is at its 
lowest level since March 1962.
    Business has slammed on the brake of investment spending, 
but fortunately the American consumer has kept the recession 
milder than anticipated. However, a strong recovery that 
restores full employment needs a pick-up in investment 
spending, and that will not happen as long as currency markets 
give a 30 percent subsidy to our international competition.
    Over the last 5 years, our goods trade deficit has 
exploded, costing good jobs across a wide array of industries. 
Last year, in the paper industry there were mill and machine 
closures at 52 locations, all considered permanent, indefinite 
or long-term. In the textile industry, 2 mills per week closed 
in 2001, and closures continue this year.
    The weakening of the yen has given Japanese car companies a 
huge price advantage. The result has been loss of market share 
by our Big Three automakers that threatens some of the best 
jobs in America.
    Boeing, which operates at the cutting edge of technology, 
is losing market share to Europe's Airbus. And losses today 
mean future losses because airlines work on a fleet principle. 
They will therefore order Airbus aircraft 5 years from now when 
they expand their fleets.
    Moreover, job losses are not restricted to manufacturing. 
Tourism and hotels are hurt by the strong dollar, and film 
production is moving offshore to cheaper destinations such as 
Canada, Australia, and New Zealand.
    Many of these jobs will never come back. These are high 
paying jobs that have been the ladder of the American Dream for 
millions of Americans. But now we are kicking the ladder away.
    Manufacturing has faster productivity growth, and 
productivity growth is the engine of rising living standards. 
But now we are shrinking our manufacturing base, and that is 
bad for future living standards.
    The Administration, as previously noticed, has refused to 
address these problems. Arguments for a strong dollar, in our 
opinion, simply do not wash.
    Inflation is not a problem, and there is no evidence that a 
lower dollar will lower the stock market or raise interest 
rates. Those who say we need a strong dollar to finance the 
trade deficit have the reasoning backward. We need to finance 
the trade deficit because we have an overvalued dollar.
    It is time for a new policy that puts American jobs and 
American workers first. It is unacceptable that Japan 
depreciates its currency. This will not solve Japan's problems, 
and will only export them to its neighbors and to us.
    China exemplifies all that is wrong with currency markets. 
It has a massive trade surplus and vast inflows of foreign 
direct investment. In a free market, China's currency should 
appreciate, but it does not because of government manipulation. 
This is a problem that appears in different shades in many 
countries.
    American workers are paying the price for currency 
manipulation. Trade cannot be fair when we allow countries to 
manipulate exchange rates to win illegitimate competitive 
advantage.
    Those who argue that we can do nothing about exchange rates 
abdicate, I believe, the national interest. The historic record 
and the 1985 Plaza Accord intervention show that we can. 
Academic research shows the same. Just as we manage interest 
rates, so too we can manage exchange rates.
    Currency markets are speculative and respond to policy 
signals. The Treasury and the Federal Reserve must take 
immediate action with their international partners. The 
upcoming G-7 summit provides an appropriate moment to do so.
    Beyond intervention today, we must avoid a repeat of 
today's overvalued dollar, just as today's problems are a 
repeat of mistakes made in the 1980's. The dollar must be a 
permanent focus of policy, and the Treasury and the Federal 
Reserve must be made explicitly accountable.
    Every trade agreement, Mr. Chairman, must include strong 
language that rules out sudden currency depreciations that more 
than nullify the benefits of any tariff reductions.
    The Senate Banking Committee has a vital oversight role to 
play in ensuring that the Treasury and the Federal Reserve live 
up to these obligations.
    Thank you for the opportunity to testify and submit a 
report, and I would be happy to answer any questions that you 
may have.
    Chairman Sarbanes. Thank you very much. We appreciate your 
testimony.
    Next, we will hear from Jerry Jasinowski, President of the 
National Association of Manufacturers. Jerry has been before 
the Committee a number of times in the past. We are pleased to 
welcome him back.

                STATEMENT OF JERRY J. JASINOWSKI

        PRESIDENT, NATIONAL ASSOCIATION OF MANUFACTURERS

    Mr. Jasinowski. Thank you very much, Mr. Chairman, Senator 
Gramm, and all the other Members of the Committee for your 
leadership on this important issue.
    I have enormous respect for Paul O'Neill. He is an old 
friend. I think his leadership and his dedication to the 
country have been extraordinary. And I think that it is only in 
the spirit that he himself invoked, which is to say, he is 
welcoming a debate, that I would like to confine my oral 
remarks to a fairly direct response to what the Secretary said, 
because I think that will be the most useful thing to the 
Committee.
    My prepared statement makes the case for why we think the 
dollar has run amok, not just for manufacturers, but also for 
this broad coalition here--and why it is bad for the economy. 
It is not just a matter of a few special interests indicating 
that this is important. There is a growing global consensus.
    Let me make five points that go fairly directly to what 
Secretary O'Neill talked about, that I think will be useful to 
the Committee. The points all go to the argument that, 
essentially, the Secretary is not addressing the reality that 
we see and the growing consensus in the world sees.
    The first reality is, there is an extraordinary consensus 
now of academics, business leaders, union leaders, 
international leaders, and others, who say the dollar is 
overvalued. And in my statement, I talk about everybody from 
the IMF to particular economists who say it is overvalued by 
historic standards.
    I think for the purposes of the Committee, though, the Big 
Mac index illustrates most dramatically the reality. This is an 
index the Economist Magazine uses to determine the extent to 
which the dollar is overvalued. It is the cost of a Big Mac in 
places around the world. The index is, according to the 
Economist Magazine now, more overvalued than it has ever been 
in history.
    I think the chart you showed, Mr. Chairman, reflects this. 
The Big Mac index reflects the reality in terms of real 
products and is similar to the kinds of issues associated with 
products that manufacturers and agriculture face very broadly.
    The second reality that I think the Secretary really does 
not address is the fact that the current account is a growing 
problem and that it is directly related to the exchange rate.
    I have here a chart, which is in my testimony as well. The 
chart essentially tracks, as you can see, the ratio of imports 
to exports, and the exchange rate for the dollar index.
    What you see is an unequivocal correlation between----
    Chairman Sarbanes. Which line is which in that?
    Mr. Jasinowski. The top line, the darker line, shows you 
the ratio of imports to exports, and that is a rough proxy for 
the trade deficit.
    Chairman Sarbanes. Right.
    Mr. Jasinowski. What we are talking about is the current 
account. Unequivocally, you see that the dollar exchange rate 
affects that.
    Now the Secretary says in his report, and others will say, 
that the current account and our trade problems are affected by 
interest rates, growth, and all the things you, Mr. Chairman, 
and the Committee, know very well. But I am here to say that, 
right now, the most important thing affecting the current 
account problems, the growing trade deficit that we have heard 
so much about, and our enormous loss of exports, is the 
exchange rate.
    The third reality that the Secretary does not address is 
the enormous negative effect that this is having, not just on 
manufacturing, but also on the entire economy. It affects the 
trade deficit. It affects employment. It affects growth. It 
affects the international global stability on which we are all 
resting our hopes for a recovery in the economy. That is why 
the IMF and many others have suggested there is a problem.
    The fourth reality, and this gets to the heart of what do 
you do about this, is that the Secretary is a major part of the 
problem through his statements that fail to recognize the 
problems associated with the dollar trade and the current 
account. This misinformation distorts the markets that in fact 
are supposed to be functioning correctly.
    I am here to argue that we do not have a perfect market in 
terms of the currency markets. We do not, principally because 
the Treasury has taken the policy position that it is not a 
problem. Second, and most importantly, by being for a strong 
dollar, you put a floor under the currency. So, I would argue 
that we do not have a perfect market in the exchange rate for 
that reason, and that the Treasury is part of the problem.
    My final point, Mr. Chairman, is that the solution is 
therefore, at least in a first instance, pretty simple. That 
is, that the Treasury ought to simply acknowledge that the 
current account is a problem, the dollar is a problem, and it 
ought to get out of advocating a strong dollar and instead say 
it is for a sound dollar based on market fundamentals. If we do 
that, I assure you we will not have a huge drop in the dollar. 
We will have a gradual movement back toward the equilibrium 
that all of us that are part of a sound dollar coalition are 
for. And I think that would mean less Government intervention 
in this market, in some respects, and a return to a truly 
perfect market.
    Thank you, Mr. Chairman.
    Chairman Sarbanes. Thank you very much. Also, we want to 
thank you for this very well considered prepared statement, 
which we very much appreciate having. But I think it was 
helpful for you to directly address some of the points that the 
Secretary made.
    Our next witness is Bob Stallman, President of the American 
Farm Bureau Federation. We do not usually have you before our 
Committee, Mr. Stallman, but we are pleased you are here today. 
We would be happy to hear from you.
    Senator Gramm. Mr. Chairman, could I just say a word about 
Bob Stallman, and I will be brief ?
    Chairman Sarbanes. Certainly.
    Senator Gramm. I have known Bob since he was a rice farmer 
in our State. He started out as a farmer talking to his 
neighbors, became involved in the county farm bureau, became 
President of the Texas Farm Bureau, and became President of the 
American Farm Bureau.
    I am sure Bob and I are not going to agree on the subject 
today, but I would like to say that Bob Stallman is living 
proof that talent wins out in America, if you have ability and 
ideas and you feel passionate about stuff, that your neighbors 
will elevate you and that starting out as a rice farmer in 
southeast Texas, you can become the spokesman for American 
agriculture if you have what it takes to become that. So it 
just reassures me, having known somebody this has happened to. 
Bob, we appreciate your being here.
    Chairman Sarbanes. Thank you.
    Mr. Stallman.

                   STATEMENT OF BOB STALLMAN

           PRESIDENT, AMERICAN FARM BUREAU FEDERATION

    Mr. Stallman. Mr. Chairman, Senator Gramm, thank you for 
the kind words. Incidentally, for the record, I still am a rice 
farmer, though just not to the extent I used to be. It is a 
pleasure to be before this Committee today.
    As the Nation's largest agricultural organization, our 
farmer members produce nearly every type of farm commodity 
grown in America and depend on access to foreign markets for 
our economic viability.
    We certainly appreciate this opportunity to testify on the 
importance of the exchange rate to U.S. agriculture. The 
exchange rate is the single most important determinant of the 
competitiveness of our exports. U.S. farmers and ranchers have 
been losing export sales for the past 3 years because the 
dollar is pricing our products out of the market, both at home 
and abroad.
    Agriculture is one of the most trade-dependent sectors of 
our economy. Our sector has maintained a trade surplus for over 
two decades, but that surplus is rapidly shrinking. One of the 
primary factors affecting our declining trade balance is the 
strong value of the dollar.
    We are also deeply concerned about countries that engage in 
currency devaluations in order to gain an export advantage for 
their producers. The real trade-weighted exchange rates for 
agricultural exports from our major competitors have exhibited 
a long-term trend of depreciation against the dollar, leaving 
it hard to conclude that this is not a deliberate monetary 
policy of these and other 
governments.
    U.S. agriculture relies on exports for one-quarter of its 
income. In addition, and coincidentally, about 25 percent of 
the agricultural production in the United States is destined 
for a foreign market. With a strong dollar, we have the double 
challenge of our products being less competitive in foreign 
markets, while products from other countries are more 
competitive in U.S. markets.
    There is a strong relationship between the value of the 
dollar and the domestic price of our commodities. As the value 
of the dollar rises, foreign buyers must spend more of their 
currency to purchase our exports, which causes them to decrease 
their consumption of our commodities, or buy from our 
competitors instead. The resulting drop in consumption drives 
U.S. commodity prices down even further.
    The increasing strength of the dollar, and steady 
depreciation of the currencies of our major export competitors, 
has had a profound impact on our ability to export. In fact, 
the rising appreciation of the dollar is one of the primary 
reasons why the agricultural economy did not experience the 
economic prosperity that most other sectors of the U.S. economy 
enjoyed between 1995 and 1999. This is also a jobs issue. USDA 
estimates that 14,300 jobs are lost for every one billion 
dollar decline in agricultural exports. As a result, 
agricultural employment lost 87,000 jobs between fiscal years 
1997 through 2000, a period wherein the real agricultural 
exchange rate was rising rapidly and U.S. agricultural exports 
were stagnating.
    For some commodities, the rising value of the dollar has 
directly contributed to the export competitiveness of our 
foreign rivals. The strong dollar enables our competitors to 
expand their production and gain market share at our expense. 
Let me give you a few commodity-specific examples.
    Beef: Since 1995, the dollar has appreciated 42 percent 
against the currencies of beef producing countries. And I know 
we had the Big Mac index over here, but that U.S. McDonald's 
Big Mac is going to have more foreign beef in it, given their 
recent announcement to purchase more beef from Australia. The 
relative exchange rate, strong value of the dollar, has caused 
that economic decision to be implemented.
    Fruits: From 1995 to 2000, U.S. imports of fruits and nuts 
jumped 33 percent, largely due to the dollar's 18 percent gain 
with respect to the currencies of foreign suppliers of these 
commodities to the United States.
    Corn: The U.S. dollar appreciated 39 percent relative to 
the Japanese yen from 1995 to 1998, adversely affecting our 
corn exports to that market.
    Soybeans: The cost of U.S. soybeans to Japanese buyers 
increased 8 percent from 1996 to 1998, due to the appreciation 
of the U.S. dollar, even though U.S. prices fell 18\1/2\ 
percent during the same period.
    In conclusion, America's farmers are the most productive in 
the world. However, the comparative advantages that our 
producers generally enjoy are certainly mitigated by the rising 
appreciation of the dollar.
    Exchange rate issues are certain to increase in importance 
for our sector, and if these issues are not resolved by 
macroeconomic policies, there will be continued pressure to 
find solutions in traditional farm and trade policies.
    The effect of long-range financial planning at the farm and 
ranch level and the overall economic health of U.S. agriculture 
depends on more stable exchange rates that do not overvalue the 
U.S. dollar against our competitors' currencies.
    Thank you, and I look forward to answering any questions at 
the conclusion of the presentations.
    Chairman Sarbanes. Thank you very much, sir.
    Our next panelist is Fred Bergsten, who is the Director of 
the 
Institute for International Economics, and a frequent 
contributor to our discussions. We are very pleased to have you 
here, Fred.

                 STATEMENT OF C. FRED BERGSTEN

        DIRECTOR, INSTITUTE FOR INTERNATIONAL ECONOMICS

    Mr. Bergsten. Mr. Chairman, thank you very much. As I 
listened to the discussion this morning, there seemed to be two 
questions before the House.
    Chairman Sarbanes. Before the Senate.
    Mr. Bergsten. Excuse me? Sorry. Before the Senate.
    [Laughter.]
    Bad error.
    [Laughter.]
    Change the words in the transcript.
    [Laughter.]
    Two questions before the Senate. One, is it a problem? And 
two, is there something you can do about it?
    My answer to both is a resounding yes, and let me briefly 
summarize my statement in trying to answer those questions.
    First, is it a problem?
    We have to keep clearly in mind that there are not one, but 
two problems, a real economy problem and a financial risk 
problem.
    The real side problem is the loss of output, loss of jobs, 
and loss of agriculture that were talked about. The financial 
risk problem is the possibility that all this could come 
crashing down in a huge financial crisis with enormous 
consequences for the economy.
    Now what is the size of the problem?
    Since the dollar hit its all-time record lows in 1995, it 
has risen by 40 to 50 percent against the various trade-
weighted averages that the Fed calculates every day. And that 
is like a rise in 40 to 50 percent in prices of the entire 
economy in world trade. When a company sees its prices go up 40 
to 50 percent in a few years against its main competition, it 
is usually in Chapter 11. That is what has happened to the 
United States as a whole.
    Every rise of 1 percent in the trade-weighted average of 
the dollar produces an increase of at least $10 billion in our 
current account deficit. And so it is clear that this rise of 
40 to 50 percent in the exchange rate over the last 6 or 7 
years explains the vast bulk of the half-trillion dollar trade 
deficit that we face today and which is getting bigger.
    Indeed, we have projected the current account over the next 
few years on reasonable economic assumptions, and assuming no 
policy change, more of what we heard from the Secretary this 
morning, and no untoward external events, the deficit would hit 
7 percent of GDP--that is $800 billion--by 2005 or 2006.
    Every study ever done, including by the Federal Reserve 
itself, and they published this, shows that once you hit 4 to 5 
percent of GDP, you are in the danger zone.
    Indeed, the big crashes of the dollar which have occurred 
once per decade since the early 1970's, have occurred without 
our current account deficit ever getting to 4 percent of GDP, 
the all-time high in the mid-1980's, before the Plaza Accord 
Agreement, and the 50 percent correction in 2 years, was 3.8 
percent. We are well beyond that. We are headed toward twice 
that. We are clearly on an unsustainable path.
    Now, in financing terms, what this requires is even worse 
than you think because we not only have to import $500 billion 
of capital each year to finance our current account deficit but 
we also have to cover our capital outflows.
    Remember that the United States itself invests lots of 
money abroad. This is a good thing. I am certainly not 
criticizing it. But that amount is another half-trillion 
dollars a year. So the result is that the U.S. imports a 
trillion dollars of foreign capital per year, to balance the 
books, which is a little more than $4 billion every working 
day.
    It is certainly not a bad thing. The point is, if that $4 
billion per day dropped to just $3 billion, let alone reversed 
into an outflow, the dollar would fall sharply. And it would 
fall, by our calculations, at least 20-25 percent to get back 
to some kind of sustainable equilibrium level. Since markets 
overshoot, it would probably go much more than that in the 
short run.
    That would cause sharp inflation, a sharp rise in interest 
rates by several percentage points, and a sharp fall in the 
stock market--a triple-whammy that would hit the economy. That 
is why I agree with the statements you made before that this is 
the single biggest risk to the U.S. economic outlook, and that 
the Secretary of the Treasury certainly ought to be concerned 
about it.
    It is stunning that he said the things you quoted this 
morning that he did say. It is reminiscent--this is a 
nonpolitical statement, just an economic analysis--of what 
happened in the first Reagan Administration, with Secretary Don 
Regan and Beryl Sprinkel, which was the epitome of benign 
neglect.
    That turned out to be so wrong and so costly to the economy 
that the second Reagan Administration had to reverse it, do the 
Plaza Accord Agreement, and drive the dollar down by 50 percent 
in the next 2 years. So it is not as if we have not seen this 
happen before. We have seen exactly this happen before. The 
Administration that permitted it to happen then had to reverse 
itself 180 degrees, enlist the rest of the world to help to 
save us from the enormous costs of that policy.
    Second question, is there something we can do about it, as 
Senator Gramm, Secretary O'Neill, and others raised, and you 
yourself acknowledge? That is the more difficult question.
    I believe there are policy changes that can rectify the 
situation substantially without significant adverse costs 
elsewhere in the economy. And that is because I believe, and I 
will try to document briefly, that sterilized intervention in 
the exchange markets works and can change currency movements in 
important terms.
    The Secretary mentioned Allan Sinai and economic theory. 
There is something now in economic theory called multiple 
equilibria.
    Economists have now realized that for any given set of 
economic fundamentals, there is in fact, a large set of 
possible market outcomes, glorified by the term multiple 
equilibria, indicates there is firm theoretical basis for what 
I am about to say. I would suggest a four-part change in 
policy.
    First is what Jerry Jasinowski just said--change the 
rhetoric, 
absolutely.
    Second, if the dollar were to rise further, as it may 
because of the rapid U.S. recovery, the United States and the 
G-7 should certainly lean against the wind of any new dollar 
rise. That would make it worse.
    Third, however, and more importantly, we should now begin 
easing the dollar down toward equilibrium levels, and I will 
explain briefly why I think now is the time to do it.
    Fourth, we should of course make it very clear to other 
countries that we will not tolerate efforts to competitively 
depreciate their currencies.
    The Treasury Report is stunning in that it acknowledges 
huge intervention by the Japanese, but does nothing about it. I 
can tell you that immediately after the rise in the yen last 
fall, the Japanese began talking it down. I thought they had 
quit, but they are at it again this week.
    The leadership of Japan's Ministry of Finance has been 
saying very clearly this week, after the yen rose four or five 
yen against the dollar, that any further rise would be 
inconsistent with our economic fundamentals and they are 
against it. They are again trying to avoid any rise in the 
exchange rate of the yen. And we should make clear that that is 
verboten and will not be accepted.
    On U.S. currency policy itself, it was encouraging that 
Secretary O'Neill today, as for many months, did not repeat the 
term, ``strong dollar.'' You will notice that he has 
assiduously avoided saying that for some time now. However, he 
said, there will be no change in policy, so I suppose it has 
the same implication.
    I would agree with what Jerry Jasinowski said, that the 
Administration should change the wording and now start 
supporting a sound dollar or some equivalent that made clear 
that they wanted to see it in sustainable equilibrium terms, in 
terms of our external position.
    The presumed reason they do not want to change is they are 
afraid that the dollar would then collapse. But at a time when 
the U.S. economy is booming, as the Secretary said, with huge 
pro-
ductivity growth, at a time when there is no dramatic growth in 

Europe or Japan to suck money away, I think it is very unlikely 
that a change in rhetoric would lead to a free fall, and that 
is why this is the ideal time to make the change--when we are 
doing well, when we are recovering strongly, and when the 
others are not doing so well, unfortunately. Now is the time to 
do it.
    The worst policy is to wait until there is an inevitable 
change in economic circumstances that drives the dollar down 
when we are not in such good shape, when we cannot accept it so 
well, which would cause enormous costs to our economy. And so, 
it seems to me that now is the time to do it.
    Final point, again, how do you do it? Change in rhetoric 
and direct intervention.
    Notice that the Rubin-Summers Treasury intervened on three 
and only three occasions, from 1995 through the end of its 
tenure in 2000. Every one of those changes, in my view, worked 
like a textbook.
    In 1995, when the yen was rising too far, got to 80, the 
dollar in fact was at its all-time record lows against both yen 
and Deutschmark. We intervened jointly with the G-7. We stopped 
the rise of those other currencies, stopped the fall of the 
dollar, turned it around, and within a few months, the dollar 
was headed up, and in fact, it has never stopped since. We were 
100 percent successful.
    In 1998, the yen was becoming too weak, just like it is 
today. It got to 145. The United Stated intervened, along with 
Japan, and stopped the decline of the yen. It stabilized in 
that range for a couple of months and then rose back to 100. It 
was a total success.
    Third intervention, September 2000. The Euro fell to its 
all-time lows. The Europeans got upset. Again, that was pushing 
the dollar to get further overvalued. Joint U.S.-E.U. 
intervention stopped the decline on a dime. The Euro turned 
around, rose 10 percent, subsequently fell back halfway. It has 
been there ever since.
    On my reading, in all three cases, three out of three, it 
worked. I believe, incidentally, the Plaza Accord was a huge 
success and the notion ex-post that it was just riding along 
going down the stream, frankly, is post hoc ergo propter hoc 
reasoning, and was not clearly in the minds of the people who 
did it at the time, who saw an enormous need to change the 
trend and do something about it.
    There has been scholarly work by Franckel and Domingues at 
my institute. The Banca d'Italia's working with classified data 
suggested that every major intervention in the 1980's and 
1990's worked and turned the currency relationships around in 
the desired direction.
    So my conclusion is very simple. There is a big problem and 
there are policy tools available to deal with the problem 
without adversely affecting other parts of our economy.
    At a minimum, we should try it. The costs are too high. The 
risks of trying this I think are very modest if it were to 
fail, but the prospects for success are very strong and I think 
that alternative policies should be pursued.
    Thank you.
    Chairman Sarbanes. Thank you very much.
    Our next panelist is Ernest Preeg, who is the Senior Fellow 
at the Manufacturers Alliance. We would be happy to hear from 
you.

                  STATEMENT OF ERNEST H. PREEG

            SENIOR FELLOW IN TRADE AND PRODUCTIVITY

              MANUFACTURERS ALLIANCE / MAPI, INC.

    Mr. Preeg. Thank you very much, Mr. Chairman. It is a 
pleasure to be here today.
    I will focus my remarks on one particularly disturbing 
aspect of the trade deficit, namely currency manipulation to 
commercial advantage by certain trading partners, and in 
particular, by China.
    I do want to say, though, as in my written statement, that 
I see the current account deficit and accumulated foreign debt 
as a problem. The most immediate concern is that a rapid rise 
in our trade deficit this year, almost all of which will be in 
the manufacturing sector, could be the Achilles's heel for the 
hoped-for sustained recovery because it is hitting our 
investment sector particularly hard, and that is the lagging 
sector.
    As for currency manipulation, the IMF clearly proscribes 
it. There is an IMF statute that members should not be 
manipulating their exchange rates to gain an unfair competitive 
advantage. And a principal indictor of such manipulation under 
IMF surveillance procedures is very precise. It says that 
members should not make protracted, large-scale interventions 
in the market in one direction--namely, to buy dollars and 
other foreign currencies--to keep their currencies down and to 
gain an unfair competitive advantage.
    Japan has gotten the most attention on this because for 
several years, they have made such protracted, large-scale 
interventions, $250 billion all told. Fred has given some 
examples of this.
    And I should state here, to clarify earlier discussion, 
what I call the great asymmetry in central bank intervention. 
If you are trying to keep your currency up, as Argentina did 
with the peso, you have to sell dollars. Everybody thus knows 
when you are going to run out of dollar holdings, and it is a 
limited time.
    In the other direction, as we are talking here, when you 
want to keep your currency down low, that is manipulate it 
down, you can buy unlimited dollars year after year, 
indefinitely, as Japan and China have been doing--as much as 
$50 billion each year--to offset the market forces in the other 
direction stemming from a trade surplus, for example.
    Turning to China, they have also manipulated their 
currency, but it is a more complicated situation. It has not 
received as much attention perhaps for that reason, because 
China has a fixed rate, but the currency is not convertible on 
capital account. In effect, the exchange rate is not really 
market-oriented.
    But the facts are nevertheless very clear, as was cited 
earlier by Senator Bunning. Last year, for example, China had a 
$25 billion trade surplus, globally, and a $45 billion inflow 
of foreign direct investment. This would put major upward 
pressure on the exchange rate. At the same time, however, the 
central bank bought $50 billion, to take dollars off the market 
and ease the pressure.
    More precisely, the Chinese central bank has taken away 
three-quarters of the upward pressure on its currency from the 
trade surplus and foreign direct investment. And here, again, 
another technical comment on the earlier discussion. What 
counts are not the gross flows in markets, a trillion dollars a 
day. Most of this is just in and out, offsetting. It is the net 
flow of trade and foreign direct investment, and the net 
borrowing of central banks that needs to be considered. And on 
this net basis, the numbers for Japan and China have been very 
large and have had substantial impact in keeping the exchange 
rate down.
    So the net result, in my judgment, is that China has a 
substantially under-valued exchange rate for the yuan and the 
direct impact, of course, is a larger trade surplus with us--
export jobs they gain and export and import-competing jobs we 
lose. There are several other benefits to China from its 
currency manipulation in my statement. I won't go into detail. 
One was mentioned earlier, that perhaps at some future point, 
they could use their excessive currency holdings for foreign 
policy leverage.
    A more immediate benefit for China is that with $220 
billion in their central bank--fungible money--there is no 
financial constraint to buying large amounts of armaments from 
Russia or elsewhere. They have huge amounts of money in the 
bank that they could use it for this, and for several other 
reasons as explained in my statement.
    I agree with the others that we need a clear and forceful 
response to this now chronic trade deficit. It is headed toward 
record levels over the next couple of years. And a $3 trillion 
net foreign debt accumulation is headed toward $5 trillion by 
mid-decade. What should we do?
    First, as Senator Gramm mentioned, we have to save more 
because we are currently living beyond our means. The foreign 
borrowing is not being used for investment, as was indicated, 
but mostly for immediate consumption. Eighty percent of our 
foreign borrowing, more or less, is for immediate consumption 
and we leave the consequent foreign debt to our children and 
grandchildren to pay interest and principle. I do not think 
that is right.
    So, we need to save more. And at the same time, we have to 
get trading partners such as China and Japan to save less and 
consume more, so that their economies do not have to be 
dependent on a large trade surplus, for which they manipulate 
their currency. They don't now have a domestic economy growing 
fast enough, and thus rely on a chronic trade surplus to 
maintain growth. We need to achieve a better balance, to save 
more and not spend beyond our means. And others need to do the 
opposite.
    The other immediate objective, in my view, is to stop 
others from manipulating their currencies so as to have bigger 
trade surpluses than they would have based on market forces 
alone.
    We have a clear opportunity to do this in the IMF based on 
very explicit surveillance criteria. All we have to do is ask 
for a consultation to say that the others should stop their 
currency manipulation. We have never done that.
    There is even an article in the GATT and the World Trade 
Organization, I believe Article XII, along the same lines. We 
have never thought seriously about that, either.
    We should take steps, both through bilateral consultations, 
and within the IMF context in a more formal way, to try, 
particularly with East Asians including Japan and China to stop 
further currency manipulation, which distorts exchange rates 
from what markets would determine.
    And for China, finally, the bilateral consultations should 
be a very high priority. We have a mutual interest in reducing 
the very lopsided, 5:1 trade imbalance, with $100 billion U.S. 
imports and only $20 billion exports, last year, and we should 
begin with the question--why is the bilateral trade so 
imbalanced?
    We should request, clearly, of China, that the central bank 
stop buying dollars at $50 billion a year, and that they bring 
their exchange rate up by 10 percent, 20 percent, or whatever 
is a reasonable first step.
    The longer-term transition of China to a fully convertible 
floating rate relationship with the dollar should also be 
discussed. We should look at this seriously because that is 
what I believe the longer-term objective should be. It is a 
mutual interest and it is the best way to avoid trade conflict 
from further unjustified Chinese currency manipulation.
    Thank you, Mr. Chairman.
    Chairman Sarbanes. Thank you very much.
    Our concluding panelist is Steve Hanke, a Professor of 
Applied Economics at Johns Hopkins University.
    Mr. Hanke.

                  STATEMENT OF STEVE H. HANKE

                 PROFESSOR OF APPLIED ECONOMICS

                    JOHNS HOPKINS UNIVERSITY

    Mr. Hanke. Thank you, Mr. Chairman, Senator Gramm.
    Let me just briefly make a few points that pick up on some 
of the things that have been discussed in the morning session. 
My remarks will highlight points that are developed in my 
prepared statement.
    Chairman Sarbanes. We will include your full prepared 
statement in the record and we appreciate your condensing it.
    Mr. Hanke. Thank you, Mr. Chairman.
    We have hearings in which ``exchange rate policy'' is 
stated, as one of the phrases in the title of the hearings 
themselves. And interestingly enough, if you look at the U.S. 
evolution of exchange rate policy in general, we really did not 
have any coherent policy stated in the United States, until 
1999, when Secretary Rubin, in April, articulated the policy.
    Then Summers followed in September 1999, after he was 
appointed Secretary, and Stanley Fischer at the IMF weighed in 
with essentially the same conclusion in January 2001.
    Now what did they say about exchange rate policy and why 
are their statements important?
    There are three generic types of exchange rates--a floating 
rate, which Rubin and company said was suitable for the United 
States. And that is a rate in which the exchange rate itself is 
on autopilot. You only have a monetary policy. You have no 
exchange rate policy under a floating exchange rate regime.
    At the other extreme, you have an absolutely fixed exchange 
rate regime in which an exchange rate policy exists, but 
monetary policy is on autopilot. And that would be things like 
orthodox currency boards or dollarized systems.
    Rubin, Summers, and Fischer came to the conclusion that I 
think all economists have come to, and that is, in a world of 
mobile capital and free capital flows, those two extreme free-
market, automatic systems are desirable. And everything else in 
between is undesirable.
    Now what is in the middle?
    A pegged-type system is in the middle. For example, 
Secretary O'Neill mentioned that China has a soft peg. Well, 
they do have a soft peg. And the reason the thing doesn't blow 
apart is that China has extremely rigorous capital controls--
the capital account is completely controlled.
    So those are the three systems and as you can see, as a 
matter of principle, the Chinese system would be undesirable, 
according to Rubin, Summers, Fischer and most economists, 
certainly the major consensus.
    What does this have to do with the hearings?
    Well, it has a couple of things to do with the hearings. 
The Bush Administration has never gotten around to articulating 
and reaffirming what Rubin and Summers did. And Krueger has 
never reaffirmed what Fischer did. So, we need some clarity. I 
think you should push Secretary O'Neill to come forward with 
some clarity on the U.S. broad policy position.
    For the United States, we accept floating. Now that has 
some implications, especially for the strong dollar rhetoric. 
Our exchange rate policy is a floating exchange rate. It is not 
a strong dollar policy. A strong dollar policy is nothing but 
rhetoric and absolute economic nonsense. It doesn't mean 
anything in economic terms. The dollar's value is determined in 
the market and under a floating exchange rate, that 
determination is on autopilot.
    So, I would agree with Jerry and Fred on this thing. Any 
adjective for the dollar--whether it is strong, sound, or 
weak--doesn't mean anything if you accept free capital mobility 
and a floating exchange rate because the dollar's price is 
simply on autopilot.
    I think, Mr. Chairman, I see a red light on your little 
gauge.
    Chairman Sarbanes. Why don't you go ahead if you have a few 
more points you want to make.
    Mr. Hanke. This rhetorical point would be one thing on 
which, oddly enough, Fred, we are in agreement.
    Now let me mention something on which Fred and I probably 
would not agree. The world is already very much unofficially 
dollarized. That means that 90 percent of all foreign exchange 
transactions have the dollar on one side of the trade. Ninety 
percent of all commodities traded in the world are invoiced in 
dollars. So, you do not have this so-called exchange rate 
problem that we have been discussing. They are buying and 
selling in dollars and invoicing in dollars.
    Now, in terms of manufactured goods, Mr. Chairman, the 
issue gets a little bit tricky to sort out and make 
generalizations. But I can tell you that about 35 percent of 
exports from Japan are actually invoiced in dollars. They are 
dollarized. And almost 65 percent of all the imports going into 
Japan are dollarized.
    The point here is, if you really want to get around these 
problems with exchange rates, Fred, and the competitiveness, 
uncom-
petitiveness, competitive devaluations and so forth, what we 
should do is try to encourage the official dollarization of 
most smaller countries--I am not suggesting Japan or Euroland 
because that would put them in the same currency bloc as the 
United States and we would not have to spend much time with 
these conversations because everyone would be buying and 
selling and invoicing and dealing in dollars. I would point out 
that, generally, the U.S. dollar can be characterized as a 
vehicle currency in the world that is truly dominant in 
staggering ways.
    We had an earlier conversation about dollar reserves held 
at the Chinese central bank, as well as the Bank of Japan and 
changes in those. About 66 percent of all the foreign reserves 
held at central banks in the world are in dollars or assets 
denominated in dollars. So, I think if we go after every 
central bank using dollars in this way, in an official way, we 
have a lot of villains out there that we are going to have to 
go after, just not Japan and China.
    Mr. Chairman, I appreciate your letting me overindulge on 
time. I think I have made some of the main points I wanted to 
make, in any case. Thank you for giving me the extra time.
    Chairman Sarbanes. Thank you very much, Professor Hanke.
    I might mention that the Committee has received a number of 
letters from across the country from various manufacturers and 
producers with respect to this hearing, expressing their 
viewpoint which has been expressed by some of our earlier 
panelists here today, which we will place in the hearing 
record. What is the response to this dollarization statement 
that Professor Hanke made?
    Mr. Jasinowski. I think it makes general sense. I do not 
know how far it can go in terms of dealing with the central 
problem of the strong dollar policy being advocated by the 
Treasury. But it does, I think, help on the demand side with 
respect to dollars. And therefore, I think it is good in that 
sense. It is also good in the sense of the dollar currency 
being a more stable currency than most. So, I would initially 
be positive toward that.
    Chairman Sarbanes. As I understand it, the assertion is 
that a good part of the Japanese trade is invoiced in dollars. 
I take it you then draw from that the conclusion that the 
exchange rate difference is not affecting the trade balance. Is 
that right?
    Mr. Bergsten. Mr. Chairman, let me take a stab at that.
    In this context, dollarization is a narcotic because, with 
most of the world's trade financed in dollars and with most of 
the reserves in central banks held in dollars it is very easy 
for us to finance these big deficits relative to other 
countries whose currencies are not widely used in international 
finance.
    Charles de Gaulle 35 years ago said that the United States 
ran deficits without tears. And the reason he said that was 
because 
he argued, and he was right then, and it is happening right 
now--
that foreigners acquire dollars as they run their trade 
surpluses, 
tend to hold them in dollar terms, and that, ipso facto, 
finances our 
deficit.
    So it is quite easy for us, relative to anybody else, to 
finance these huge boxcar deficits, and there is no secret, in 
fact, to why we have been able to run them. In part, it is 
because the dollar is the world's currency.
    The flip side of that, however, is that it is quite 
difficult for the United States to change its exchange rate if 
it decides it wants to do so because its exchange rate--our 
dollar exchange rate--is essentially in the hands of other 
countries.
    As Hanke said, we float freely. So if Japan wants to 
intervene and buy dollars for their reserves, they have the 
perfect right to do that under the way the system works.
    We then have to take an initiative to counter that and say, 
quoting Ernie Preeg, but that is not consistent with the IMF 
rules and with international equilibrium. But we are in a free-
floating system where the kind of debate we are having around 
this table today is replicated in every G-7 and other meeting 
where they address this, because there are really no rules of 
the game and there is no notion of what is an equilibrium 
exchange rate.
    That is why for many years I have supported a target zone 
exchange rate system. I do not agree with Hanke that there is a 
consensus on the so-called two corners approach. The world has 
been moving very rapidly away from that because it realizes the 
shortcomings. But that is for a different day.
    The point is when the United States decides that it needs 
to do something about its current account and the exchange 
rate, it has to take a major initiative.
    John Connally did it in 1971 and brought down the Bretton 
Woods system of fixed rates in order to get the dollar 
depreciated.
    Jim Baker did it at the Plaza Accord in 1985. To bring the 
dollar down, he had to get G-7 agreement to bring the dollar 
down. The United States could not do it by itself.
    I am thinking now of Senator Gramm's comment about the 
cheap shovel. The fact that the dollar is international 
currency makes it much easier for us to buy the cheap shovel 
and that has big consumer benefits. But the fact that it does 
create deficits without tears and makes it easy to finance, 
makes it easy for the dollar to get overvalued and to cause the 
problems that we are talking about today.
    One other historical example that proves the point is the 
U.K. All through the period of the sterling's dominance as the 
world's currency, in the 19th century, and into the early 20th 
century, the exchange rate of the sterling was vastly 
overvalued.
    The British manufacturing sector ran into the ground and 
here they are 100 years later without much. I hope we do not go 
that way. It is a slow process. It is more like termites in the 
woodwork than it is a crashing crisis, although every once in a 
while the sterling and the dollar had a crisis.
    But the role of the dollar is actually, in this context, 
rather insidious, and it sets us up for the kind of competitive 
problems we have and the occasional crash in the exchange rate, 
which I repeat, we have experienced once a decade now 
throughout the modern post-war period.
    Chairman Sarbanes. Mr. Preeg.
    Mr. Preeg. Mr. Chairman, in response to your question about 
when should countries dollarize, it is their choice. This goes 
back to the optimum currency area discussions and analysis of 
40 or 50 years ago.
    My own assessment, and it is widely shared, is that smaller 
economies that are very open to trade investment, and that are 
predominantly dependent on one major trading partner like the 
United States, are the most apt to be net beneficiaries of 
dollar-
ization. There are pluses and minuses that have be considered, 
and this is a net assessment.
    In my judgment, the countries of the Caribbean Basin, and I 
believe also Canada and Mexico, based on the numbers, plus and 
minus, would thus benefit from dollarization. Argentina is not 
in that category and has paid a heavy price.
    The second point, trade is invoiced in dollars, but that is 
not, in my judgment, relevant because it is the dollar prices 
that count.
    Toyota car exports to the United States may be invoiced in 
dollars, but at what dollar price? And if Japan keeps the 
exchange rate down, Toyota can maintain lower dollar prices.
    Chairman Sarbanes. That is the point I was trying to make. 
The fact that you are invoicing in dollars does not take out of 
the 
picture the problem of a mismatch in the exchange rates. Is 
that 
correct?
    Mr. Jasinowski. I think that is right, Mr. Chairman, it 
does not. I should have said that myself, and that is what 
Ernie's saying.
    Chairman Sarbanes. Yes. Did you want to add something?
    Mr. Hanke. If I may. One thing you asked, is it desirable 
to dollarize?
    Chairman Sarbanes. Now, I wasn't really addressing that 
question because I think that depends a lot on the countries 
and the nature of the trade. I was trying to get to the 
question, the assertion that the Japanese were invoicing in 
dollars. You gave some figures of the percent of trade.
    Mr. Hanke. Right.
    Chairman Sarbanes. I was really trying to explore whether 
that means that it renders the exchange rate discrepancy 
irrelevant.
    I think Mr. Preeg essentially answered that question 
because it is still relevant in terms of what dollar level you 
place on the invoice, so to speak. So that is affected by the 
exchange rates.
    Mr. Bergsten. The exchange rate would become irrelevant 
only for a country that dollarized and adopted the dollar as 
its official currency, not one that just invoices dollars. You 
are right, the invoicing is a technical thing.
    Chairman Sarbanes. Well, that is what I was trying to get 
at.
    Mr. Hanke. It gets a little bit tricky because, let's say 
you are importing, one big import, and it is oil. And it is 
priced in dollars. Well, that affects your cost structure 
because that is an input that you are bringing into your 
economy. It is purely priced in dollars.
    Chairman Sarbanes. That is a reasonable point on oil. But 
we do not have that in either the Japan or China trade where we 
are running these extremely large deficits.
    I am struck by how disproportionate the trading 
relationship is. It is 5:1 in China and it is about 2:1, I 
think, in Japan. With the Europeans, they are at about 45 
percent, I guess, of the trade is our exports and 55. So that 
is in a much narrower range. But this China and Japan trade, 
particularly China now because that is a growing trade, the 
disproportion, I do not know how long you can sustain that 
disproportion.
    Mr. Hanke. I have spoken at least to Under Secretary Taylor 
privately about this, and he has an appreciation for the 
bipolar view expressed by Rubin and Summers. If we adhere to 
that, we should be putting a lot of pressure on the Chinese to 
change their exchange rate set-up and get rid of capital 
controls. Right?
    Mr. Preeg. Right. Short of that, they should stop 
intervening now and bring their currency down 10 or 20 percent.
    Mr. Hanke. Now one thing I would like to ask Fred----
    Mr. Preeg. Well----
    Mr. Hanke. If I could ask Fred----
    Chairman Sarbanes. Let me regain control here because, as 
interesting as this is----
    [Laughter.]
    Time is passing us by and I want to make sure Senator Gramm 
gets his shot.
    Senator Gramm. Mr. Chairman, I appreciate that. I do not 
want to miss my cheap lunch.
    [Laughter.]
    Let me first say that I never met anybody who said to me, I 
want to have a strong dollar. If there is such a person out 
there, I never met them. I have to believe that this strong 
dollar business is a strawman. I represent 21 million people 
and they have greatly diverse views. Some of them even oppose 
me.
    [Laughter.]
    But I cannot help but believe that, out of 21 million 
people, there would be some strong dollar guy and I would have 
heard from him. So, I am just mystified by all this strong 
dollar business. And I have to conclude that it is a strawman.
    Second, we have not had a crisis in the dollar since we 
went on flexible exchange rates. I remember I was an economist 
and I took the world very seriously.
    [Laughter.]
    I remember when Nixon went on price controls. We got a 
group of people together, my sweet wife, who is also an 
economist, and several of our colleagues, and we decided, since 
the world was going to hell, a Republican president had gone on 
wage and price controls and they had not worked since 
Diacletian, or the Code of Hammarabbi, that there was reason to 
be disturbed.
    So in 1971, we went out to eat, and we did note that one 
thing about flexible exchange rates, and there was a debate 
then that the dollarization debate then was the gold standard. 
There was a little debate, should we be on a gold standard 
flexible exchange rate? But nobody with any sense thought we 
ought to have pegged exchange rates, because we were always 
defending the dollar.
    Though I would have to say, when I was a graduate student, 
I thought, well, maybe I would want to defend the dollar. It 
sounds exciting. You have your sword. You are defending it. We 
have had no crisis in the dollar that I can see, and I have 
been here. I have watched every day. My keen observations, I 
have not seen it.
    Now let me turn to this chart. I cannot afford one of these 
big charts. But I see a lot of different things on this chart 
than other people see.
    First of all, let's just go 3 years on either side of 1985. 
In 1982, 1983, 1984, and 1985, the economy was blowing and 
going and the value of the dollar was just shooting right 
through the roof. Did a crisis occur and the value of the 
dollar just collapse in 1985? Well, if it did, I missed it, and 
I was here.
    In 1985, the value of the dollar falls right through the 
floor and yet, I remember no crisis. And the economy was about 
as good in 1986, 1987, and 1988 as it was in 1983, 1984, and 
1985. Now what does that tell me? Well, it tells me that market 
forces produced the high-value dollar and market forces 
produced the low-value dollar and market forces generate what 
market forces generate in terms of underlying economic forces. 
In fact, I could have a theory based on these numbers that 
elections determine the value of the dollar.
    When Ronald Reagan was elected President and a Republican 
Senate was elected, the value of the dollar went up like a 
rocket. And when Republicans lost control of the Senate, the 
value of the dollar collapsed.
    [Laughter.]
    And when Republicans won control of the House and Senate in 
1995, the value of the dollar went up like a rocket.
    Now do I really believe that there is an election theory of 
currency values? Well, I believe it more than I believe that 
there is manipulation of exchange rates. I think there is more 
scientific basis to it because there is a logic to it.
    Where would you get $50 billion a year to put into currency 
manipulation, Mr. Preeg?
    Mr. Preeg. What they do to keep their currency down is you 
buy dollars.
    Senator Gramm. Yes, but where do you get the money to buy 
it?
    Mr. Preeg. With the Chinese printing press.
    Senator Gramm. Fifty billion dollars--printing? They do not 
print dollars.
    Mr. Preeg. No, yuan. They are buying dollars, paying out 
their currency in order to take those dollars off the market 
and keep the exchange rate down.
    It is the opposite of what Argentina went through. China is 
simply taking those dollars off the market because people have 
all these dollars from the trade surplus and the FDI. The 
dollar holders want to convert them into yuan. And the capital 
account is constricted.
    So what the Chinese central bank does is to print yuan, $50 
billion last year, and give it to these people who give the 
central bank in return the $50 billion. The dollars are thus 
taken off the market and there is less upward pressure on the 
exchange rate in formal and informal markets.
    That is the great asymmetry, as I said before. There is an 
entirely different situation when you are trying to defend an 
over-
valued currency and you only have so many dollars to sell. But 
when you are buying dollars that people are willing to sell, as 
has 
been happening in Japan and China, there is no limit to the 
official purchases.
    Senator Gramm. Why does it work in China and fail in Japan?
    Mr. Preeg. It has been working in Japan the last 5 years, 
too.
    Senator Gramm. Well, the economy has gone to hell. How is 
it working? Why haven't they protected all these manufacturing 
jobs that we are exporting?
    Mr. Preeg. No, they haven't. The objective is simply to 
keep a big trade surplus. We economists call it mercantilist.
    Senator Gramm. Is that your objective?
    Mr. Preeg. No, that is the Japanese objective.
    Senator Gramm. But our objective is prosperity. Right?
    Mr. Preeg. Well----
    Senator Gramm. It is mine. Is that yours?
    Mr. Preeg. My objective is to have market-oriented exchange 
rates.
    For the Japanese, it may be a foolish policy, but they have 
kept the largest trade surplus in the world over the past 5 
years, to a large extent because they have manipulated their 
currency below market-determined levels.
    You may say that they shouldn't do that. I would say that 
they shouldn't do that. You shouldn't make your economy 
dependent on a large trade surplus as they have. They should do 
the structural reforms that everybody advises them to do.
    Senator Gramm. I am running out of time and I am not going 
to get into an argument with you. But let me tell you what I 
think is happening.
    Chairman Sarbanes. Actually, the Japanese now are looking 
for the trade to pull their economy up.
    Senator Gramm. I would say that Japan has had a huge net 
capital outflow because people are not investing there and 
people there that are able are investing here, and that has 
been the determining factor.
    Mr. Bergsten. Except, Senator, that, as he said, part of 
their, ``capital outflow,'' has been a huge build-up in the 
official reserves of the Bank of Japan, which now exceed $400 
billion. It has----
    Senator Gramm. I am glad they have it. The policy in China 
under your thesis would be it would be just as good to not sell 
us the goods, but take them out to sea and throw them 
overboard.
    Mr. Bergsten. No. In their case----
    Senator Gramm. And print the money to pay for them, and 
just go right on.
    Mr. Bergsten. Just to elaborate on what Ernie said, in the 
Chinese case, because of exchange controls, they require the 
export earnings of a Chinese exporter to be sold to the central 
bank for local currency.
    Senator Gramm. I understand they do that. Their economy 
would be better if they did not. Are you proposing that we do 
it?
    Mr. Preeg. No.
    Mr. Bergsten. I am proposing that we suggest they not do 
it.
    Mr. Preeg. Right.
    Senator Gramm. I do not mind suggesting they not do it.
    Mr. Bergsten. That is what we are saying.
    Senator Gramm. If you are in China, do not do it. It is 
stupid.
    Mr. Bergsten. That is what we are saying.
    [Laughter.]
    But the implication would then be an appreciation of the 
renminbi and some modest depreciation of the dollar, which 
would help solve the problem that we are talking about here. 
But it would be through their change in that case, and 
likewise, with Japan.
    Chairman Sarbanes. Jerry, did you want to add something?
    Mr. Jasinowski. Since Senator Gramm liked the chart, and 
certainly saw a number of things in it beyond what I saw, I 
wanted to just say, Senator, the chart always reflected the 
fact that there are a number of variables that influence trade, 
as you know better than anyone, from growth to interest rates 
to the performance of the economy--and the chart reflects that. 
And therefore, your comments are correct.
    We are not here to say that the exchange rate is the only 
determinant of trade, I should say. We are here to say, though, 
that anybody who says that the exchange rate does not affect 
trade--that is our position--is dead wrong.
    Senator Gramm. Oh, of course it does. But what affects 
exchange rates? That is where we differ.
    Mr. Jasinowski. Okay. But then I want to go on to repeat 
the point that I said earlier. If you have a Treasury policy, 
and we certainly have heard it and we would be happy to 
document it for the Committee, about a strong dollar, and the 
rhetoric----
    Senator Gramm. The Secretary never uttered strong dollar 
when he was here. And he was belligerent and he would have said 
it had he meant it.
    Mr. Jasinowski. Well, I also can tell you if you go back to 
the Reagan Administration, I was involved with the Plaza 
Accord. I was involved with Secretary Baker and others and 
there were comments that came out of that Administration about 
a strong dollar and how wonderful it was. If you have any 
Administration that is shouting from the rooftop, even if they 
do not use the term, ``strong dollar'' about how unmitigated 
higher and higher exchange rates for the dollar are desirable 
you are going to affect trade flows. That is the only point 
that I would make.
    Senator Gramm. Well, the only thing I would say is that, of 
all the times that I met with President Reagan, and of all the 
conversations that I listened to, I never heard him mention 
strong dollar. I never heard him mention it.
    Mr. Bergsten. Mr. Chairman, could I say one other thing to 
Senator Gramm because you said, ``Senator, you had not 
experienced any crises under floating exchange rates?''
    Senator Gramm. I did not see one in 1985.
    Mr. Bergsten. I want to give you two examples.
    Senator Gramm. Okay.
    Mr. Bergsten. If the chart went back a couple of years 
earlier--and I have scars on my back because I was in the 
Carter treasury--there was a dollar crisis in the late 1970's 
under floating rates. The dollar collapsed----
    Senator Gramm. Because of inflation.
    Mr. Bergsten. Because of inflation and it added, then, to 
the inflation and it pushed up interest rates, and we had to do 
a huge intervention in the exchange markets in addition to 
doing things on the domestic front.
    Paul Volcker finally came to the Fed.
    That was a real crisis under floating rates. But I want to 
make a more subtle point. There was a crisis in 1985 with that 
strong dollar, even aside from jobs and all that. The crisis 
was in trade policy.
    You may remember, friends of mine in the House--I cannot 
quote any Senators--said, if the Smoot-Hawley tariff itself had 
come to the floor at that time, it would have passed, because 
of the huge decline in our competitive position.
    You remember, there were Gephardt amendments----
    Senator Gramm. Listen, I remember the automobile industry 
came to me and said, we are going to have to go out of 
business. General Motors could go broke. We were producing 
crappy cars. We were producing crappy trucks. The guys on 
Monday were thinking about the weekend. The guys on Friday were 
thinking about the weekend to come. They were having--what is 
the country song--daydreams about night things in the middle of 
the afternoon.
    [Laughter.]
    We got the hell kicked out of us. They came here and said 
to Reagan, protect us. And Reagan, in essence, said, compete or 
die.
    Mr. Bergsten. No.
    Senator Gramm. And now we make the best trucks in the world 
and our cars are as good as anybody's in the world. Why? 
Because we had to.
    Mr. Bergsten. No, but Senator----
    Senator Gramm. You all created the crisis in the Carter 
Administration.
    Mr. Bergsten. No. President Reagan put import controls on 
cars. He had the Japanese do the so-called voluntary export 
restraints that limited car exports here for 10 years. He did 
it on steel.
    Senator Gramm. He did it absolutely as little as he could 
get away with. He jawboned.
    Chairman Sarbanes. How much did the Plaza----
    Mr. Bergsten. It was because of the overvalued dollar.
    Chairman Sarbanes. By how much did the Plaza Accord, done 
during the Reagan Administration by Secretary Baker, affect 
this relationship of currencies?
    Mr. Bergsten. The dollar came down 50 percent on average 
over the next 2 years.
    Chairman Sarbanes. Fifty percent.
    Mr. Bergsten. Fifty percent, having gone up 50 percent from 
1980 to 1985. I am not criticizing President Reagan. I am----
    Senator Gramm. Cause, or did it just happen?
    Mr. Bergsten. It was a response to the policy mix of the 
huge budget deficits and very high interest rates that brought 
in huge amounts of capital, drove the dollar sky high, and I 
actually had sympathy with the Reagan Administration when they 
went for import controls on autos, steel, machine tools, all 
those things. But it was because the exchange rate had driven 
the firms into an uncompetitive position. My point is simply, 
that is what we are confronting again today.
    Chairman Sarbanes. Mr. Preeg, you wanted to add something?
    Mr. Preeg. Just a technical correction. I believe it was 
closer to 40 percent. But it had already come down 10 percent 
before the Plaza meeting. The Plaza participants agreed that 
the dollar should go another 12 percent, which is an awfully 
precise projection. And there was a very modest intervention. 
They were very small numbers compared with today. And then the 
dollar overshot and went down another 30 percent.
    So my judgment is that the market forces were already in 
play because the dollar had already come down 10 percent, and 
we may be starting that way today. Very heavy market forces 
were in play, although the official intervention did help.
    Also, politically, calling for G-7 intervention is 
something I would advocate today. Rather, we should say that it 
is in our mutual interest to gradually bring down the U.S. 
trade deficit. If we once said that and let the market forces 
respond, I believe that the dollar would begin to move down 
somewhat.
    Senator Gramm. Mr. Chairman, I am going to lunch. But I 
want to thank you. It was an excellent hearing.
    Chairman Sarbanes. Yes. We are going to draw it to a close.
    I want to read into the record an interview that Secretary 
O'Neill had with the AFX News Limited Service. These are 
quotes. Of course, the Secretary is not here and I guess he 
could argue that he has been misquoted, but anyhow, this is 
what people read and this is what they take their message or 
signals from. This was on March 15, so it was not that long 
ago:
    We have a so-called strong dollar policy and it is 
consistent and constant and there is no change, he said, 
suggesting he is immune to U.S. industry complaints. I do not 
feel pressured to change the strong dollar policy, he stressed.
    That is because, earlier, they asked him about whether he 
was experiencing a lot of pressure. Actually, he said, O'Neill 
would not comment on whether he expects the rebound in U.S. 
manufacturing to help ease the pressure manufacturers have put 
on the Bush Administration to change the strong dollar policy. 
I hadn't noticed, he facetiously said of the repeated lobbying 
attempts by manufacturing associations and U.S. automakers to 
get the Administration to abandon his policy. And then he went 
on with this quote about a strong dollar and not feeling 
pressure.
    The Treasury Secretary also said he does not regard the 
current account deficit to be a risk to the economy because it 
is irrelevant. I just think it is a meaningless concept in a 
globalized economy, he said, despite some forecasts that the 
deficit could reach 6 percent of GDP within the next 3 years. 
Economic policymakers should not pay attention to the deficit, 
he said, explaining that the only reason that I pay attention 
to it at all is because there are so many people who mistakenly 
do so.
    I think today was more or less consistent with these 
statements.
    Let me ask this question. Do you think that the exchange 
rates, that a Plaza-like effort, or a major effort--has the 
economy developed in such a way worldwide that your ability to 
have an impact has been diminished or undercut? Or if you 
prepared to move ahead with an active policy, could you have an 
impact?
    Mr. Jasinowski. Mr. Chairman, let me just start the 
response by saying that most of us have stressed a several part 
policy correction. The first part of the correction is for the 
Secretary of the Treasury to acknowledge the problem, to stop 
talking about a strong dollar, and to allow markets to make 
some judgment--apart from the Treasury putting a floor under 
the dollar.
    Words do make a difference. Rhetoric affects the markets. 
That is policy step number one. And that will clearly work. 
There is wide consensus on that. In fact, there is a quote in 
my testimony about how much the market-makers believe the 
dollar would adjust by that alone.
    The second step, which Fred has emphasized, is that if we 
proceeded with an effort to get agreement among our major 
trading partners and have them support a new set of policies 
that would stress fundamental factors, and intervention, yes, 
it could have an effect.
    Mr. Bergsten. Just to echo what I said earlier, Mr. 
Chairman, I actually think the prospects for intervention 
working now are at least as good as in the past at the time of 
the Plaza Accord.
    I noted that the Rubin-Summers Treasury tried it only three 
times in 5 years. I think it worked just like a textbook would 
say, on all three cases. The fact that they have not intervened 
much actually means that, if they were to do it now, it would 
clearly have more effect. If intervention is done every day 
routinely----
    Chairman Sarbanes. It would require a joint effort, I take 
it, by the G-7.
    Mr. Bergsten. There are several criteria. It has to be 
sustained, cooperative, well-coordinated. The rhetoric has to 
be consistent.
    Chairman Sarbanes. Do you think it is likely we would get a 
cooperative, well-coordinated effort on the part of the others?
    Mr. Bergsten. I think the Europeans clearly would agree to 
intervene to strengthen the Euro. There would be difficulty 
with them on how much. The Europeans would agree to move the 
Euro back at least to 1:1 against the dollar. They might begin 
to get hesitant beyond that, even though more than that is 
clearly necessary, but I think they would clearly agree to 
start it.
    Japan, given the weakness of its economy that we have 
talked about, and the fact that it is scrambling for any scrap 
of positive news, would be reluctant right now. But they have 
the world's biggest trade surplus. It is soaring again because 
of the recent decline in the yen. We would simply have to 
insist that they cooperated, which, incidentally, would then 
put more pressure on them to make the kind of domestic 
structural reforms they need, anyway, and I think would be 
beneficial in the broader sense as well.
    Chairman Sarbanes. Mr. Preeg.
    Mr. Preeg. I think the interventions that Fred mentioned 
earlier are really token interventions of a few billion, $5 or 
$10 billion.
    Mr. Bergsten. Which is so amazing why they work.
    Mr. Preeg. They give a political signal, and it is not the 
economics. And the comparison of figures, again back to China. 
China intervened with $50 billion last year, while China has 
one-fifth the trade that we do. So for a comparable impact on 
our trade or our exchange rate, we would need $250 billion of 
U.S. intervention per year. And we are talking about $2 or $3 
billion during the decade of the 1990's.
    The orders of magnitude compared with what Japan and China 
are doing, comparing their trade levels and ours, indicates 
token U.S. intervention in economic terms. But even token 
intervention can have political significance in that markets 
would sense that the dollar is going to go down.
    Chairman Sarbanes. At any rate, I take it it is your view 
that even just the rhetoric that we are using is helping to 
skew this thing in the wrong direction.
    Mr. Bergsten. That is clear, and the market people say that 
repeatedly. One question another time to ask the Secretary is, 
what would be the downside of changing your rhetoric? Why does 
he not want to change his rhetoric?
    The reason is he fears he would drive the dollar down too 
far, too fast. Now, I think that is not a realistic fear, but 
that is the reason. That is the only argument he and his 
predecessors could make for not changing the rhetoric when they 
were implored to do so. They clearly think it would have an 
impact, or else they would accept to do it.
    Ernie made also a very important point. The three cases I 
mentioned, the amounts of intervention were very modest. And to 
me, that makes it all the more clear how effective the tool is. 
You do not have to spend a lot of money. It is the signaling 
effect. It is indicating with your money where your mouth is. 
You want to see a change. You want to correct the current 
account problem.
    Mr. Jasinowski. Mr. Chairman.
    Chairman Sarbanes. We have to draw this to a close.
    Mr. Jasinowski. One suggestion to make along these lines, 
going back to a point that Steve made, is to seek a precise 
written statement from the Treasury as to what our policy or 
nonpolicy is, which is what I have been arguing in part for 
that would help clarify where we are.
    Here we have one of the most important policy issues before 
the country and nobody is quite sure what the Treasury policy 
is. And it does seem to me greater clarity is essential.
    Chairman Sarbanes. The Secretary says there is no problem.
    Mr. Jasinowski. Well, I think there is.
    Chairman Sarbanes. I am going to have to draw to a close. 
Did you want to add anything?
    Mr. Hanke. I would like to briefly make a remark on this 
last round of things.
    Chairman Sarbanes. If you could keep it brief.
    Mr. Hanke. Yes. I think if we have an exchange rate policy 
that is a floating exchange rate policy, the Secretary should 
refrain from all open-mouth operations in all respects and just 
keep quiet--say absolutely nothing on it.
    The second point, Mr. Chairman, is, I think I detect in 
your view, and the views of my colleagues here, that, well, 
somehow, the balance of payments is getting a little bit out of 
whack and extreme values are showing up and we have to do 
something about it.
    My own view on that is a little bit different. That is, a 
little bit more like the Secretary's. We have a floating 
exchange rate policy, which acts automatically. And therefore, 
these balance of payments adjustments just take care of 
themselves, Fred.
    Mr. Bergsten. Yes, but they do not.
    Chairman Sarbanes. They won't take care of themselves if 
the currencies are being overvalued for one reason or another, 
either because we are making these pronouncements about the 
strong dollar and/or because China and Japan are sort of 
working against the way the market forces work in order to make 
the purchases. My perception is that the market is not working 
pure and simple as a market. It is being impinged upon in a lot 
of ways.
    Mr. Hanke. Fred, let me make my third point because it fits 
into this. We agree on this thing.
    Chairman Sarbanes. Yes.
    Mr. Hanke. My view is we should become neutral and 
sanitized on the whole exchange rate comment thing. Let the 
balance of payments accounts adjust naturally and over time, 
market forces will take care of that, too.
    Back to your question, Mr. Chairman, about whether some 
kind of policy change now, intervention, three-part thing like 
Jerry says, would work. My view is that the market is set up to 
be taken down.
    So right now, I am Chairman of the Friedberg Mercantile 
Group. Our business is trading currencies. And we are short the 
dollar against 10 very peripheral currencies. And the reason it 
is a great trade is because we pick up the carry and make 
interest carrying a short position against the so-called strong 
dollar.
    The war on terrorism has changed things enormously. And the 
perception that people have in the world about the United 
States and how great the prospects might be in the future for 
the U.S. economy--cranking up a big war machine against an 
enemy that even our Secretary of Defense says is elusive--is 
that we are in a war of indeterminate duration that is going to 
start eating up real resources in the economy and start 
whacking away at productivity in the economy.
    The story we are getting about the economy has been very 
rosy and that is why there have been deficits without tears, 
Fred.
    But this thing, I think, is a little bit on a pivot now. So 
even though I disagree with Fred and Jerry in terms of an 
activist policy to correct the balance of payments imbalances, 
I would have to agree that, if you were going to do it, I think 
now is a great time to do it, in a technical sense.
    Chairman Sarbanes. Well, this has been a very helpful 
panel, obviously.
    Mr. Trumka and Mr. Stallman, I just want to say to you, 
when we were talking about the cheap shovel, I was thinking to 
myself, if we do away with these jobs, who is going to have a 
paycheck that will enable them to buy the shovel, whether it is 
a worker or a farmer? So, we have to keep that in mind as well.
    Thank you all very much. It has been a very good panel. The 
hearing is adjourned.
    [Whereupon, at 12:58 p.m., the hearing was adjourned.]
    [Prepared statements, response to written questions, and 
additional material supplied for the record follow:]

             PREPARED STATEMENT OF SENATOR DEBBIE STABENOW

    Thank you, Mr. Chairman. I welcome the opportunity to discuss 
exchange rate policy and I appreciate that the Treasury Secretary and 
our other witnesses have come to testify before us today.
    The issue of exchange rates and, in particular, currency 
manipulation is one that has a profound impact on my home State of 
Michigan, especially as it relates to the automotive sector. I am 
concerned that the Administration does not seem to be aggressively 
addressing this issue.
    It is not a coincidence that the on-going weakening of the yen has 
occurred at the same time that Japanese automakers are experiencing 
record profits and American automakers are facing significant losses. 
Indeed, recently, the weakened yen has effectively given Japanese 
automakers up to a 30 percent cost advantage over U.S. manufacturers.
    On the floor of the Senate, we are beginning a discussion on 
promoting trade. Free and fair trade can be good for our country, but 
we must be outspoken about anticompetitive tools in the global 
marketplace. Currency manipulation is one of those anticompetitive 
tools.
    Japan intervened in the currency market a staggering 11 times last 
September alone. This resulted in an 11 percent decline in the value of 
the yen against the dollar. I understand that the Japanese face 
difficult economic challenges that create incentives for them to 
devalue their currency, but our Government cannot stand idly by and 
watch our domestic manufacturers lose out.
    It is not fair to our domestic auto manufacturers who deserve to 
compete on a fair and level playing field. It is not fair to our auto 
workers who will lose jobs due to this invisible tariff caused by 
currency manipulation. Indeed, Mr. Chairman, it is not fair to a whole 
number of industries who suffer unfairly.
    I look forward to hearing from the Treasury Secretary today about 
what the Bush Administration is going to do about this problem and I 
also look forward to hearing the perspectives of our other witnesses.

                               ----------
               PREPARED STATEMENT OF SENATOR CHUCK HAGEL

    Thank you, Mr. Chairman, for holding this hearing today to explore 
concerns about the value of the dollar against other currencies.
    I know there are sectors of the economy that have been hit hard 
over the last year by the recession and September 11. Farmers, textile 
workers, manufacturers, and all exporters have especially been 
impacted.
    There are several factors that have helped create this situation, 
including the trade barriers of other countries, production subsidies 
that distort markets both here and abroad, technological advances that 
have lowered the prices of production, and lower demand in other 
countries that are going through recessions. Some will also say the 
blame lies with the strong dollar. I am not persuaded that the strong 
dollar is a primary factor attributing to the difficulties in our 
economy. There are down sides to a strong dollar. However, an 
appreciating dollar can be compatible with a rising value of exports, a 
falling value of imports, a growing trade surplus, and increased 
employment.
    Given the degree in which traders around the world value the 
dollar, can one say that the dollar is overvalued? It is true that the 
dollar is at a stronger level relative to other currencies, but this 
reflects the productivity, creativity, and value of American labor and 
resources.
    I am concerned about the unintended consequences of intervention in 
the value of the dollar. For instance, how will our interest rates, 
Government expenditures, and capital inflow be impacted?
    There are many benefits to having a strong dollar. Most 
importantly, a strong 
dollar attracts investment which provides new capital resulting in new 
jobs and 
increased productivity in the United States.
    One reason for the current strength of the dollar is that foreign 
investors desire to purchase American assets. In large part, this is 
due to the increase in national productivity that has raised the rate 
of return on American capital.
    I am looking forward to hearing Secretary O'Neill and our other 
panelists discuss these issues today.
    Because the strength of the economy is based on many different 
factors, attempting to manage one of those factors will have an impact 
on all of the others. We need to be cautious when we talk about 
intervening in the market when there is no way to be even relatively 
certain of how other pieces of the market will move as a result of any 
action taken.
                               ----------
                 PREPARED STATEMENT OF PAUL H. O'NEILL

               Secretary, U.S. Department of the Treasury
                              May 1, 2002

    Chairman Sarbanes, Ranking Member Gramm, Members of the Banking 
Committee, I thank you for this opportunity to appear before you this 
morning to discuss our International Economic and Exchange Rate Policy.
    The April 2002 Report reviews global economic developments in the 
second half of 2001. This interval and the most recent months encompass 
a turbulent period in which the events of September 11 and their 
aftermath shook the United States and world economies, and a period 
when the underlying strength in the U.S. economy showed itself 
forcefully, leading the world back to recovery. I have said before that 
creating economic growth and jobs in the U.S. economy is our overriding 
concern and that getting our economic policies right at home is one of 
the best contributions we can make to global economic growth.
    Increasing economic growth and reducing economic instability are 
vital interests of the United States. For this reason, I would like to 
touch on several of the Administration's broad policy initiatives for 
facilitating growth and stability.
Reducing Barriers to International Trade
    The global economic slowdown, from which we are recovering, brings 
into sharp focus the importance of international trade. Total U.S. 
trade in goods and services amounts to about one quarter of GDP. It now 
touches almost all parts of our economy and is a vital ingredient in 
its health, creating millions of jobs that pay above-average wages.
    President Bush achieved a key objective in his trade agenda with 
the WTO Ministerial decision in Doha to launch multilateral trade 
negotiations. Negotiations are already underway for a Free Trade Area 
of the Americas (FTAA) and for Free Trade Agreements (FTA's) with Chile 
and Singapore. In January 2002, the United States announced that it 
will explore an FTA with the countries of Central America. An FTAA, 
when combined with existing free trade agreements, and bilateral FTA's 
with Chile and Singapore, will fully open market access overseas for 
nearly 50 percent of U.S. exports.
    The Treasury has a special interest in promoting further 
liberalization of trade in financial services. The growth potential in 
many countries is being held back by a lack of deep and liquid capital 
markets. The swift removal of barriers in key markets will help 
strengthen financial systems internationally. It will also mean more 
American jobs in a sector with above-average wages.
    In sum, both to help bolster growth and create new export and job 
opportunities for America, it is vital for the Senate to pass, and the 
Congress to expeditiously enact, Trade Promotion Authority.
Reform of the International Monetary Fund
    The primary role of the International Monetary Fund is to foster 
conditions in the international economic and financial system that 
support growth. First and foremost, the IMF must seek to prevent crises 
that undermine and reverse growth. The IMF is making progress in 
enhancing crisis prevention, including through increased transparency. 
For example, nearly all countries borrowing from the IMF now release 
the details of their reform programs, but more steps are needed to 
release information and encourage policymakers to take quick action to 
avert potential crises. Indeed, no matter how good the IMF's analysis 
and policy advice are, their impact will be limited if they do not 
serve to inform the public and markets. We look forward to further 
progress on transparency in coming months.
    To help prevent financial crises and better resolve them when they 
occur, we are working with others in the official sector to implement a 
market-oriented approach to the sovereign debt restructuring process. 
This contractual approach would incorporate new clauses, which would 
describe as precisely as possible what would happen in the event of a 
sovereign debt restructuring process, into debt contracts. We have 
proposed three clauses: Super majority decisionmaking by creditors; a 
process by which a sovereign would initiate a restructuring or 
rescheduling--including a cooling-off, or standstill, period; and a 
description of how creditors would engage with borrowers. While we 
believe it is important to move forward with this contractual approach 
as expeditiously as possible, we also support continued work on the 
IMF's statutory approach to sovereign debt restructuring. We believe 
that the two approaches are complementary.
Reform of the Multilateral Development Banks
    Rising productivity is the driving force behind increases in 
economic growth and rising per capita income. The multilateral 
development banks (MDB's) can deliver better results by being 
rigorously selective in their lending, focusing their activities on a 
discrete set of high-impact, productivity-enhancing activities that 
diversify the sources of growth, foster competitive and open markets, 
promote accountable governance, raise human productivity, and expand 
access of the poor to physical infrastructure, new productive 
technologies and social services.
    Education and private sector development in particular need to 
feature more prominently as a critical element in lifting people out of 
poverty.
    Private capital flows now dwarf official development assistance; 
the challenge is to deploy development assistance in areas where we 
know it will unleash the entrepreneurial and creative capacities of 
people living in the poorest countries and to encourage individual 
investment. Investment climate reforms and capacity-building at the 
Government and enterprise level should be at the front and center of 
development policies. The scale of global poverty and unrealized human 
potential underscores the importance of the MDB's (and all other 
donors) focusing much greater attention on improving the effectiveness 
of their assistance. Delivering results means insisting on rigorous 
quantifiable measures of each aid project and accountability from each 
aid institution's impact in improving living standards. An incentive 
structure must exist where performance will be rewarded and 
nonperformance will not. The United States has proposed such a 
structure for the IDA-13 replenishment in which the U.S. base-case 
annual contribution to IDA can be increased if specified input and 
output triggers are met in priority growth and poverty-reduction areas 
such as private sector development, primary education and health.
    President Bush proposed that up to 50 percent of the World Bank and 
other MDB funds for the poorest countries be provided as grants rather 
than as loans. Investments in crucial social sectors (e.g., health, 
education, water supply and sanitation) do not directly or sufficiently 
generate the revenue needed to service new debt. Grants are the best 
way to help poor countries make such productive investments without 
saddling them with ever-larger debt burdens.
Millennium Challenge Account
    Effective assistance means delivering against a set of priority 
objectives that is measurable. It requires a solid partnership between 
donors and client countries on priority reforms that drive growth and 
poverty reduction, while underscoring the need to measure the impact 
and accountability of those reforms.
    On March 14, President Bush outlined a major new vision for 
development based on the shared interests of developed nations alike in 
peace, security, and prosperity.
    The President's compact for global development proposes a truly 
historic, shared commitment to stop the cycle of poverty in the 
developing world and is defined by a new partnership between developed 
and developing countries to achieve measurable development results.
    The compact creates a separate development assistance account 
called the Millennium Challenge Account. It will be funded by 
substantial increases over and above the approximately $10 billion in 
existing U.S. development assistance (better known as Official 
Development Assistance or ODA).
    To take advantage of Millennium Challenge Account funds, developing 
countries must be committed to sound policies that promote growth and 
development, including the need to fight poverty. We will channel these 
funds only to developing countries that demonstrate a strong commitment 
to:

 Governing justly (e.g., rule of law, anticorruption measures, 
    upholding human rights).

 Investing in people (e.g., investment in education and 
    healthcare).

 Economic freedom (e.g., more open markets, sustainable budget 
    policies, strong support for development, policies promoting 
    enterprise).

    Experience has shown that policies that are effective in promoting 
these goals 
underpin successful growth, productivity increases, and poverty 
reduction. Further, these goals are mutually reinforcing.
    Over the coming months we will be asking for ideas from our 
development partners--donors, developing countries, academics, NGO's--
on developing a set of clear, concrete, and objective criteria for 
measuring progress in these areas.
Combatting Financing of Terrorism
    Depriving terrorists of financial resources is critical to the war 
on terrorism. The President has directed me to take all measures 
necessary to pursue this goal.
    On September 23, 2001, President Bush issued an Executive Order 
listing 27 terrorist organizations and individuals and directing the 
blocking of their property. This Executive Order has now been extended 
to a total of 202 individuals and entities. To date, all but a handful 
of countries have committed to join this effort. There are now 161 
countries and jurisdictions that have blocking orders on terrorist 
assets in force and over $104 million in terrorist assets has been 
frozen globally since September 11--some $34 million here in the United 
States, and another $70 million by other countries or jurisdictions. A 
portion of that amount linked to the Taliban has recently been 
unblocked for use by the new Afghan Interim Authority.
    On April 19, I announced with my counterparts from the Group of 
Seven an unprecedented joint listing of terrorist targets. In March, 
the United States and Saudi Arabia designated jointly the Bosnia and 
Somalia offices of the Saudi-based charity Al-Haramain. These joint 
designations mark a new level of coordination in the fight against 
international terrorism.
Cooperation on International Tax Matters
    International cooperation and coordination on tax matters are 
critically important for reducing investment distortions and for 
promoting the proper functioning of 
financial markets and systems. Tax rules should not serve as an 
artificial barrier to cross-border investment.
    The United States has bilateral income tax treaties with 
approximately 60 countries. The purpose of those treaties is to 
coordinate our respective income tax systems so as to avoid double 
taxation and to reduce or eliminate tax ``toll charges'' on cross-
border investment. We are working to update and modernize existing tax 
treaties and to expand our treaty network.
    As I have said many times, we have an absolute obligation to 
enforce the tax laws of the United States, because failing to do so 
undermines the confidence of honest taxpayers in the fairness of our 
tax system. This can be done more efficiently, given the increasingly 
global nature of economic activities, with the cooperation of other 
countries. Currently, we have effective tax information exchange 
arrangements with many of the world's financial centers. We are working 
to extend and deepen this network.
International Economic Conditions
    I would like to turn now to global economic conditions.
    As you know, the U.S. economy began slowing in the summer of 2000 
and this weakness extended through the first half of 2001. Then, the 
terrorist attacks of September 11 set off disruptions that quickly 
swept through our economy. The events battered consumption as consumers 
stayed at home, and with our passenger transport system significantly 
impacted, many associated industries such as tourism and hotels were 
badly hit. Activity fell at a 1.3 percent annual rate in the third 
quarter.
    Prior to September 11, I had been optimistic about the prospects 
for U.S. recovery. My optimism now appears to have been well justified. 
The fourth quarter showed a healthy rebound at a 1.7 percent annual 
rate. Economic indicators for 2002 already paint a hopeful picture of 
an economy bouncing back. I believe that the data will show in the 
final analysis that last year's downturn in real GDP will be the 
shortest, shallowest on record.
    Why was the optimistic view well founded? Even before September 11, 
the economy appeared to be moving forward at a slow, but positive rate. 
The inventory overhang was being reduced. The Administration and 
Congress had responded with timely relief action. The tax rebates and 
rate cuts from the Economic Growth and Tax Relief Reconciliation Act of 
2001 had put money in people's pockets and increased incentives in the 
economy to work, save, and invest. The Federal Reserve had aggressively 
lowered interest rates and energy prices were then coming down.
    Most importantly, the fundamental strengths of our economic system 
remain well intact--the American people are hard working; our markets 
are the most flexible and dynamic in the world; and our macroeconomic 
policies are sound. Our economy is the most advanced in the world 
because our economic structures are predicated on the recognition that 
the private sector drives growth, and that the role of Government is to 
provide a framework that promotes competition and encourages individual 
decisionmaking. This has produced, among other things, financial 
markets that are the deepest and most liquid in the world.
    The confluence of these factors is reflected in the remarkable 
productivity growth of our economy. Unlike in past recessions, 
productivity continued to rise last year and posted an extraordinary 
5.2 percent gain at an annual rate in the fourth quarter. Meanwhile, 
trend productivity growth remains around 2\1/2\ percent, sharply higher 
than the 1\1/2\ percent trend rate from 1973 through 1995, keeping 
inflation pressures well at bay.
    I am convinced that the United States has regained its economic 
footing. In fact, the figures released just last week showed real GDP 
rising at an exceptionally strong 5.8 percent annual rate. This 
performance is a testimony to the inherent resilience of our economy 
that over the past 6 months has continually surprised on the upside.
    So far, I have focused on the United States. The world economy, 
while beginning to recover from the recent slowdown, is still in the 
early stage of recovery. Last year, global growth was highly anemic, at 
roughly 2\1/2\ percent. Prospects for 2002 are somewhat better but 
strong growth may not be fully visible until the second half of the 
year.
    Before becoming the Secretary of the Treasury, I had the pleasure 
of gaining a special appreciation for the strength of the Japanese 
economy and its people. Over the last decade, however, Japan's economic 
performance has been well below its potential. The resulting cost has 
been high not only for Japan, but also for the world economy. Restoring 
strong Japanese growth is one of the keys to unlocking strong global 
growth.
    President Bush has expressed support for Prime Minister Koizumi's 
commitment to reform. The United States also shares his view that it is 
important for Japan to increase price competition through deregulation 
and structural reform and to vigorously tackle its banking sector 
problems. We in the United States learned from the S&L crisis the 
importance of comprehensively addressing banking sector problems and 
returning distressed assets to private hands by selling loan claims and 
underlying collateral rapidly in the market.
    We also learned that these reforms can take place only in a 
supportive macroeconomic environment. For the last 7 years, except for 
1997 in response to a one-time tax increase, Japan's economy has been 
mired in deflation. Last March, the Bank of Japan committed to expand 
the money supply until the CPI was either stable or increased slightly 
on a year on year basis. Since then, a welcome and sharp expansion in 
monetary aggregates has indeed taken place. So far, however, deflation 
remains entrenched.
    The Euro-zone recorded its best growth in a decade in 2000. Going 
into 2001, there was substantial optimism that the foundations for 
sustained growth were well in place. But despite these expectations, 
Euro-zone growth slowed markedly and was negative in the fourth 
quarter. While Europe too was affected by the events of September 11, 
Europe's slowdown in 2001 underscored the fact that the interactions 
and transmission mechanisms among our economies run deep and extend 
well beyond the realm of trade.
    The Euro-zone is poised to begin growing anew. However, the 
consensus outlook is that the recovery will lag and be slower than the 
U.S. upturn. That said, it is in many respects difficult to speak about 
the Euro-area as a single entity. Indeed, there are many very 
successful pockets of reform, such as Ireland, Spain, and the 
Netherlands. But European policymakers recognize the need more 
generally to implement tax reforms within the context of efforts aimed 
at achieving medium-term fiscal stability and to undertake structural 
reforms targeted especially at increasing employment and raising 
potential growth.
    On April 19-20, I hosted a meeting of the G-7 Finance Ministers and 
Central Bank Governors. We recognized that a recovery is already 
underway in our economies, influenced by macroeconomic policies put in 
place last year. Nonetheless, while confident about our collective 
prospects, we also agreed that downside risks remain, especially those 
arising from oil markets. In this spirit, we agreed that each of our 
countries has a responsibility to implement sound macroeconomic 
policies and structural reforms to sustain recovery and support 
strengthened productivity growth in our own economies and in the global 
economy.
    The U.S. current account deficit was around 1\1/2\ percent GDP in 
the mid-1990's. It rose to 4\1/2\ percent in 2000 before falling, 
during last year's global slowdown, to just over 4 percent in 2001. We 
have all heard the view that this is a threat to America's economic 
fortunes and global financial stability. I believe that this view 
ignores forces that are working in the market. The current account 
represents the gap between domestic savings and investment and has 
grown in the face of a productivity-fed U.S. investment boom for the 
past decade. It is financed by international capital inflows that have 
risen over this period due to strong foreign interest in investing in 
the United States.
    In the last 2 years, these capital inflows were sustained despite a 
slowing of U.S. economic activity, a fall in U.S. interest rates, and a 
decline in equity prices. This is a clear demonstration that foreigners 
regard investment in the United States as continuing to offer extremely 
attractive rates of return. These inflows are attracted by the long-
term soundness and relative strength of our economy's fundamentals: Our 
underlying productivity growth, our low inflation and sound 
macroeconomic policies, our flexible labor markets, and our financial 
markets which are the deepest and most liquid of any in the world. As I 
often say, these investments in our economy's future are not a gift. 
They are made because of the prospect of a sound return.
    Emerging market and developing economies also felt the effects of 
the slowdown in the major economies in 2001, and their prospects were 
also set back by the uncertainties stemming from the events of 
September 11. However, I am hopeful that their prospects will brighten 
over the course of this year. The truth is that many emerging markets 
have not performed well in recent years and investment flows going to 
these markets have declined sharply. On the positive side, though, many 
emerging market economies are now better able to withstand external 
shocks, having reduced short-term external liabilities and built up 
reserves. Many countries, such as Brazil, Indonesia, and South Korea, 
have moved to more flexible exchange rates regimes, which allow their 
exchange rates to absorb the brunt of external shocks. I think there is 
a much greater appreciation throughout these countries on the need to 
run sound policies. And there has been very little contagion from 
recent events in Argentina.
    I would also like to submit for the record the Report to Congress 
on International Economic and Exchange Rate Policies as mandated by 
Section 3004 of the Omnibus Trade and Competitiveness Act of 1988.
    In conclusion, I thank you again for this opportunity to testify 
before you. I would be delighted to answer any questions you may have.



















                PREPARED STATEMENT OF RICHARD L. TRUMKA

                          Secretary-Treasurer
                    American Federation of Labor and
                  Congress of Industrial Organizations
                              May 1, 2002

    Chairman Sarbanes, Members of the Committee, I am glad to have the 
opportunity to talk with you today on behalf of the 13 million working 
men and women of the AFL-CIO about the economic impacts of the 
overvalued dollar.
    As we struggle to escape the grip of recession, the overvalued 
dollar represents a serious problem. It is also causing long-term 
damage by destroying our manufacturing base. If we fail to redress the 
problem there is a danger that our fragile 
recovery will be short-lived, pushing us into a double-dip recession.
    Manufacturing is ground-zero of the recession, and its troubles are 
intimately connected to the dollar. Since March 2001, we have lost 1.4 
million jobs, of which 1.3 million have been manufacturing jobs. 
Manufacturing has therefore accounted for 93 percent of all job losses 
despite being only 14 percent of total employment. Today, manufacturing 
employment is at its lowest level since March 1962.
    Business has slammed the brake on investment spending, but 
fortunately the American consumer has kept the recession milder than 
anticipated. However, a strong recovery that restores full employment 
needs a pick-up in investment spending. And that will not happen as 
long as currency markets give a 30 percent subsidy to our international 
competition.
    Over the last 5 years our goods trade deficit has exploded from 
$198 billion to $427 billion, costing good jobs across a wide array of 
industries.

 Last year, in the paper industry there were mill and machine 
    closures at 52 locations. All are considered permanent, indefinite 
    or long-term.

 In the textile industry two mills per week closed in 2001, and 
    closures have continued this year.

 The weakening of the yen has given Japanese car companies a 
    huge price advantage. The result has been loss of market share by 
    our Big Three automakers that threatens some of the best jobs in 
    America.

 Boeing, which operates at the cutting edge of technology, is 
    losing market share to Europe's Airbus. And losses today mean 
    future losses because airlines work on a fleet principle. They will 
    therefore order Airbus aircraft 5 years from now when they expand 
    their fleets.

 Moreover, job losses are not restricted to manufacturing. 
    Tourism and hotels are hurt by the strong dollar, and film 
    production is moving offshore to cheaper destinations such as 
    Canada, Australia, and New Zealand.

    Many of these jobs will never come back. These are higher paying 
jobs that have been the ladder to the American Dream for millions of 
Americans. But now we are kicking away that ladder.
    Manufacturing has faster productivity growth, and productivity 
growth is the engine of rising living standards. But now we are 
shrinking our manufacturing base, and that is bad for future living 
standards.
    The Administration has shown blind indifference to these problems. 
Arguments for a ``strong dollar'' do not wash.
    Inflation is not a problem, and there is no evidence that a lower 
dollar will lower the stock market or raise interest rates. Those who 
say we need a strong dollar to finance the trade deficit have the 
reasoning back-to-front. We need to finance the trade deficit because 
we have an overvalued dollar.
    It is time for a new policy that puts American jobs and American 
workers first.
    It is unacceptable that Japan depreciate its currency. This will 
not solve Japan's problems, and will only export them to its neighbors 
and us.
    China exemplifies all that is wrong with currency markets. It has a 
massive trade surplus and vast inflows of foreign direct investment. In 
a free market, China's currency should appreciate, but it does not 
because of government manipulation. This is a problem that appears in 
different shades in many countries.
    American workers are paying the price of currency manipulation. 
Trade cannot be ``fair'' when we allow countries to manipulate exchange 
rates to win illegitimate competitive advantage.
    Those who argue we can do nothing about exchange rates abdicate the 
national interest. The historical record and the 1985 Plaza Accord 
intervention show we can. Academic research shows the same. Just as we 
manage interest rates, so too we can manage exchange rates.
    Currency markets are speculative and respond to policy signals. The 
Treasury and the Federal Reserve must take immediate action with their 
international partners. The upcoming G-7 summit provides an appropriate 
moment to do so.
    Beyond intervention today, we must avoid a repeat of today's 
overvalued dollar, just as today's problems are a repeat of mistakes 
made in the 1980's. The dollar must be a permanent focus of policy, and 
the Treasury and the Federal Reserve must be made explicitly 
accountable.
    And every trade agreement must include strong specific language 
that rules out sudden currency depreciations that more than nullify the 
benefits of any tariff reductions. We have been NAFTA-ed once, and that 
is more than enough.
    The Senate Banking Committee has a vital oversight role to play in 
ensuring that the Treasury and the Federal Reserve live up to these 
obligations.
    I thank you for the opportunity to testify before you, and I will 
be happy to answer any questions you may have.



































































               PREPARED STATEMENT OF JERRY J. JASINOWSKI

            President, National Association of Manufacturers
                              May 1, 2002

    Mr. Chairman, Members of the Committee, I am pleased to be here 
this morning on behalf of America's manufacturers to participate in 
this discussion of U.S. International Economic and Exchange Rate 
Policy. U.S. manufacturing is suffering very strong negative effects 
from current U.S. exchange rate policy, and we appreciate the 
opportunity to state our views on the value of the U.S. dollar and the 
impact it is having on American industry.
    The National Association of Manufacturers represents 14,000 
American firms--10,000 of which are small- and medium-sized companies. 
Manufacturing is vital to America. It comprises one-fifth of all the 
goods and services produced by the U.S. economy and directly supports 
56 million Americans--the nearly 18 million American men and woman who 
make things in America and their families.
    I am pleased to join the other members of this panel today, and am 
particularly pleased to be testifying along with Richard Trumka, the 
Secretary-Treasurer of the AFL-CIO. The National Association of 
Manufacturers and the AFL-CIO differ on many things, but we are united 
in lock-step in our need to have the dollar begin reflecting economic 
fundamentals.
The Dollar is Overvalued, and Everybody Knows It
    Mr. Chairman, I would like to make three points today: First, the 
U.S. dollar is very overvalued; second, this overvaluation is having a 
devastating effect on U.S. manufacturing and on jobs; and third, the 
overvaluation is fixable--for it is the result of market imperfections 
that are preventing the dollar from adjusting to a more normal level. 
How do we know the dollar is overvalued?
    To begin with, NAM members are on the cutting edge of U.S. trade; 
and our members have been telling us that after years of being highly 
competitive in world markets, their customers are now saying the 
foreign currency price of made-in-the-USA products have become 25-30 
percent more expensive than foreign products. This did not happen 
because U.S. producers became less productive or efficient. And it did 
not happen because they raised their dollar prices. It happened only 
because the price of the dollar rose in terms of foreign currencies.
    About two-thirds of the companies represented at the recent NAM 
Board of Directors meeting said that the dollar is having serious 
effects on their firms, and this is an important reason why the NAM 
Board passed a resolution calling on the Administration to act to 
correct the dollar's overvaluation. A copy is attached to my statement.
    The dollar is now at its highest level in 16 years. After remaining 
fairly stable for the better part of a decade, the dollar began a sharp 
climb starting in January 1997. It has now appreciated about 30 percent 
against major currencies, as measured by the Federal Reserve Board's 
widely-used price-adjusted index of major currencies. The sharp rise in 
the dollar is clearly evident in Figure 1, appended to my statement. 
This graph makes it plain that the dollar is not in any sense in 
``normal territory.'' In fact, the extent of the post-1997 climb of the 
dollar has been exceeded only once before--the severe overvaluation of 
the dollar in 1982-1985 that put U.S. trade into a tailspin. 
Unfortunately, a close look at Figure 1 shows an uncomfortable parallel 
to the path followed by the dollar in the early 1980's.
    The dollar's rise has exactly the same effect as the sudden 
imposition of a new 30 percent tariff against U.S.-made goods. Congress 
and the Administration would howl with anger if Europe, Japan, Canada, 
and others were to slap such huge new tariffs on United States 
products--yet there has so far been little concern for an overvalued 
dollar that is doing the same thing. Worse, the dollar is also making 
many foreign products artificially cheap in the U.S. market. The Bureau 
of Labor Statistics' capital goods import price index, for example, has 
fallen nearly 20 percent in the last few years.
    The NAM may have been the first in saying that the dollar was 
overvalued, but we are now in growing company. We are joined by over 
50 trade associations representing manufacturing and agriculture, who 
have come together in the Coalition for a Sound Dollar--advocating a 
dollar that is consistent with economic fundamentals.
    We are also joined by the International Monetary Fund, whose just-
released Global Economic Outlook says that one of the principal risks 
to the sustainability and durability of the upturn in the United States 
and elsewhere is the overvaluation of the dollar. The European Central 
Bank concurs in saying the Euro is ``very undervalued'' and the dollar 
is ``very overvalued.'' The Chairman of the Bank of England and of the G-
10 Group of Central Bankers also said the dollar is overvalued.
    U.S. Government officials have also commented. New York Fed 
President McDonough has said the dollar is overvalued. The Chairman of 
the President's Council of Economic Advisors, Glenn Hubbard, told the 
press that the strong dollar is bad for U.S. manufacturers.
    The President's Trade Representative, Ambassador Zoellick, has said 
the strong dollar is leading to a flood of imports and providing 
export-led growth to other countries. Former Federal Reserve Board 
Chairman Paul Volcker testified last year that maintaining a stable 
U.S. economy might require ``strengthening of the Euro and the yen 
relative to the dollar.'' And Keith Collins, Chief Economist, U.S. 
Department of Agriculture, said ``The high value of the dollar is 
expected to continue to impair the U.S. competitive position in world 
markets. . . . The strong dollar not only makes U.S. products more 
expensive, it insulates foreign competitors from market price declines 
. . .''
    Additionally, we are joined by the financial community. For 
example, Larry Kantor, Global Head of Currency Strategy for J.P. Morgan 
Chase told National Public Radio that, ``We judge the dollar to be high 
relative to its fundamentals, something on the order of 20 percent at 
most . . .'' And Morgan Stanley currency expert Joachim Fels, stated 
flatly to Fortune Magazine that, ``The dollar is overvalued, and 
everybody knows it.''
    Then, finally, there is the Big Mac Index. Don't laugh, The 
Economist Magazine's Big Mac Index, comparing Big Mac prices around the 
world, has consistently been among the most accurate indicators of 
currency valuation and future currency changes. The current issue of 
the Economist says, ``Overall, the dollar now looks more overvalued 
against the average of the other big currencies than at any time in the 
life of the Big Mac Index.''
    Even Paul O'Neill has commented on dollar overvaluation, and has in 
the past agreed that the dollar can become overvalued and depart from 
its normal level--harming U.S. industry. Of course, he wasn't Secretary 
of the Treasury when he said so. Nevertheless, his words from 1985 are 
surely indicative of his belief. When the dollar became badly 
overvalued in 1985, he said the strong dollar ``. . . has turned the 
world on its head. We have suffered a major loss in competitive 
position because of exchange rates.'' He went on to say, ``Exchange 
rates moving back to normal 
levels would be very good news for our industry. We would recoup most 
if not all of our export volume.''
    Mr. O'Neill's words were good advice then, and are just as relevant 
today.
The Overvalued Dollar is Having a Huge Effect
    The overvaluation of the dollar is one of the most serious economic 
problems--perhaps the single most serious economic problem--now facing 
manufacturing in this country. It is decimating U.S. manufactured goods 
exports, artificially stimulating imports, and putting hundreds of 
thousands of American workers out of work. It is leading to plant 
closures and to the offshore movement of production away from the 
United States, with harmful long-term consequences for future U.S. 
economic leadership.
    This is a matter to be taken seriously not only because of the cost 
in terms of jobs that have been lost, but also because manufactured 
goods comprise over 85 percent of all U.S. goods exports--and two-
thirds of all exports of goods and services. America's ability to pay 
its international bills depends on America's manufacturing industry.
Effect on Trade and Jobs
    The effect on U.S. manufacturing has been huge, as is detailed in 
the NAM analysis titled, ``Overvalued U.S. Dollar Puts Hundreds of 
Thousands Out of Work,'' which I ask be made part of the record of this 
hearing. That report shows the dollar's overvaluation has had a major 
impact on exports, imports, the trade balance, and jobs.
    Exports of U.S. manufactured goods have plunged $140 billion in the 
last 18 months, at an annual rate--the largest such fall in U.S. 
history (Figure 2). This fall, which is more than a 20 percent drop, is 
so huge that it accounts for close to two-fifths of the entire fall in 
U.S. manufacturing output and jobs in the current manufacturing 
recession--over 500,000 lost factory jobs.
    The recession from which we are beginning to emerge was, to a 
remarkable degree, a manufacturing recession. Comprising 14 percent of 
the American workforce, the manufacturing sector accounted for 80 
percent of the job loss in the entire U.S. economy. Manufacturing lost 
about 1,500,000 jobs--and over 500,000 of them were directly due to the 
unprecedented fall in American exports. The export losses, principally 
due to the overvalued dollar, are a key factor explaining why the 
manufacturing sector has fared so much more poorly than the rest of the 
economy in this recession.
    To put the $140 billion export drop in a different perspective, it 
is instructive to realize that the NAM estimates a successful Free 
Trade Area of the Americas agreement (FTAA) could triple U.S. exports 
to South America from $60 billion to $200 billion within 10 years of 
implementation--which is scheduled to begin in 2006. Thus over the next 
14 years, the FTAA may result in a $140 billion increase in U.S. 
exports. American exports have fallen by that much in just the last 18 
months!
    Additional hundreds of thousands of jobs have been lost on the 
import-competing side as well, though this is more difficult to 
measure. From the beginning of 1997 through the first quarter of 2002, 
U.S. manufacturing output rose 12 percent, while the volume of goods 
imports soared 45 percent--almost four times as fast. Much of this is 
due to the fact that import prices fell 10 percent relative to domestic 
manufacturer's prices. Import prices fell even more rapidly in some 
sectors--such as in imported capital goods, where they fell 17 percent, 
reflecting the rising dollar.
    This is evident in what has happened to some individual industries. 
For example, prior to 1997 the U.S. paper industry routinely supplied 
about 80 percent of the growth in the U.S. market for paper. Since 
1997, however, 90 percent of the growth in demand for paper in the 
United States has been met by imports. The U.S. paper industry has 
closed 60 plants since 1998.
    The U.S. textile industry, through large investments and 
productivity improvements, and generally stable prices for Asian 
imports, had been able to hold its own until 1997. Since the dollar 
began to rise in that year, dollar import prices for textile products 
fell 23 percent, imports from Asia soared, and 177,000 U.S. textile 
jobs were lost.
    The Treasury Department's periodic examinations of exchange rates 
and trade 
curiously have not mentioned any effect of exchange rates on trade. 
Instead the Treasury attributes all the U.S. trade changes solely to 
faster economic growth in the United States than abroad. While slower 
economic growth abroad certainly has contributed to the U.S. export 
slowdown, it has been a subordinate cause, and the principal cause has 
been the huge shift in relative prices brought about by the rise of the 
dollar.
    For example, U.S. exports to the European Union dropped 20 percent 
over the last year and a half. European industrial production declined 
only about 4 percent during that time period. While this slowdown 
certainly had some influence on declining U.S. exports, typically each 
1 percent change in European industrial production 
results in a little less than a 2 percent shift in U.S. exports. Thus, 
the decline in European industrial production should have cut U.S. 
exports by about 7 percent--leaving a 13 percent residual that can only 
be explained by the dollar's overvaluation.
    A much stronger relationship exists between currency misalignment 
and trade shifts, as is depicted in Figure 3, attached to my statement, 
which clearly shows how dollar overvaluation affects trade flows. The 
graph shows two economic series: (1) the ratio of U.S. imports to U.S. 
exports--i.e., how much larger imports are than exports; and (2) the 
Federal Reserve Board index of the value of the dollar. Even a cursory 
examination of the graph shows the close relationship. The time lag 
between a change in exchange rates and a change in trade patterns is 
visible as well, particularly in the exchange rate peak in 1985 that 
resulted in imports cresting at being 80 percent larger than exports in 
1987.
    Largely as a result of the import and export effects of the 
overvalued dollar, the manufactured goods trade deficit has grown so 
much that it has reached a record 21 percent of U.S. manufacturing GDP 
(gross value added in manufacturing)--more than double what it was in 
1997.
    Treasury Secretary O'Neill was quoted recently in the press as 
saying that he thought the trade deficit was of no consequence because 
capital inflows are strong. We differ sharply with this statement, as 
does the International Monetary Fund and the vast preponderance of 
economic evidence. The current account deficit has three very 
significant consequences. The first is that the continuing deficit 
generates an ever-increasing load of foreign debt that one day will 
have to be paid, and at large cost. Federal Reserve Chairman Greenspan 
and many others, including a worried International Monetary Fund, have 
pointed out that there could be serious consequences on the United 
States and global economies.
    The second aspect is its damage to U.S. industry--particularly to 
manufacturing. Perhaps one of the most worrisome aspects of the dollar-
induced shift in the U.S. trade balance is what has happened to U.S. 
trade in technology-intensive products. This is America's most 
competitive sector, and is based on the best of American research and 
development, productivity, and innovation. It is always a sector we 
have taken for granted in trade.
    Indeed, as recently as 1997 it generated a $40 billion trade 
surplus for the United States. That surplus has been declining at an 
accelerating rate, and has now, for the first time in our history, 
moved into a substantial deficit, running at an annual rate of $20 
billion. If the United States cannot compete in knowledge-intensive, 
technology-intensive trade, where can it compete?
    The third aspect is that dollar overvaluation and the consequent 
huge trade and current account deficits erode support for free trade 
policies and contribute to rising protectionist sentiments. When 
industries and displaced workers see their sales and jobs disappearing 
because of falling exports and rising imports despite their best 
efforts to be competitive, their natural reaction is to urge that trade 
policies be changed. America's historic support for free trade policies 
was threatened in the 1980's overvaluation, and the current 
overvaluation and trade deficits are the principal reasons why public 
support for further trade liberalization is weak.
Effect on Small- and Medium-Sized Firms
    While manufactured goods exports are widely assumed to be 
associated with large firms, in truth more than 95 percent of all 
exporters are small- or medium-sized firms. Exporting has been a major 
source of growth for small-manufacturers. For example, according to the 
NAM's surveys of small- and medium-sized member companies, the 
proportion of these companies that generated at least 25 percent of 
their total business from exports grew from 5 percent in 1993 to almost 
10 percent in 1998--nearly doubling. With 95 percent of the world's 
consumers outside our country's borders, small manufacturers have found 
world markets to be a major source of growth and jobs.
    Unfortunately, the sharp rise in the dollar over the last few years 
has led to a major reversal. Based on the most recent NAM survey of its 
small and medium membership, all the export gains since 1993 have been 
erased. Last year the proportion of smaller companies exporting at 
least 25 percent of their production fell to only 4.2 percent. And for 
this year, only 3.8 percent anticipate exports to be at least 25 
percent of their business.
Effect on Earnings
    Finally, American firms' profits have been strongly affected, 
including from the fact that profits from overseas operations have been 
reduced sharply as earnings from abroad are converted back into 
dollars. After recovering from a drop due to the Asian financial crisis 
in 1997, manufacturing after-tax earnings peaked at $76 billion in the 
first quarter of 2000. By the first quarter of 2001, earnings had 
collapsed to $-1.7 billion, a level not seen since the 1st quarter of 
1992. Reduced 
exports, heightened import competition, and the conversion into dollars 
from operations abroad have had a major impact. Foreign operations, 
especially in Europe, represent a sizable proportion of global sales 
and profits for many large American firms. As foreign earnings are 
converted into dollars and have had to be marked down 30 percent or 
more because of the shift in currency values, the impact on total 
corporate profits has been huge. Corporate releases in recent weeks 
have been 
replete with reports of reduced earnings because of the overvalued 
dollar.
How Individual Companies Have Been Affected
    To understand the real extent of the injury being caused to U.S. 
manufacturers it is necessary to look at the effect dollar 
overvaluation is actually having on individual companies and their 
employees. Many NAM member companies have written to the Treasury 
Department urging action to bring relief from the overvalued dollar.
    Typically they relate that after having been competitive in world 
markets for years, they are now losing their foreign business. Many 
tell of export decreases of 25 percent, and some have lost almost all 
their export business.
    Some letters are from large companies that are world industry 
leaders. Others are from small companies, many of them family-owned. 
They tell a story of being unable to compete not because of a decline 
in product quality or productivity and not because of any price 
increases in dollar terms--but only because of the rise in the dollar's 
value relative to other currencies. All of them are losing sales 
overseas or find they can no longer compete against imports into the 
U.S. market. Many of them are having to reduce their workforces. Others 
say they have no choice but to close their U.S. plant and start 
production overseas. This is the cost of having an overvalued currency.
    These are not poorly-managed companies. They are not ``whiners.'' 
They are among the best U.S. manufacturers, and many had built large 
export markets, won Government export awards, installed the latest 
machinery and technology, and proudly sold their American-made products 
around the world. I have appended about a dozen of these stories to my 
testimony.
Correcting the Currency Misalignment
    Currency values should--and over the longer term do--reflect 
economic funda-
mentals. However, the normal market adjustment mechanisms appear to 
have been thwarted in the case of the dollar's recent rise. While about 
one-fourth of the dollar appreciation since 1997 took place during 
1997-1998 as capital fled to the safety of the U.S. economy in the wake 
of the Asian financial crisis, three-quarters of the rise in the dollar 
took place after 1998 in spite of, not because of, the economic 
fundamentals of the United States. In the face of slowing economic 
growth, declining interest rates, and rising manufacturing 
unemployment, the dollar has remained high.
    Interest rate differentials are one of the key factors normally 
expected to affect exchange rates. In June 1999, the U.S. Federal Funds 
rate stood at 5 percent, roughly 2 percentage points above the European 
Central Bank's key lending rate. This was certainly a factor 
contributing to dollar strength. However, repeated interest rate cuts 
have now put the Federal Funds rate fully 1\1/2\ percentage points 
below European rates. Why hasn't the dollar fallen relative to the 
Euro?
    Economic growth differentials are another important factor. In the 
late 1990's, U.S. economic growth averaged more than 4 percent, 
outpacing our major trading partners. However, U.S. economic growth 
slowed substantially beginning in the second half of 2000. By 
comparison, while economic growth in Europe and the Pacific Rim has 
also slowed, most analysts now expect economic growth to favor our 
trad-
ing partners overseas after the 1st quarter of 2002. Clearly, the 
impressive growth 
disparity between the United States and economies abroad in the late 
1990's has 
shifted. Why hasn't this been reflected in exchange rates?
    Trade and current account balances are important as well. The U.S. 
trade deficit now stands at more than $400 billion, or 4.4 percent of 
real GDP--up significantly from just 1.4 percent in 1997. During the 
late 1990's the outflow of U.S. dollars, which is the flip side of a 
large trade deficit, was largely used to acquire U.S. assets--primarily 
U.S. plant and equipment in the form of direct investment. However, 
business investment demand in the United States has been negative for 5 
quarters running. Combined with continuing large trade deficits, this 
translates into an oversupply of dollars in the world financial system 
which should put downward pressure on the value of the dollar. Why 
hasn't that happened?
    Unless economic theory is to be rewritten, clearly there are market 
imperfections at work. By far the most important factor interfering 
with the market is the Treasury's maintenance of a ``strong dollar no 
matter what'' policy, a carryover from the Clinton Administration. This 
rhetoric is artificially propping up the dollar--and causing severe 
economic dislocation especially for manufacturing.
    The Treasury's statements are inherently contradictory. On the one 
hand it says that a strong dollar policy is necessary in order to 
continue to attract the capital needed to finance the trade deficit 
(which is caused by the strong dollar). On the other hand, its says 
that the dollar is strong because the United States is the best place 
to invest, and rapid foreign capital inflows are driving up the dollar 
through the free operation of the marketplace.
    But if the latter were true--that the dollar remains strong because 
of market forces--then it wouldn't matter if the Treasury said the 
United States had a strong dollar policy, a weak dollar policy, or even 
no dollar policy at all. Markets would only care about the economic 
fundamentals of U.S. growth, productivity, and returns to capital.
    But what would really happen if the Treasury announced it no longer 
had a strong dollar policy and was adopting a policy of benign 
neglect--letting the markets set the dollar wherever they thought it 
should be?
    Larry Kantor, Global Head of Currency Strategy for J.P. Morgan 
Chase, answered that on National Public Radio recently, when he said 
that if markets, ``hear even a slight change in the rhetoric, it does 
risk a pretty sharp fall in the dollar.'' Why? Because the dollar is 
very high compared to its economic fundamentals. It should have been 
adjusting for some time now, but has not.
    If markets no longer believed the Treasury would keep the dollar at 
its present levels, market expectations would change overnight, realism 
would take hold, and the dollar's correction would begin immediately. 
As Morgan Stanley told Fortune Magazine, ``the dollar is overvalued, 
and everybody knows it.'' Thus, we believe the Treasury's policy is in 
effect distorting the market and preventing market forces from working. 
It is time to end this policy and to allow the market to correct the 
valuation of the dollar.
    Accordingly, we believe the Administration should stop and take the 
following steps:

    1. Announce clearly that exchange rates are not reflecting economic 
fundamentals, that the Treasury is adopting a sound dollar policy of 
benign neglect, and that the United States will not intervene in 
exchange markets to maintain the value of the dollar.
    2. Seek cooperation with other major economies in obtaining common 
agreement and public statements that their currencies need to 
appreciate against the dollar.
    3. Make clear that the United States will resist, and take 
offsetting action as necessary, foreign country interventions designed 
to retard movement of currencies toward equilibrium.
    4. Seek agreement that the G-8 countries should state their 
intention to work together, as they stated in 1985 when the dollar was 
badly overvalued, and to make a clear and unambiguous announcement at 
their next meeting, in June, that:

 external imbalances have become too great and are contributing 
    to protectionist pressures which, if not resisted, could lead to 
    serious damage to the world economy; and
 exchange rates should play a role in adjusting external 
    imbalances and in order to do this exchange rates should better 
    reflect fundamental economic conditions than has been the case.

    Should currencies begin adjusting too rapidly, coordinated 
intervention in the market can assure an orderly movement. When 
countries coordinate intervention and clearly state their intentions, 
markets react. The experience of the 1985 Plaza Accord is instructive. 
This Accord restored currency stability and broke the back of the 
rising protectionism. The preponderance of economic research, 
meticulously reviewed in the September 2001 issue of the American 
Economic Association's highly respected Review of Economic Literature, 
makes it plain that highly visible coordinated action, including 
intervention, does work.
The Treasury's Report on Exchange Rate Policy
    In concluding my remarks, Mr. Chairman, I would like to offer some 
views on the Treasury's Annual Report on International Economic and 
Exchange Rate Policy. Section 3005 of the Omnibus Trade and 
Competitiveness Act of 1988 requires the Secretary of the Treasury to 
provide Congress with periodic reports on exchange rates and economic 
policies.
    Of particular interest to the NAM is the requirement (Section 
3005(b)(4)) that the Treasury's report include an assessment of the 
impact of the exchange rate of the dollar on production and employment 
in the United States and on the international competitive performance 
of U.S. industries. We have been disappointed consistently that the 
Treasury's reports have not, and do not, contain such an assessment. 
The reports have contained no discussion at all of the effect the 
appreciation of the dollar has had on trade in U.S. manufactured goods 
or in farm commodities.
    More transparency and visibility is desirable here, both for 
policymakers and for the public. The NAM, therefore, recommends that 
the Commerce Department and the Agriculture Department be required by 
the Congress to begin preparing semiannual reports directly analyzing 
the effect of exchange rates on U.S. trade, pro-
duction, and employment. These reports would be separate from the 
Treasury's 
macroeconomic reports, and would be produced independently by the 
Commerce and Agriculture Departments. Moreover, as part of their 
reports, they should be required to survey what private sector 
economists are saying about the effect of exchange rates on trade and 
production.
    Mr. Chairman, I appreciate the opportunity of appearing before this 
Committee; and we look forward to working with you to persuade the 
Administration to drop its pegging of the dollar through its ``strong 
dollar'' policy and to adopt a ``sound dollar'' policy in which markets 
set currency rates based on economic fundamentals. The longer this 
change is delayed, the worse matters will get.
    Thank you, Mr. Chairman.

    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
                   PREPARED STATEMENT OF BOB STALLMAN

               President, American Farm Bureau Federation
                              May 1, 2002

    Mr. Chairman, Members of the Committee, I am Bob Stallman, 
President of the American Farm Bureau Federation and a rice and cattle 
producer from Columbus, Texas. AFBF represents more than 5.1 million 
member families in all 50 States and Puerto Rico. Our members produce 
nearly every type of farm commodity grown in America and depend on 
access to foreign markets for our economic viability.
    We appreciate the opportunity to testify on the importance of the 
exchange rate to U.S. agriculture. Over-valuation of the dollar is one 
of the most pressing international economic problems facing America's 
agriculture and manufacturing sectors. U.S. farmers and ranchers have 
been losing export sales for the past 3 years because the dollar is 
pricing our products out of the market--both at home and abroad. In 
addition, the higher exchange rate of the U.S. dollar has resulted in 
rising agricultural imports due to increased purchasing power. The 
purchasing power of the dollar grew 21 percent from 1995 to 2000 in 
comparison to the exchange rate value of those nations that supply food 
to our country.
    Agriculture is one of the most trade dependent sectors of our 
economy. Our sector has maintained a trade surplus for over two 
decades, but that surplus is shrinking. One of the primary factors 
affecting our declining trade balance is the strong value of the 
dollar.
    In addition, the value of the dollar has significantly impacted 
agricultural employment. According to a recent USDA study, agricultural 
employment lost 87,000 jobs between fiscal years 1997 and 2000, a 
period in which the real agricultural exchange rate was rising rapidly 
and U.S. agricultural exports were stagnant.
    The sharp rise of the dollar since 1995 has reduced our ability to 
compete in foreign markets. In 1996, U.S. agricultural exports reached 
a record $60 billion, but declined sharply to a low of $49 billion in 
1999. This decline came as the U.S. dollar strengthened. USDA estimates 
that 14,300 jobs are lost for every $1 billion decline in agricultural 
exports. The short-term outlook for agricultural exports is not 
expected to improve significantly. Slow United States and global 
economic growth in 2001-2002 and a strong U.S. dollar will result in 
weak prices for the agricultural sector, according to USDA. The 
continued strength of the U.S. dollar will be a primary constraint on 
agricultural export growth.
    We are deeply concerned about countries that engage in currency 
devaluations in order to gain an export advantage for their producers. 
The real trade-weighted exchange rates for agricultural exports from 
all of the major competitor countries, including Canada, Australia, 
Argentina, China, and Malaysia, have exhibited a long-term trend of 
depreciation against the dollar, contrary to market fundamentals. This 
trend has persisted over several decades, leaving it hard to conclude 
that this is not a deliberate monetary policy of these and other 
governments.
    U.S. agriculture relies on exports for one-quarter of its income. 
In addition, about 25 percent of agricultural production in the United 
States is destined for a foreign market. A number of our commodities 
are highly dependent on trade for a sizable portion of their 
production. Some crops, like walnuts and wheat, about one out of two 
acres is exported. Exports now account for nearly one-quarter of our 
apple, beef and corn production and more than one-third of grapefruit 
and soybean production.
    As productivity growth of U.S. farms and ranches continues to 
exceed the growth in U.S. population, our dependence on trade will 
increase. Only 4 percent of the world's consumers live in the United 
States. It is estimated that 99 percent of the growth in the global 
demand for food over the next 25 years will be in foreign 
markets.
    Our country is also a major importer of food and fiber. The 
aggregate import share of U.S. food consumption has been rising 
steadily, along with the strength of the U.S. dollar. For nearly 20 
years, imports accounted for 7.5 percent of total U.S. food 
consumption. The share of imports climbed to 8.6 percent in 1996 and 
9.3 percent in 1999. These jumps in import share coincided with the 
strong value of the dollar and U.S. economic growth.
    With a strong dollar, we have the double challenge of our products 
being less competitive in other markets while products from other 
countries are more competitive in U.S. markets.
    In addition, there is a strong relationship between the value of 
the dollar and the domestic price of our commodities. As the value of 
the dollar rises, foreign buyers must spend more of their currency to 
purchase our exports. This causes foreign buyers to decrease their 
consumption of U.S. commodities or buy from our competitors instead. 
The resulting drop in consumption drives U.S. commodity prices down 
even further.
    Net farm income is not directly tied to the rise and fall of the 
U.S. exchange rate; rather it is the exchange rate that affects the 
price competitiveness of our exports. The resulting change in the 
volume of trade--increased exports when exchange rates are low and 
decreased exports when exchange rates are high--directly impacts farm 
income. As you know, U.S. agricultural commodity prices are the lowest 
they have been in over two decades. Further price depressions stemming 
from the strong value of the dollar are exacerbating an already dire 
situation.
    The exchange rate is the single most important determinant of the 
competitiveness of our exports. Other important determinants of U.S. 
agricultural export values include income growth rates in developing 
countries, the growth and productivity of the foreign agricultural 
sectors against which we compete, export subsidies use by our 
competitors and weather conditions.
    USDA's Economic Research Service estimates that movements in 
exchange rates have historically accounted for 25 percent of the change 
in U.S. agricultural exports. The elasticity of export demand for all 
agricultural products with respect to the value of the dollar is 1.38. 
This means that a 1 percent increase in the value of the dollar is 
associated with a 1.38 percent reduction in the value of U.S. 
agricultural exports.
    The elasticity of export demand for individual agricultural 
commodities is 1.77, thus resulting in a 1.77 percent decline in the 
export value of specific commodities when the U.S. dollar appreciates 1 
percent. The export dependency of U.S. agriculture, combined with the 
highly elastic response of U.S. agricultural export values to changes 
in the exchange rate underscore the need to maintain a stable exchange 
rate policy without overstating the value of the dollar.
    The increasing strength of the dollar, and steady depreciation of 
the currencies of our major export competitors, has had a profound 
impact on our ability to export. In fact, the rising appreciation of 
the dollar is one of the primary reasons why the agricultural economy 
did not experience the economic prosperity that most other sectors of 
the U.S. economy enjoyed between 1995 and 1999. The dollar's increased 
purchasing power, and rising U.S. disposable income encouraged 
Americans to buy more imported products, while high prices of U.S. food 
and agricultural exports, in foreign currency terms, discouraged demand 
for our goods. As a result of the rapidly appreciating dollar, our 
competitors gained an advantage in third-country markets over our 
exports without even adjusting their sales price.
    It is abundantly clear that the strong dollar is severely 
handicapping our ability to compete. Agricultural analysts note that 
macroeconomic fundamentals point to continued weak export performance 
in the near future.
    For some commodities, the rising value of the dollar has directly 
contributed to the export competitiveness of our foreign rivals. 
Sharply depreciating currencies such as the Canadian and Australian 
dollars, the European Euro, the Brazilian real and the Korean won have 
enabled our competitors to out-compete us in a number of third-country 
markets.
    The strong dollar is enabling our competitors to expand their 
production and gain market share at our expense. Recent USDA estimates 
note that U.S. corn export sales have fallen 3 percent and wheat 
shipments 10.5 percent as a result of the appreciation of the dollar.

Meats
    Since 1995, the dollar has appreciated 42 percent against the 
currencies of beef producing countries. The rise in red meat imports 
from 6.4 percent in 1996 to 8.9 percent in 2000 is explained in part by 
the strength of the dollar. In addition, the recent announcement by 
McDonald's to buy imported beef was largely driven by the price 
advantage it faced vis-a-vis its competitors, other U.S. fast food 
chains that have historically used imported beef trimmings. Imported 
trimmings are cheaper than U.S. trimmings due to the strong U.S. 
dollar.

Horticultural Products
    During the period 1995-2000, U.S. imports of fruits and nuts jumped 
33 percent, largely due to the dollar's 18 percent gain with respect to 
the currencies of foreign suppliers of these commodities to the United 
States. The dollar rose only 3 percent against currencies of foreign 
vegetable importers to the United States. The appreciation of the 
Mexican peso in price adjusted terms helped to mitigate the strength of 
the dollar against the currency of Mexico, the country that supplies 
the majority of U.S. vegetable imports.
    A Farm Bureau-commissioned study documented the impact of the 
exchange rate on corn, wheat, soybeans, and melons.

Corn
    United States corn prices in Japan have been affected by adverse 
exchange rate movements. The U.S. landed corn price decreased from 
$3.64/bu in 1995 to $3.31/bu in 1998. The United States dollar 
appreciated 39 percent relative to the Japanese yen, from 94.23/$ 
to 130.81/$. The yen price of U.S. corn increased from 343/bu 
to 4331bu, an increase of 26 percent even though the U.S. dollar 
price had declined 9.1 percent. United States exports of corn to Japan 
fell 11.3 percent, from 16 mmt to 14.2 mmt.

Wheat
    Exchange rates had similar impacts on the Mexican wheat market. 
Between 1995 and 1999, the price of United States wheat delivered to 
Mexico declined from $3.95/bu to $3.20/bu. The United States dollar 
appreciated 48 percent relative to the Mexican peso (NP) during this 
period from NP6.45/$ to NP9.58/$. This appreciation led to a 20 percent 
increase in the peso price of U.S. wheat from NP25.46/bu to NP30.64/bu, 
though the U.S. dollar price of wheat declined 19 percent. However, 
even with higher prices in peso terms, the volume of United States 
wheat exports to Mexico rose significantly during this time, from 
791,000 mt to 1.8 mmt (130 percent). This contrasts with the Japanese 
results for two main reasons. First, Japan is a mature market with an 
established demand, extremely sensitive to price and geographically 
distant from major grain suppliers. Second, the growth of the Mexican 
market, coupled with its proximity to United States suppliers, has more 
than compensated for the increase in peso wheat prices.

Soybeans
    Between 1996 and 1998 the U.S. average annual farm price for 
soybeans declined from $7.27/bushel (bu) to $5.93/bu, an 18.5 percent 
drop. Over the same period, the United States dollar appreciated 20 
percent relative to the Japanese yen, going from 108.81/$ to 
130.82/$. When the yen price of United States soybeans landed in 
Japan is compared over this period of time it is important to note that 
the price of U.S. soybeans in dollars fell from $9.09/bu to $8.16/bu, 
but in yen the landed price actually increased from 989/bu to 
1,068/bu, an increase of 8 percent. The cost of United States 
soybeans to Japanese buyers increased primarily due to the appreciation 
of the United States dollar even though United States prices had fallen 
significantly. The result was higher priced United States soybeans in 
Japan when compared to soybeans from Brazil, which fell from 986/
bu to 958/bu, allowing Brazilian soybeans to be sold in Japan for 
about $1.00/bu less than United States soybeans. United States soybean 
exports to Japan declined during this period from 3.9 million metric 
tons (mmt) to 3.7 mmt (200,000 mt, or 5 percent), while exports from 
Brazil increased from 379,000 mt to 524,000 mt (145,000 mt, or 38 
percent).

Poultry
    Recent empirical evidence supports the strong relationship between 
exchange rates and agricultural trade. Kapombe and Colyer \1\ found 
that a 1 percent increase in the Japanese yen-United States dollar 
exchange rate led to a .96 reduction in Japanese demand for United 
States broilers. In addition, they also found that a 
1 percent increase in the Hong Kong-United States exchange rate 
resulted in a .56 percent decline in Hong Kong demand for United States 
broilers, while a similar change in the Mexican peso--United States 
dollar exchange rate led to a .58 drop in Mexican demand.
---------------------------------------------------------------------------
    \1\ Kapombe, C.M. and D. Coyler. ``A Structural Time Series 
Analysis of U.S. Broiler Exports.'' American Journal of Agricultural 
Economics, 21 (December 1999): 295-307.
---------------------------------------------------------------------------
Melons
    Other empirical studies have also documented the importance of the 
Mexican peso-United States dollar exchange rate in influencing United 
States imports of melons (Espinosa-Arellano, Fuller, and Malaga).\2\ 
Their results suggest that the 1994-1995 Mexican peso devaluation 
increased United States imports of watermelon, honeydew, and cantaloupe 
by 36, 18 and 4 percent, respectively in the short run. In fact, a 
survey of historical empirical literature since the early 1970's has 
revealed that in 32 separate studies of the role of exchange rates on 
U.S. agricultural trade, the exchange rate was found to be an important 
explanatory variable in 24 of the studies (Kristinek).\3\
---------------------------------------------------------------------------
    \2\ Espinosa-Arellano, J.J., S. Fuller and J. Malaga. ``Analysis of 
Forces Affecting Competitiveness of Mexico in Supplying U.S. Winter 
Melon Market.'' International Food and Agribusiness Management Review 
1, No. 4 (1998): 495-507.
    \3\ Kristinek, Jennifer. ``The Impact of Exchange Rates of Beef and 
Cattle Trade in North America.'' Texas A&M University, 2001.
---------------------------------------------------------------------------
Conclusion
    American farmers are the most productive in the world. However, the 
comparative advantages that our producers generally enjoy, abundant, 
fertile natural resources, access to high-quality inputs and 
technology, for example, are mitigated by the rising appreciation of 
the dollar. The strong value of the dollar has, in many instances, shut 
our exports out of foreign markets and increased import competition in 
the U.S. market.
    In short, U.S. agriculture is part of a worldwide food production 
system. We do not advocate isolation as a means to shield our sector 
from the economic forces that shape world trade. However, we cannot 
effectively plan our farming and ranching enterprises in a world where 
exchange rates suddenly depreciate by 50 percent, as happened with the 
Mexican peso in late 1994, or shift more slowly, such as the 50 percent 
decline in the Brazilian real from 1995 to 2000.
    Exchange rate issues are certain to increase in importance as U.S. 
agriculture produces more for export markets and U.S. food and fiber 
markets become more open to imports. If these issues are not resolved 
by macroeconomic policies, there will be continued pressure to find 
solutions in traditional farm policies.
    Effective long-range financial planning at the farm and ranch level 
and the overall economic health of U.S. agriculture depends on more 
stable exchange rates that do not overvalue the U.S. dollar against our 
competitors' currencies.









                 PREPARED STATEMENT OF C. FRED BERGSTEN

             Director, Institute of International Economics
                              May 1, 2002

The Rise of the Dollar
    Since hitting its all-time lows in early 1995, the dollar has risen 
by a trade-weighted average of 40-50 percent in real terms against 
larger and smaller baskets of currencies of its trading partners. It 
has climbed by well over 50 percent against the yen and the European 
currencies. It could rise considerably further over the next year if 
the United States continues to recover more quickly and more robustly 
than Europe and Japan (or anybody else) from last year's worldwide 
slowdown, as is quite likely.
    Every rise of 1 percent in the trade-weighted dollar produces a 
rise of at least $10 billion in the U.S. current account deficit.\1\ 
Hence the currency's appreciation over the past 7 years accounts for a 
large share of the total external imbalance, which will probably 
approximate $500 billion this year and be close to 5 percent of GDP, 
entering the traditional ``danger zone'' where the United States and 
other OECD countries have traditionally experienced correction of their 
external deficits.\2\ The deficits rose at an average rate of $100 
billion (or over 50 percent) per year during the late 1990's, an 
explosive and obviously unsustainable path that may now have resumed. 
They dropped back to annual rates closer to $400 billion during 2001, 
with the drop in U.S. economic growth and hence import levels, but rose 
again sharply in the first quarter of this year (and in fact subtracted 
1.2 percentage points from our economic growth in that period).
---------------------------------------------------------------------------
    \1\ William R. Cline, American Trade Adjustment: The Global Impact, 
Policy Analyses in International Economics 26, Washington: Institute 
for International Economics, 1989.
    \2\ See Catherine L. Mann, Is the U.S. Trade Deficit Sustainable?, 
Washington: Institute for International Economics, September 1999, 
especially pp. 156-57, and Caroline Freund ``Current Account Adjustment 
in Industrial Countries'' International Finance Discussion Papers 692: 
Federal Reserve Board of Governors, December 2001.
---------------------------------------------------------------------------
    Our latest projections at the Institute for International Economics 
suggest that, absent any corrective action, the U.S. current account 
deficit will rise to 7 percent of GDP by 2006 (about $800 billion).\3\ 
The previous sharp falls in the dollar, which have occurred about once 
per decade since the early 1970's, were triggered by external 
imbalances that never even reached 4 percent of GDP. Our latest 
calculation is that the dollar is overvalued in trade terms by 20-25 
percent, i.e., a depreciation of that magnitude would reduce the 
current account deficit to the level of around 2-2\1/2\ percent of GDP 
that is likely to prove sustainable over the longer run.\4\
---------------------------------------------------------------------------
    \3\ Catherine L. Mann, ``How Long the Strong Dollar?'' Institute 
for International Economics, March 2002.
    \4\ Simon Wren-Lewis, Exchange Rates for the Dollar, Yen and Euro, 
International Economics Policy Brief 98-3, Institute for International 
Economics, Washington, July 1998. The International Monetary Fund has 
publicly expressed a similar view, e.g., in its World Economic Outlook 
of May 2001.
---------------------------------------------------------------------------
    These annual imbalances add to the negative net international 
investment position of the United States, which reached $2.2 trillion 
at the end of 2000 as a cumulative result of the deficits of the past 
20 years. As recently as 1980, the United States was the world's 
largest creditor country. It has now been the world's largest debtor 
for some time. Its negative international investment position is rising 
by 20-25 percent per year. This trajectory too is clearly 
unsustainable.
The Impact of the Strong Dollar
    These external deficits and debts levy several significant costs on 
the United States:

 Over the longer run, they mean that we will pay rising annual 
    amounts of debt service to the rest of the world with a consequent 
    decline in our national income. These payouts are surprisingly 
    small so far, amounting to only about $14 billion in 2001, because 
    foreign investment by Americans yields a substantially higher 
    return than foreigners' investments here. However, the numbers are 
    clearly negative and will become substantially larger over time.
 In the short run, any increases in the deficit subtract from 
    our gross domestic product. Export output falls and domestic demand 
    that could be met by domestic output is instead satisfied by higher 
    imports. U.S. output and employment suffer as a result and must be 
    of concern unless the economy is at full employment because of 
    booming domestic demand, as in the late 1990's (on which, see more 
    below) but not now. Since most of our goods trade is in 
    manufactured products, the deterioration of the trade balance has 
    contributed substantially to the large, and perhaps permanent, loss 
    of employment in that high-paying sector--whose wages average 13 
    percent higher and benefits average close to 40 percent higher than 
    for the manufacturing sector as a whole.\5\
---------------------------------------------------------------------------
    \5\ Howard Lewis, III and J. David Richardson, Why Global 
Commitment Really Matters! Institute for International Economics, 
October 2001.
---------------------------------------------------------------------------
 At almost any time, markets could decide that the deficits and 
    debt are unsustainable and reduce their new investments in dollars 
    sufficiently to drive the exchange rate down sharply. The United 
    States must attract about $2 billion of net capital inflow every 
    working day to finance the deficits at their current level. Since 
    gross U.S. capital outflows have been running about as large as the 
    current account deficit, our gross capital inflows must average 
    about $4 billion per working day--and totaled about $1 trillion in 
    2000. Any decline in the level of these inflows, let alone their 
    reversal via a selloff from the $10 trillion of outstanding dollar 
    holdings of foreigners, would produce increases in the U.S. price 
    level and higher interest rates (and almost certainly a fall in the 
    stock market as well). This ``triple whammy'' would severely hurt 
    the U.S. economy.\6\
---------------------------------------------------------------------------
    \6\ For a more optimistic view, see Richard N. Cooper, Is the U.S. 
Current Account Deficit Sustainable? Will It Be Sustained? Brookings 
Papers on Economic Activity 2001:1, pp. 217-26.
---------------------------------------------------------------------------
 In terms of domestic policy, large external deficits and the 
    overvalued dollar that produces them have been the most accurate 
    leading indicator of resistance to trade liberalization throughout 
    the postwar period. Paul Volcker has recently noted, for example, 
    the correlation between the roughly 30 percent tariffs on steel 
    just imposed by President Bush and the decline of roughly 30 
    percent in the value of the Euro since its creation in 1999. The 
    deficits generated relatively little concern in the late 1990's, 
    because growth was so strong and unemployment so low, but are 
    clearly doing so now as indicated by the other statements to the 
    Committee this morning. Antitrade pressures will almost certainly 
    rise again if the economy fails to resume rapid growth on a 
    sustained basis and especially if unemployment fails to fall much 
    from its current levels.
 It should also be noted that a disorderly correction of the 
    dollar's overvaluation would produce major foreign policy problems, 
    especially with Europe. A decline of 20-25 percent in the average 
    value of the dollar would require a much larger decline against the 
    Euro because the currencies of many of our closest trading partners 
    (such as Canada and Mexico) would fall at least part of the way 
    with the dollar itself. A complete dollar correction would in fact 
    require the Euro to rise well beyond its initial starting point in 
    1999 and more than 30 percent above current levels. This would 
    sharply reduce Europe's competitive position and trigger major 
    complaints there, deeply exacerbating the transatlantic trade 
    conflict that is already so severe.\7\
---------------------------------------------------------------------------
    \7\ C. Fred Bergsten, ``The Need for A TransAtlantic G-2,'' The 
Washington Post, April 2002.

    At the same time, it must be recognized that the external deficits 
and dollar appreciation provided important benefits to the U.S. economy 
during the boom period of the late 1990's. With growth at 5-6 percent 
in those years, and unemployment falling to a 30 year low of 4 percent, 
the sharp rise in net imports and the climb in the dollar itself helped 
to dampen inflationary pressures. The capital inflows that financed the 
deficit funded part of our investment boom and held interest rates in 
check, permitting monetary policy to accommodate the rapid growth. 
Under such circumstances, the ``strong dollar'' policy enunciated by 
the Clinton Administration (though never defined nor made operational) 
was defensible.\8\
---------------------------------------------------------------------------
    \8\ C. Fred Bergsten, ``Strong Dollar, Weak Policy,'' The 
International Economy, July/August 2001 and ``Ducking a Dollar 
Crisis,'' The International Economy, September/October 2001.
---------------------------------------------------------------------------
    No such defense is possible under current circumstances, however. 
The economic slowdown and rise in unemployment in 2000-2001 underlined 
the costs of the external deficit. The absence of inflationary pressure 
obviates the chief benefit of large net imports. The sharp reduction in 
interest rates over the past year reduces the need for large capital 
inflows. Investment is now limited by excess capacity and lagging 
demand, rather than by any shortage of capital, so that particular 
benefit of the earlier inflows has largely disappeared.
    It is thus stunning that Secretary O'Neill, in an interview 
published on March 15, suggested that the current account deficit is 
``a meaningless concept'' and that ``the only reason I pay attention to 
it at all is because there are so many people who mistakenly do''--a 
very different view that he expressed as CEO of International Paper in 
the middle 1980's when the dollar was also hugely overvalued and he 
could observe its impact directly. Similar statements of ``benign 
neglect'' by his predecessor Secretary Donald Regan (and especially 
Under Secretary Beryl Sprinkle) in the first Reagan Administration 
turned out to be so wrong, and so costly for the economy, that they had 
to be totally reversed by the second Reagan Administration via the 
Plaza Accord in 1985 to drive the dollar down by 50 percent over the 
succeeding 2 years.
A New Dollar Policy
    It is thus time for a change in the dollar policy of the United 
States. There is no basis for maintaining the ``strong dollar'' mantra 
of the prior boom period. At a minimum, the United States and its G-7 
partners should ``lean against the wind'' of any renewed dollar 
appreciation to keep the problem from getting worse. Indeed, they 
should now begin easing the dollar down toward its long-run equilibrium 
level through a combination of altered rhetoric and direct intervention 
to support other currencies, especially the Euro.
    The new policy should also make clear to other countries that the 
United States will not accept any efforts to competitively depreciate 
their currencies against the dollar. This dimension is particularly 
needed because Japan intervened massively last fall, once again, to 
keep the yen from rising as documented in the Treasury's latest Report 
to Congress on International Economic and Exchange Rate Policy. After 
halting the yen's rise, at about 116:1 against the dollar, the Japanese 
then actively talked it down to about 135:1. This latest episode of 
competitive depreciation of the yen apparently ended in January but it 
clearly had a major impact in the currency's level that persists today.
    The Japanese characterized this intervention as part of an effort 
to combat deflation by pumping more yen into their economy. However, 
there are many other assets that the Bank of Japan could buy to expand 
domestic liquidity--even if one thought that doing so could be 
effective when demand for money is so low due to the depressed state of 
the Japanese economy. Moreover, it appears that the Bank of Japan 
sterilized the monetary effects of the currency intervention (as usual) 
so it made little or no contribution toward easing monetary conditions 
anyway.
    The more plausible explanation of the intervention is that Japan 
was once again seeking to export its domestic economic problems to the 
rest of the world, as it has done on numerous occasions in the past. 
One can readily sympathize with Japan's plight, in light of its 
economy's ``decade of decline'' and the failure of so many of its 
efforts to use traditional monetary and fiscal instruments to restore 
growth.\9\ One might even countenance a temporary decline in the yen 
that resulted from 
implementation of needed reforms in Japan, as suggested by the 
Administration 
during its early days.
---------------------------------------------------------------------------
    \9\ Adam Posen, Restoring Japan's Economic Growth, Washington: 
Institute for International Economics, 1998.
---------------------------------------------------------------------------
    But the renewed rise of Japan's trade surplus that is already 
evident will ease pressure on the country to take the decisive steps 
needed to deal with the huge problems of its banking system--the 
fundamental requirement to get its economy back on track--and cannot be 
accepted as an alternative to such reforms. Moreover, especially in the 
context of last year's global economic slowdown, any such exporting of 
Japan's problems to other countries is highly inappropriate and must be 
resisted--through all the relevant multilateral forums, notably the IMF 
and G-7, as well as bilaterally by the United States.\10\ It is thus 
disturbing that the new Treasury Report ignores the problem even after 
identifying and acknowledging the existence of the massive intervention 
last fall, and indeed implies that it was somehow related to the 
terrorist attacks of September 11 and thus excusable.
---------------------------------------------------------------------------
    \10\ C. Fred Bergsten, Marcus Noland and Takatoshi Ito, No More 
Bashing: Building a New Japan--United States Economic Relationship, 
Washington: Institute for International Economics, 2001.
---------------------------------------------------------------------------
    On the broader issue of U.S. currency policy, it is encouraging 
that neither Secretary O'Neill nor any other Administration official 
has repeated the ``strong dollar'' rhetoric since September 11, or even 
for some time before. Though the Treasury denies that there has been 
any change in policy, the absence of ``strong dollar'' language is 
promising. The Administration should now substitute advocacy of a 
``sound dollar,'' or some equivalent, to signal a substantive change in 
attitude.
    The presumed reason for the Administration's reluctance to embrace 
such a shift is a fear that the dollar could then shift course abruptly 
and go into a sharp decline that would trigger some of the deleterious 
consequences cited above. There is little risk of any such ``free 
fall'' for the foreseeable future, however, in light of the far 
stronger fundamentals of the United States economy (vis-a-vis both 
Europe and Japan) that have in fact held the dollar so high for so 
long. The dollar in fact remained quite strong during 2000-2001 despite 
the sharp falls in U.S. economic growth, interest rates, and equity 
prices--all of which would have traditionally been expected to produce 
a depreciation of the exchange rate. At the same time, there are no 
foreseeable sharp pickups in Europe or Japan (or anywhere else) that 
would pull large amounts of investment away from the United States. 
Hence this is an excellent time to start easing the dollar down toward 
its sustainable equilibrium level, especially as it has already fallen 
by 3-4 percent over the past few months and that ``leaning with the 
wind'' is most likely to be effective.
    The worst policy course is to wait until the inevitable change in 
economic fortunes, whenever it comes, triggers a shift in market 
sentiment against the dollar. Coming on top of the huge underlying 
imbalance, such an alteration of investor views could indeed trigger a 
very sharp fall in our currency and a ``hard landing'' for the economy. 
There is in fact a third factor that could then also kick in and make 
the ensuing adjustment even nastier: The likely structural portfolio 
shift into Euros that will almost certainly occur at some point due to 
the likelihood that that currency, based on an economy as large as the 
United States and with even greater trade, will move up alongside the 
dollar as a global key currency.\11\
---------------------------------------------------------------------------
    \11\ C. Fred Bergsten, ``The Dollar and the Euro,'' Foreign 
Affairs, July/August 1997.
---------------------------------------------------------------------------
    The risk of maintaining the Administration's policy of ``benign 
neglect'' would be substantially increased if the likely strong 
recovery of our economy over the next year or so were to trigger a 
renewed appreciation of the currency that, in combination with the 
growth pickup itself, would send our external deficits soaring even 
further.\12\ Under such circumstances, continuation of the ``strong 
dollar'' rhetoric would be particularly inappropriate because it would 
encourage an even greater rise in the currency's overvaluation. It 
would be a huge mistake to let the dollar rise to levels from which it 
would be even more certain to come crashing down.
---------------------------------------------------------------------------
    \12\ The sharp reduction in the U.S. budget surplus, resulting from 
the tax cuts of early 2001 and the post-September 11 stimulus package, 
further enhances the prospect of larger trade deficits via a strong 
dollar. The fall in the surplus means that Government saving will 
decline sharply, by perhaps 2-3 percent of GDP, and that an equivalent 
amount of additional foreign capital will have to be imported--implying 
a similar jump in the trade deficit--unless private saving were to rise 
by a like amount, which is not only unlikely but also undesirable since 
the goal of the stimulus efforts is to promote increased consumer 
demand and thus a restoration of rapid economic growth. See C. Fred 
Bergsten, ``Can the United States Afford the Tax Cuts of 2001?'' 
American Economic Association, January 5, 2002.
---------------------------------------------------------------------------
    Such a situation would be reminiscent of what actually occurred in 
1984-1985. Even after the ``Reagan dollar'' had risen by about 25 
percent in 1981-1983, and already shifted the U.S. current account from 
balance in 1980 toward a deficit of over $100 billion, the dollar rose 
by another 25 percent or so in what all subsequent analysts have 
characterized as a purely ``speculative bubble.'' The Reagan 
Administration itself was then forced to engineer the Plaza Accord in 
September 1985 to drive the dollar down by more than 50 percent against 
the other main currencies by the end of 1987.
    There are of course those who doubt the effectiveness of sterilized 
intervention in the currency markets. Such a view ignores the fact that 
all three cases of intervention by the Rubin-Summers Treasury worked in 
textbook fashion. Joint United States-Japan intervention stopped and 
reversed the excessive strengthening of the yen in 1995. Similar 
intervention stopped and sharply reversed the excessive weakening of 
the yen in 1998. Joint U.S.-EU intervention in late 2000 stopped the 
slide of the Euro and prompted a 10 percent rebound. But the best 
evidence comes from the Administration itself: Why is it so afraid to 
alter the ``strong dollar'' mantra if it believes there would be no 
impact from doing so? Does anyone really think that the dollar would 
fail to decline toward a more desirable level if Secretary O'Neill and 
his G-7 colleagues were to start calling for such a correction? An 
effective alternative policy is clearly available.
    We also know that currency depreciation, supported by sound 
domestic policies, produces the desired changes in current account 
balances with a lag of 2 or 3 years. The large dollar decline of 1985-
1987, for example, led to virtual elimination of the U.S. current 
account deficit in the early 1990's. The sharp appreciation of the yen 
produced a similar correction in the Japanese surplus.
    Hence there is a strong case for a new U.S. policy toward the 
dollar. Virtually every sector of the economy is now calling for such a 
change, as indicated at this hearing: The business community through 
the National Association of Manufacturers, labor through the AFL-CIO, 
agriculture through the American Farm Bureau. Important parts of Wall 
Street, including former Fed Chairman Paul Volcker and the chief 
economist of Goldman Sachs, have issued similar calls. It is time for 
the Administration to change its policy toward the dollar, to improve 
the prospects for the U.S. economy and U.S. trade policy, and to reduce 
the risks of the much more severe adjustment that will inevitably 
hammer us later if it continues to ignore the problem.

                 PREPARED STATEMENT OF ERNEST H. PREEG

                Senior Fellow in Trade and Productivity
                  Manufacturers Alliance / MAPI, Inc.
                              May 1, 2002

    Thank you, Mr. Chairman, for this opportunity to appear before your 
Committee to address the impact of the dollar on the U.S. balance of 
trade, economic growth, and long-term economic stability. I will focus 
my presentation heavily on one particularly disturbing aspect of the 
trade deficit, namely currency manipulation to commercial advantage by 
some trading partners, and in particular by China, the nation with whom 
we have the largest and most lopsided trade deficit. To put this issue 
in broader context, however, I begin with brief comments on three basic 
concerns I have about the chronic and very large overall U.S. trade 
deficit.

Three Basic Concerns About the Trade Deficit
    The first, most immediate concern, is the impact of a larger trade 
deficit on U.S. economic recovery this year and next. The U.S. trade 
deficit was $345 billion in 2001, and could rise sharply to $400 
billion or more this year, as a result of a faster initial rate of 
economic recovery in the United States compared with our major trading 
partners and the time-lagged adverse trade impact of the strengthening 
of the dollar over the past 2 years. More than 80 percent of the 
deficit--in the order of $350 billion this year--will fall on the 
manufacturing sector, which has been hardest hit by the economic slump 
of the past 18 months. U.S. manufacturing industry, through new product 
innovation and capital investment, is the engine for overall growth in 
the U.S. economy, and a major increase in the trade deficit for 
manufactures could be the Achilles' heel for the hoped-for strong 
rebound in such productivity-enhancing investment and sustained overall 
growth.
    The second, somewhat longer term concern, is that the longer we 
maintain a trade deficit--or more precisely current account deficit--in 
the prospective order of 5-6 percent of GDP, the larger becomes the 
U.S. international debtor position, and the greater becomes the 
likelihood of a more disruptive ``hard landing'' for the dollar and the 
U.S. economy when the inevitable downward adjustment on trade account 
finally occurs. The chronic trade deficit has transformed the United 
States from the largest net creditor nation in the mid-1980's to the 
unprecedented largest net debtor nation approaching $3 trillion of net 
foreign debt today, projected to $5 trillion by mid-decade. There is 
near consensus that this foreign debt accumulation course is 
unsustainable and the question is rather how and when we will confront 
the point of unsustainability. I believe an earlier downward adjustment 
in the trade deficit--which would entail a depreciation of the dollar 
exchange rate by perhaps 10-20 percent--would be less disruptive and 
better for longer term economic stability, in the United States and for 
the world economy, than a prolonged further debt buildup until 
financial markets finally react against the dollar under the cloud of a 
$5 trillion U.S. foreign debt.
    My third and even longer term--but no less important--concern about 
the trade deficit and the consequent buildup of foreign debt is the 
social inequity we are imposing on our children and grandchildren. A 
current account deficit of $500 billion per year means we are living 
beyond our means by roughly 5 percent of GDP, mostly for immediate 
personal consumption and to a lesser extent for investment.\1\ This 
consumer binge is being paid for through foreign borrowing comparable 
to the current account deficit, and the resulting $3-$5 trillion 
buildup of foreign debt is being left to our children 
and grandchildren to service indefinitely or to pay off fully in 
principal. With a younger generation of Americans already concerned 
about paying rising Social Security and Medicare commitments to the 
current older generation, the foreign debt buildup is one more 
intergenerational income transfer being undertaken essentially by 
stealth.
---------------------------------------------------------------------------
    \1\ Actually, about 80 percent consumption and 20 percent 
investment. For a full explanation of this important yet often 
misunderstood relationship, see Ernest H. Preeg, The Trade Deficit, the 
Dollar, and the U.S. National Interest (Hudson Institute, 2000), 
Chapter 4; a briefer explanation by the author is in ``A rose-tinted 
view of the deficit,'' Financial Times, June 22, 2000.
---------------------------------------------------------------------------
    These are my three principal concerns about the trade deficit. As 
to what we can or should do to reduce the deficit, there are two 
principal remedies. The first is to increase domestic savings, thereby 
reducing the need to borrow abroad, about which there is more in the 
concluding section of this presentation. The second and more immediate 
way to reduce the trade deficit is to restrain others from 
``manipulating'' their exchange rates to commercial advantage.
U.S. Benign Neglect of Currency Manipulation by Others
    We currently have a predominantly floating exchange rate 
international financial system. The United States has a basically free 
float policy, with official market intervention rare and in only token 
amounts. The EU, Canada, and Mexico have similarly followed a free 
float during the past several years. Others, however, 
particularly in East Asia, implement a heavily managed float through 
large scale official purchases of foreign exchange, principally dollars, 
in order to keep their exchange rates lower than they would be subject 
to market forces alone, and consequently to push the dollar higher. 
This managed approach is ``mercantilist'' in that the objective is to 
maintain a large trade surplus as a matter of national policy, and the 
result for the United States is a trade deficit larger than it would 
be based on market forces alone.
    Article IV of the IMF Articles of Agreement states that members 
shall, ``avoid manipulating exchange rates to gain an unfair 
competitive advantage,'' and, under IMF surveillance procedures, a 
principal indicator of such manipulation is ``protracted large scale 
intervention in one direction in the exchange market.'' Protracted 
purchases of dollars by certain East Asian central banks would thus 
clearly qualify as currency manipulation, under the IMF definition, but 
the U.S. Treasury has rarely raised the issue, preferring a policy of 
benign neglect.
    Japan, the largest trade surplus nation in the world, is an 
outstanding example of such currency manipulation, with $250 billion of 
official foreign exchange purchases (almost all dollars) since 1995, 
including $33 billion in September and October 2001 alone when market 
forces were putting upward pressure on the yen. The yen, meanwhile, 
declined by 15 percent vis-a-vis the dollar during 2001. South Korea is 
another more recent example of such currency manipulation. The Korean 
central bank bought $9 billion of foreign exchange during 2001 while 
the nation recorded a $9 billion trade surplus. In effect, the central 
bank purchases entirely offset any upward pressure on the won from the 
trade surplus, and the Korean currency, in fact, depreciated 5 percent 
against the dollar during the year.
    This form of currency manipulation does not, of course, explain all 
of the strengthening of the dollar vis-a-vis these currencies in recent 
years, but currency traders know that the central banks involved will 
not let their currencies strengthen significantly, and therefore they 
hold back speculative purchases even when market conditions would 
otherwise indicate a currency appreciation. It is also noteworthy that 
the relevant indicators involved are net figures, whether for central 
bank intervention, trade flows, or capital market transactions, and on 
this basis the net purchases of foreign exchange by the Bank of Japan 
in recent years have probably held the yen at a significantly lower 
level than would have prevailed based on market forces alone. And 
consequently, Japan has likewise maintained a significantly larger 
trade surplus with the United States, especially in price-sensitive 
industries such as the automotive sector.

The Uniquely Powerful Chinese Currency Manipulation
    Chinese exchange rate policy is an important special case which 
spells currency manipulation in a different way. The Chinese currency 
has a fixed rate to the dollar but is nonconvertible on capital 
account. Over the past year, there has been a $25 billion trade 
surplus, a $45 billion net inflow of foreign direct investment--which 
also puts upward market pressures on the exchange rate--and over $50 
billion of central bank purchases of foreign exchange. In this case, 
the central bank purchases offset almost three-quarters of market-
generated upward pressure on the yuan from the trade surplus and the 
FDI inflow combined. Moreover, these official foreign 
exchange purchases may have been even larger except for an unfolding 
financial 
scandal involving billions of dollars of missing reserves.\2\
---------------------------------------------------------------------------
    \2\ See the Financial Times, January 16, 2002, ``Banker's fall 
throws spotlight on China's missing billions.''
---------------------------------------------------------------------------
    Based on the IMF definition, China has clearly been manipulating 
its currency for mercantilist purposes. The Bank of China has made 
protracted large scale purchases of foreign exchange--$150 billion 
since 1995--in order to maintain a large trade surplus as an offset to 
poor growth performance in the domestic economy. A direct measure of 
the manipulation is not possible because of the nonconvertible fixed 
exchange rate. There is no doubt, however, that if the central bank had 
not purchased $50 billion in 2001, there would have been strong upward 
pressures on the yuan in formal and informal markets. The bottom line 
is that the Chinese yuan is substantially undervalued and should 
certainly not be devalued as the Chinese government occasionally 
threatens to do.

The Benefits and Costs of Chinese Currency Manipulation
    The unique form of Chinese currency manipulation provides a mix of 
benefits and costs for China and for the United States. The most direct 
result is a larger trade surplus for China, which means more export-
oriented jobs in the Chinese economy. From the United States point of 
view, of course, it means a larger trade deficit with China and the 
loss of export-oriented and import-competing jobs. In 2001, United 
States imports from China were $102 billion, or more than five times 
larger than the $19 billion of United States exports to China.
    One problem for China in implementing currency manipulation through 
a fixed but nonconvertible exchange rate is that it creates 
breathtaking opportunities for official corruption, as noted above. A 
floating rate, however heavily managed, would do the manipulation job 
more efficiently, as it does for Japan, and China will, for this and 
other reasons, likely move in this direction as its economy becomes 
progressively more open to international trade and investment.
    Additional benefits to China from its cumulative purchase of 
foreign exchange accrue in other areas of foreign policy. With $220 
billion of ready cash in the central bank--far greater than any measure 
of ``adequate'' reserves for commercial purposes \3\-- Chinese purchases 
of weapons and other military equipment abroad, as regularly received 
from Russia, in particular, can be made without financial constraint.
---------------------------------------------------------------------------
    \3\ The World Bank rule of thumb for adequate reserves is 25 
percent of annual imports; China and Japan now have foreign exchange 
reserves of approximately 100 percent of annual imports.
---------------------------------------------------------------------------
    A similar conclusion can and should be drawn about China as an 
economic aid ``graduate.'' There is no longer any justification for 
China to receive several billion dollars per year in long-term loans on 
favorable terms from the World Bank, the Asian Development Bank, and 
some bilateral donors, when there are $220 billion of unutilized funds 
stashed away in the Central Bank. And yet the development banks 
continue to lend large sums to China!
    Another geo-economic advantage to China from its large reserves is 
the ability to offer concessionary trade and investment finance to 
other Asian nations, particularly in Southeast Asia, as a means of 
strengthening Chinese economic engagement in the region at the expense 
of the United States. Some first steps along these lines have been 
taken together with Japan, to weaken ``United States economic 
hegemony,'' and such trade-related incentives will likely be expanded 
in support of the recent Chinese initiative for a free trade 
arrangement with the Association of Southeast Asian Nations (ASEAN).
    Finally, and more speculatively, China at some future point could 
use its official dollar holdings as foreign policy leverage against the 
United States by threatening to sell large quantities of dollars on the 
market, or merely shift its reserves away from dollars and into Euros 
and yen. This will not happen anytime soon because the result would be 
a decline in the dollar and an adverse impact on Chinese 
exports. At some future point, however, if China were to become less 
dependent 
on exports to the United States for economic growth, such a threat 
could become 
credible. For example, the threat of substantial Chinese sales of 
dollars, with its implications for a disruptive decline in the dollar 
and the U.S. stock market, especially during a downward phase in the 
U.S. economy and/or an election year, could influence the course of 
U.S. policy toward Taiwan. Chinese military officers, in fact, in their 
studies of nonconventional defense strategies, include reference to 
George Soros and his attack on the British pound in 1992 as a template 
for disrupting a rival's (i.e., the United States) economic system.
    Thus, the Chinese currency manipulation is very real and 
substantial, with wide-ranging implications, and it deserves, as a 
policy response, something more than the total official neglect it has 
received up to this point.

A Long Overdue Policy Response
    The United States should adopt a clear and forceful strategy for 
reducing its chronically large external deficit. Indeed, such an 
initiative is long overdue.
    The first step in such a strategy would be to have frank 
discussions with major trading partners as to why it is a mutual 
interest to reduce current imbalances on current account. These 
consultations could take place within the G-7 finance ministers' 
framework and with key trading partners, including China, Mexico, and 
South Korea.
    The substance of the strategy should begin with a joint commitment 
to a free or very lightly managed floating exchange rate relationship, 
except for those nations engaged in full monetary union. Within this 
international financial framework, the macroeconomic response would be 
for the United States to take steps to increase its domestic savings 
while other, large trade surplus countries would take corresponding 
steps to increase domestic consumption. These domestic steps would 
force adjustment in the trade imbalances, in large part through 
downward movement of the dollar exchange rate.
    The U.S. policy objective for the exchange rate would consequently 
change from current categoric support for a strong dollar to a neutral 
reliance on market forces to establish the rate, with the expectation 
of some downward adjustment of the 
dollar in parallel with a declining trade deficit. Such a United States 
stated objective, in conjunction with complementary statements by major 
trading partners, would, in itself, likely lead to some decline in the 
dollar and the beginning of the trade adjustment process.
    Another immediate objective should be to restrain others from 
further currency manipulation to competitive advantage. This could be 
done through G-7 and bilateral discussions and, in parallel, more 
formal consultations within the IMF. The point of departure would be 
that nations with persistently large trade surpluses--and even more so 
if they have large FDI inflows as well--should cease official purchases 
of foreign exchange or any other actions that would maintain their 
currencies below market-determined levels. A joint announcement to this 
effect should further influence financial market behavior, with upward 
pressures on floating currencies that have recently been subject to 
substantial manipulation, such as the yen and the Korean won, and 
corresponding downward movement of the dollar.
    China, once again, is an important special case in view of its 
nonconvertible fixed rate to the dollar, and should thus be given a 
very high priority for bilateral consultations. The mutual interest in 
reducing the extremely lopsided bilateral trade account should be 
assessed in detail, starting with the question as to why China has such 
a large trade surplus with the United States and moderate trade 
deficits with most other trading partners. A United States request to 
China to cease official foreign exchange purchases and to adjust its 
fixed rate upward would define the immediate United States objectives. 
The longer term transition of China toward a fully convertible, 
floating rate relationship with the dollar should also be examined 
seriously, as a mutual interest, and as the best way to avoid trade 
conflict resulting from further unjustified Chinese currency 
manipulation.
                               ----------
                  PREPARED STATEMENT OF STEVE H. HANKE

                     Professor of Applied Economics
                        Johns Hopkins University
                              May 1, 2002

    Mr. Chairman, thank you for this opportunity to express my views on 
exchange rate policies. Commentary about exchange rate policies often 
originates in polemical, and more or less political, attempts at self-
justification. In consequence, the discourse is often confused and 
confusing. In an attempt to bring some clarity to the topic, I will 
begin by presenting some principles and characteristics of exchange 
rate regimes.

Exchange Rate Regimes
    There are three types of exchange rate regimes: Floating, fixed, 
and pegged rates. Each type has different characteristics and generates 
different results. Although floating and fixed rates appear to be 
dissimilar, they are members of the same family. Both are ``automatic'' 
free-market mechanisms for international payments. With a ``clean'' 
floating rate, a monetary authority sets a monetary policy, but has no 
exchange rate policy--the exchange rate is on autopilot. In 
consequence, the monetary base is determined domestically by a monetary 
authority. In other words, when a central bank purchases bonds or bills 
and increases its net domestic assets, the monetary base increases and 
vice versa. Whereas, with a fixed rate, a monetary 
authority sets the exchange rate, but has no monetary policy--monetary 
policy is on autopilot. In consequence, under a fixed-rate regime, the 
monetary base is determined by the balance of payments. In other words, 
when a country's official net foreign reserves increase, its monetary 
base increases and vice versa. With both of these free-market exchange 
rate mechanisms, there cannot be conflicts between 
exchange rate and monetary policies, and balance-of-payments crises 
cannot rear their ugly heads. Market forces automatically rebalance 
financial flows and avert balance-of-payments crises.
    Floating- and fixed-rate regimes are equally desirable in 
principle. However, floating rates, unlike fixed rates, have rarely 
performed well in developing countries 
because these countries lack (in varying degrees) strong independent 
institutions, 
coherent and predictable systems of governance and the rule of law. 
Accordingly, they cannot establish confidence in their currencies. 
Indeed, they usually lack either a sound past performance or credible 
guarantees for future monetary stability. In consequence, a floating 
currency usually becomes a sinking currency in a developing country.
    Fixed and pegged rates appear to be the same. However, they are 
fundamentally different. Pegged rates are not free-market mechanisms 
for international payments. Pegged rates (adjustable pegs, bands, 
crawling pegs, managed floats, etc.), require the monetary authority to 
manage the exchange rate and monetary policy simultaneously. With a 
pegged rate, the monetary base contains both domestic (domestic assets) 
and foreign (foreign reserves) components. Unlike floating and fixed 
rates, pegged rates almost always result in conflicts between exchange 
rate and monetary policies. For example, when capital inflows become 
``excessive'' under a pegged system, a monetary authority often 
attempts to sterilize the ensuing increase in the foreign component of 
the monetary base by reducing the domestic component of the monetary 
base. And when outflows become ``excessive,'' an authority attempts to 
offset the decrease in the foreign component of the base with an 
increase in the domestic component of the monetary base. Balance-of-
payments crises erupt as a monetary authority begins to offset more and 
more of the reduction in the foreign component of the monetary base with 
domestically created base money. When this occurs in a country with free 
capital mobility, it is only a matter of time before market participants 
spot the contradictions between exchange rate and monetary policies and 
force a devaluation. Table 1 summarizes the main characteristics and 
results anticipated with floating, fixed, and pegged exchange rates, when 
free capital mobility is allowed.

The Evolution of U.S. Exchange Rate Regime Policies
    If a country adopts a fixed exchange rate regime (either an 
orthodox currency board \1\ or official ``dollarization'') and allows 
free capital mobility, it must give up monetary autonomy. 
Alternatively, if a country wants monetary autonomy and free capital 
mobility, it must adopt a floating exchange rate. If a country has a 
pegged exchange rate, it must restrict capital mobility to avoid 
balance of payments and currency crises.
---------------------------------------------------------------------------
    \1\ Contrary to the popular impression, Argentina's convertibility 
system was not an orthodox currency board. Some students of currency 
board systems pointed this out almost a decade ago. They anticipated 
that Argentina's convertibility system would eventually degenerate into 
a pegged exchange rate system and that it would blow up. See Steve H. 
Hanke, Lars Jonung and Kurt Schuler, Russian Currency and Finance: A 
Currency Board Approach to Reform. London: Routledge, 1993, pp. 72-77.
---------------------------------------------------------------------------
    Over the past decade, the advantages of free capital mobility have 
become clear, and restrictions of capital mobility have been 
dramatically reduced. However, most developing countries have continued 
to employ some variant of pegged exchange rates. And not surprisingly, 
major balance of payments and currency crises have 
occurred frequently in the 1990's.
    In a world of increasing capital mobility, the U.S. Government had 
no coherent policy on exchange rates until the late 1990's. Motivated 
by criticism from a small group of economists (including myself ), 
Former Senator Connie Mack's campaign for official dollarization in 
countries with low quality currencies, and the fallout from the 
currency crises that engulfed Mexico, Asia, and Russia, the U.S. 
Treasury finally produced a clear policy statement on exchange rate 
regimes. Given that the U.S. embraces free capital mobility, Treasury 
Secretary Robert Rubin correctly concluded, in a speech made at The 
Johns Hopkins University on April 21, 1999, that either floating or 
fixed exchange rates were acceptable, but that pegged rates were not. 
And shortly after Lawrence Summers became Treasury Secretary, he 
presented the same policy conclusions at an address he delivered at 
Yale University on September 22, 1999. Stanley Fischer, the Former 
Deputy Managing Director of the International Monetary Fund, weighed in 
with the same message, when he delivered the Distinguished Lecture on 
Economics in Government at the annual meeting of the American Economic 
Association in New Orleans on January 6, 2001.
    With these policy pronouncements, the U.S. Treasury's (and the 
IMF's) position on exchange rates became clear. In principle, the 
position was correct. In practice, it was (and continues to be) applied 
correctly in the case of the U.S. dollar, where a floating exchange 
rate regime continues to be embraced. In developing countries, however, 
the United States and the IMF have not adhered to the position with any 
rigor. For example, Brazil and Turkey were both given the green light 
to continue or establish pegged exchange rate regimes shortly after 
U.S. officials indicated that these set-ups were, in principle, 
unacceptable.
    The Bush Administration has not yet articulated a clear policy on 
exchange rate regimes. Secretary O'Neill would do well to clear the air 
and make a statement along the same lines as Messrs. Rubin and Summers. 
Indeed, since the United States espouses free capital mobility, the 
only logical course is for U.S. policy to embrace floating rates or 
fixed rates (orthodox currency boards or official dollarization), and 
to reject pegged rates. With the departure of Stanley Fischer, the 
IMF's position on exchange rate regimes has become fuzzy. Anne Krueger, 
Fischer's successor, would do well to follow his lead and reaffirm 
Fischer's conclusions.

The ``Strong'' Dollar Mantra
    The exchange rate--the nominal exchange rate quoted in the market--
is a price. With a floating exchange rate policy, the price freely 
adjusts to changes in individuals' and business' expectations about 
conditions here and abroad. The dollar broadly strengthened against 
other currencies after the mid-1990's because market participants 
expected to receive higher rates of return on their investments in the 
United States than abroad. For example, consider for a moment the fate 
of the Euro versus the dollar since the Euro's launch on January 1, 
1999. Then, the exchange rate was 1.17 dollars per Euro; today it's 
about 0.90. The dollar strengthened by 30 percent against the Euro 
primarily because market participants anticipated brighter prospects 
and higher rates of return in the United States than in Euroland, and 
capital flowed out of Euro-denominated assets into equities, bonds, and 
other U.S. investments.
    This brings me to the ``strong dollar'' mantra. This rhetorical 
phrase, which was prompted by the dollar's broad strength in the 
markets, is unfortunate and confusing, at best. The combination of a 
floating exchange rate and the pursuit of low inflation, which the 
United States has had for many years now, is a policy. The ``strong 
dollar'' is not. Indeed, given a floating exchange rate regime, it is 
impossible to know what a so-called strong dollar policy is because the 
price of the dollar on foreign-exchange markets is on autopilot. The 
price is (or should be) determined by buyers and sellers, and U.S. 
Government officials should refrain from trying to influence it by 
``open-mouth operations.'' As long as the United States embraces a 
floating exchange rate policy, the Treasury Secretary should strike the 
term ``strong dollar'' from his lexicon when engaging in discourses 
about exchange rate policies. The phrase ``strong dollar'' is 
meaningless and leads to no end of confusion.
The Dollar's Dominance
    So under a floating-rate policy, one in which the dollar's price is 
on autopilot, what can be said about the dollar? We can say that the 
dollar is the world's dominant currency, more so with each passing 
year.
    Consider some facts about the U.S. dollar and its role in the 
world's monetary affairs. Thanks to its stability, liquidity and low 
transactions costs, the dollar occupies a commanding role. It is the 
world's dominant international currency, a unique feature that gives 
the United States an edge in attracting capital inflows to finance 
current account deficits at a relatively low cost. This prompted 
Charles de Gaulle, when he was President of France, to characterize the 
benefits derived from the 
dollar's dominant position as an ``exorbitant privilege.'' \2\
---------------------------------------------------------------------------
    \2\ I thank Fred Bergsten for reminding me of de Gaulle's astute 
observation.

 Ninety percent of all internationally-traded commodities are 
    invoiced and priced in dollars.
 The invoicing and pricing of manufactured goods in 
    international trade presents a much more complicated picture. The 
    dollar, however, dominates. For example, 37 percent of the United 
    Kingdom's exports to Germany are invoiced in dollars, not Euros or 
    Sterling.
 The dollar is employed on one side of 90 percent of all 
    foreign exchange transactions.
 Over 66 percent of all central bank reserves are denominated 
    in dollars, and that percentage has been steadily increasing since 
    1990.
 The second most popular hand-to-hand currency used by 
    foreigners is the dollar, with their own domestic currencies in 
    first place. That explains why an estimated 50-70 percent of all 
    dollar notes circulate overseas.
 The dollar is the second most popular denomination used by 
    foreigners for on-shore bank accounts, with their domestic unit of 
    account usually in first place. 
    According to the IMF, the average ratio of dollar-denominated bank 
    accounts to broad money in highly dollarized countries is 0.59, and 
    for moderated dollarized countries, the ratio is 0.18. Not 
    surprisingly, the dollar is the king of off-shore bank accounts.
 Fifty percent of the internationally-traded bonds are 
    denominated in U.S. dollars.
 The dollar also dominates the world's equity markets, with 60 
    percent of the capitalized value of all traded companies in the 
    world denominated in dollars. And that is not all. Capital markets 
    throughout the world are rapidly shifting into dollars. To lower 
    their cost of capital, foreign companies are beating a path to the 
    New York Stock Exchange and Nasdaq, which of course both trade in 
    dollars. Many traditional foreign companies now issue American 
    Depositary Receipts in New York. These ADR's, representing claims 
    on shares in foreign companies, are traded in dollars, and 
    dividends are paid in dollars. For example, 58.7 percent of the 
    total capitalization of all traded Latin American companies is 
    denominated in dollars, and for the two largest Latin economies, 
    Brazil and Mexico, the dollarized percentages are 69.9 percent and 
    42 percent, respectively.

    All this boils down to a simple fact: The world is already highly 
and unofficially dollarized. And unless the quality of the dollar 
deteriorates, that is the way things will stay. If more countries with 
low-quality currencies would officially replace their domestic currencies 
with the dollar, the competitive devaluations that so many 
fret about would come to an abrupt halt. And exchange rate crises that 
frequently engulf countries with half-baked currencies would be a thing 
of the past. After all, countries that are officially dollarized do not 
have an exchange rate vis-a-vis the dollar.

The Dollar's Price

    The dollar's strength against major currencies since 1995 and 
particularly since the start of 2000 has persuaded many, particularly 
the dollar bears, that the dollar's price is too ``high'' and 
unsustainable. The dollar's ``high'' price has also generated 
predictable howls from those who assert that the ``strong dollar'' has 
made their businesses uncompetitive and squeezed their margins.

    Just how ``high'' is the dollar's price? It depends on how you 
measure it. If we use the Federal Reserve's broad dollar index or IMF's 
dollar index, it appears that the dollar is at a ``high'' level and 
perhaps not sustainable (see Chart 1). However, if we use ABN-AMRO's 
trade-weighted dollar index, the dollar does not appear to be as 
``strong'' as many believe. The weighting used by ABN-AMRO is more 
representative of the realities (see Table 2). Indeed, ABN-AMRO's 
dollar index more accurately reflects the dollar's trade weighted price 
than do either the IMF's or the Fed's dollar indexes.\3\ Perhaps that 
explains why the dollar bears have been disappointed so often in the 
past few years: They have been looking at the wrong indexes.

    \3\ The ABN-AMRO index is based on the Fed `broad' index weighting 
system. To avoid creating an unwieldy index and to reduce 
susceptibility to potential distortions from sharp fluctuations in 
nominal values in developing economies, the ABN-AMRO index does not 
explicitly include weights for minor U.S. trading partners. It does, 
however, include weights for medium-sized trading partners such as the 
UK, Mexico, China, Hong Kong, and Malaysia.

    Yet another way to look at the dollar indexes, which are 
constructed by a few 
experts, is through the lens of the Austrian School of Economics. As 
Friedrich von Hayek, a leader of the Austrian School, observed, the 
most important function of a market is to process widely dispersed bits 
of information from many market participants to generate an easily 
understood metric--a price. Not surprisingly, the judgments of many 
market participants, who are putting real money at risk, are deemed to 
be more important, as they should be, than artificial constructs 
produced by a small group of experts. Accordingly, the dollar's price 
is where buyers and sellers agree it should be. To the extent that the 
dollar's price is too ``high'' simply means that the consensus of the 
many market participants differs from the few who are in the business 
---------------------------------------------------------------------------
of constructing artificial indexes.

    Under a floating exchange rate regime, the future course of the 
dollar will be determined by expectations about prospective rates of 
return in the United States and overseas, as well as the risks 
involved. Judgments about future returns and risks are, of course, 
difficult and highly dependent on, as Lord Keynes put it, the state of 
confidence. In this respect, all we know is that the United States 
engaged in a new, long war against an elusive enemy which will consume 
meaningful real resources, eventually becoming a drag on productivity. 
This suggests that capital flows to the United States (as evidenced by 
recent data), might not be as forthcoming in the future as they were 
during the past few years. If that is the case, the floating dollar 
will weaken in the markets and market forces will automatically cause 
those ``troubling'' U.S. current account deficits to shrink.

    In closing, under floating rates, the less said in Washington, DC 
about the level and course of the dollar's price, the better. After 
all, under floating, the dollar's exchange rate is on autopilot. Alas, 
this is probably asking for too much. When it comes to exchange rates 
and adjustments in the balance of payments, many of the cognoscenti in 
Washington have a distaste for automaticity. For them, the consequences 
of a country's balance of payments should not spread themselves out 
inconspicuously in time and scope. Instead, they should remain 
concentrated and visible as a signal for policy changes and as a pivot 
for expert consultations.





         RESPONSE TO WRITTEN QUESTION OF SENATOR AKAKA 
                      FROM PAUL H. O'NEILL

Q.1. This week the Associated Press reported that the Treasury 
Department would borrow one billion dollars instead of retiring 
$89 billion of the national debt, which had been projected in 
January. This was the first time since 1995 that the Government 
needed to borrow money in the April- June quarter. Three-
quarters of the increase in borrowing was due to lower-than-
expected tax revenue. In the fourth quarter of last year, 
foreign investors purchased $33.3 billion in U.S. Treasury 
Securities. This debt adds to the current account deficit. What 
are the impacts of the Federal budget deficit and the tax cuts 
enacted last year on the current account deficit?

A.1. There is no direct connection between the Federal budget 
and current account deficits. The current account reflects the 
balance between savings and investment in the economy. This 
fiscal year's Federal deficit is related to the recent downturn 
in the U.S. economy and the spending requirements of the war on 
terrorism. The deficit is not large by international standards. 
The decline in revenue that naturally occurs during cyclical 
downturns, and the 
Administration's tax cuts, were critical in stimulating the 
timely 
recovery of the U.S. economy, and ensuring that the recent 
recession was among the mildest and shortest on record.

       RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING 
                     FROM RICHARD L. TRUMKA

Q.1. What happens if the Secretary decides to ``talk down'' the 
dollar, but foreign investors still look at our economy as the 
strongest in the world and the best return for their 
investment? Won't the foreign investors still send their money 
here, and keep the dollar at a high rate against other 
currencies?

A.1. That foreigners view the U.S. economy as the strongest in 
the world is a strength and advantage to us. That said, it is 
still possible for the dollar to get out of alignment owing to 
speculative pressures, and there are many empirical measures 
that show the dollar is overvalued today.
    Foreign investor attitudes toward the United States are one 
reason for the high value of the dollar. But equally important 
is Treasury's policy toward the dollar. By constantly talking 
about a ``strong dollar,'' and by failing to speak out against 
the many countries who intervene to keep their currencies low 
in order to gain competitive advantage, the Treasury has 
encouraged speculators to think that they face a ``one way 
bet.'' That is, the dollar will remain strong and other 
currencies will remain weak. This policy must end, and ending 
it is fully consistent with the United States 
remaining an attractive place for foreign investment.

Q.2. If the Treasury went to an aggressive policy to lower the 
dollar, it would raise import prices for the consumer. Would we 
not risk increased inflation under such a scenario?

A.2. There are three reasons to discount the ``inflation risk'' 
scenario:
    First, a lower dollar will cause import prices to rise 
slightly because foreign firms pass through part of the 
exchange rate change. But that need not translate into damaging 
generalized price inflation. Most U.S. manufacturing firms have 
massive excess capacity and stand ready to step into the breach 
and fill the gap left by importing firms. As a result of this 
substitution, the net impact on inflation and consumers stands 
to be quite moderate. Moreover, any increase in import prices 
will be a one-off increase, and therefore will not generate 
continuing inflation.
    Second, the current environment is one of very low 
inflation, bordering on deflation. At these levels, even if a 
small increase in inflation were to materialize it might 
actually be a good thing by pushing the economy away from a 
deflation--which is economically disastrous in an environment 
where business and firms are heavily indebted.
    Finally, an important consideration is that the real issue 
is ``dollar adjustment now'' versus ``dollar adjustment 
later.'' It is widely agreed that the dollar and the trade 
deficit are unsustainable at current levels. Doing nothing 
risks a damaging and painful adjustment down the road, and in 
the meantime the overvalued dollar will have hollowed out our 
manufacturing sector, destroyed good manufacturing jobs, and 
undermined our economic recovery. A better strategy is to 
manage the adjustment, avoid the damaging economic effects of 
delay, and avoid a possible financial crash that might occur 
when markets ultimately decide to correct.

       RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING 
                    FROM JERRY J. JASINOWSKI

Q.1. What happens if the Secretary decides to ``talk down'' the 
dollar, but foreign investors still look at our economy as the 
strongest in the world and the best return for their 
investment? Won't the foreign investors still send their money 
here, and keep the dollar at a high rate against other 
currencies?

A.1. The fundamental force which drives investment flows is 
access to developed and thriving markets. And with the 
expectation that productivity growth (the main driver behind a 
sustainable growth and increased living standards) will 
continue to be robust in coming years, there is no doubt that 
the United States will continue to be an attractive market for 
worldwide investment. While this outlook does not support a 
weak dollar, it also does not support a dollar 30 percent above 
its level in 1997--a level reach in February 2002. The record 
actually shows that investment inflows do not react to changes 
in the dollar--but rather to changes in the outlook for the 
economy.
    Capital will continue to flow into the United States as the 
dollar returns to normal, and, in fact, direct investment 
inflows may actually increase. That is what happened after the 
1985 correction of the dollar. During 1985 -1987 the dollar 
fell 40 percent--returning to normal levels prevailing prior to 
1985. During the time the dollar was appreciating--up until 
mid-1985--foreign direct investment into the United States 
averaged $4.5 billion per quarter. But after the dollar started 
to fall, direct investment inflows nearly tripled, to $12.3 
billion per quarter. Why? Because the dollar's return to 
normalcy made the United States a better place to invest.

Q.2. If the Treasury went to an aggressive policy to lower the 
dollar, it would raise import prices for the consumer. Would we 
not risk increased inflation under such a scenario?

A.2. Certainly a declining dollar will put some upward pressure 
on prices, for we have been having a free ride for several 
years while the dollar became increasingly overvalued. The 
adjustment, however, will be mild. According to NAM estimates 
based on the widely-used Washington University Macro Model, a 
15 percent dollar devaluation over the next year and a half 
would only result in a one-time increase in the GDP deflator 
(the widest measure of prices in the U.S. economy) of less than 
1 percent.
    This is because inflation has been held down principally by 
the high productivity growth of U.S. industry--especially 
manufacturing. Declining import prices for consumer goods have 
actually not had that much of an inflation-restraining impact. 
Bureau of Labor Statistics data show that despite the 30 
percent rise in the dollar since 1997, consumer goods import 
prices have fallen only 6 percent. Part of the explanation for 
this is in the fact that a significant proportion of consumer 
goods imports come from China, whose currency has remained 
pegged to the dollar. Additionally, a significant part of the 
consumer price index is related to energy imports, and these 
are denominated in dollars--thus being impervious to 
fluctuations in the value of the dollar.
    Import prices for capital goods, however, have fallen 25 
percent, which has put U.S. capital goods industries at an 
enormous disadvantage. As the prices of these imports rise, we 
would anticipate a shift back to U.S. production and a reduced 
rate of import growth. Inflation will also be restrained by the 
huge capacity overhang in the U.S. economy. Federal Reserve 
Board data shows capacity utilization to be extremely low--less 
than 75 percent. This makes it very difficult to raise prices, 
showing that this is actually a good time for the dollar to 
decline to more normal levels. The worst time for the dollar to 
decline would be during a period of overheated boom.
    A mild inflationary response to a dollar devaluation is 
supported not only by econometric modeling, but also by 
history. After a sharp appreciation in the early 1980's, the 
dollar fell by 40 percent in 2 years starting in mid-1985. 
While a strengthening dollar played a role in bringing down 
inflation, which was running near double digits in the early 
1980's to a more moderate 3.1 percent by 1985, no significant 
pickup in inflation accompanied the 1985-1987 correction. In 
fact, between 1986 and 1988, the inflation rate actually 
averaged 0.3 percentage points lower than the inflation rate at 
the height of the dollar's peak in 1985.
    Thus, while a weak or devaluing dollar falling to 
abnormally low levels may cause inflation, the evidence 
indicates that a dollar declining to normal levels has little 
inflationary impact.

       RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING 
                       FROM BOB STALLMAN

Q.1. What happens if the Secretary decides to ``talk down'' the 
dollar, but foreign investors still look at our economy as the 
strongest in the world and the best return for their 
investment? Won't the foreign investors still send their money 
here and keep the dollar at a high rate against other 
currencies?

A.1. The American Farm Bureau Federation (AFBF) does not favor 
the Secretary either ``talking up'' or ``talking down'' the 
value of the dollar. We also recognize the importance of 
maintaining a vibrant economy, one that attracts ample foreign 
investment. It is equally important to ensure that all sectors 
of the U.S. economy have the opportunity to thrive in a manner 
that is not impaired by an overvalued dollar.
    The strong dollar is severely affecting sectors, like 
agriculture, that are highly dependent on exports. For this 
reason, we support a Congressionally mandated study of the 
impact of the value of the dollar on the U.S. economy. Such a 
study should take into account the ability of the United States 
to attract foreign investment and not only maintain, but also 
increase, exports.

Q.2. If the Treasury went to an aggressive policy to lower the 
dollar, it would raise import prices for the consumer. Would we 
not risk increased inflation under such a scenario?

A.2. AFBF does not support pursuing an aggressive policy to 
lower the dollar. Such a policy is not likely to be effective 
in today's technology-based global economy wherein massive 
intervention would be required, but would not have long lasting 
effects. We remain concerned, however, with the actions taken 
by some U.S. trading partners to intervene repeatedly in 
international exchange markets in a concerted attempt to 
devalue their currencies vis-a-vis the dollar and believe that 
the United States should respond to these currency manipulation 
attempts by other countries.
    AFBF believes that the value of the dollar should be set by 
the market without interference by either our Government or a 
foreign government trying to manage the dollars value it to 
achieve a certain economic outcome.
    Thank you very much for the opportunity to clarify our 
position on this issue.

       RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING 
                      FROM ERNEST H. PREEG

Q.1. What happens if the Secretary decides to ``talk down'' the 
dollar, but foreign investors still look at our economy as the 
strongest in the world and the best return for their 
investment? Won't the foreign investors still send their money 
here, and keep the dollar at a high rate against other 
currencies?

A.1. The phrase ``talk down'' is ambiguous. If it implies 
follow-up actions, such as large and persistent United States 
official financial market intervention to bring the dollar rate 
down below a market-based rate (as do Japan and China, for 
example), such a statement would make foreign investors 
hesitate in anticipation of such a ``manipulated'' lower 
dollar. I oppose such a talk down/intervention strategy, and I 
do not believe Secretary O'Neill has any intention of doing so. 
If, in contrast, ``talk down'' simply means a personal 
assessment by the Secretary that market forces are likely to 
lead to a lower dollar, related to the unsustainability of the 
record trade deficit, investors would likely maintain their 
existing assessment as to whether the U.S. economy offered the 
best rate of return on their investments.

Q.2. If the Treasury went to an aggressive policy to lower the 
dollar, it would raise import prices for the consumer. Would we 
not risk increased inflation under such a scenario?

A.2. If the dollar declined for any reason, import prices would 
rise for the consumer, and there would be some corresponding 
rise in the overall rate of inflation. In the context of a 10-
20 percent decline in the dollar, however, it would be a 
relatively small, one-time upward blip in the inflation trend.

       RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING 
                      FROM STEVE H. HANKE

Q.1. What happens if the Secretary decides to ``talk down'' the 
dollar, but foreign investors still look at our economy as the 
strongest in the world and the best return for their 
investment? Won't the foreign investors still send their money 
here, and keep the dollar at a high rate against other 
currencies?

A.1. If the Secretary decides to ``talk down'' the dollar, 
which I believe would be imprudent, net financial flows that 
favor the United States would be disrupted temporarily and the 
dollar would probably weaken temporarily. But if rates of 
return on capital, adjusted for risk, are anticipated to be 
superior in the United States, net financial flows will 
continue to favor the United States. Given that the United 
States has a floating exchange rate regime, the value of the 
dollar is determined in the market. It is on autopilot. 
Accordingly, under the scenario sketched above, the current 
account deficit as a percent of GDP will continue to increase 
and so will the dollar's nominal exchange rate. This should not 
be cause for alarm. It would simply be a reflection of the 
superior underlying economic fundamentals in the United States 
vis-a-vis those in the rest of the world.

Q.2. If the Treasury went to an aggressive policy to lower the 
dollar, it would raise import prices for the consumer. Would we 
not risk increased inflation under such a scenario?

A.2. On the assumption that the U.S. Treasury possesses the 
policy levers to aggressively lower the value of the dollar--a 
highly questionable assumption--and that these bear fruit, the 
dollar would weaken and import prices would rise for the 
consumer. And, yes, inflation would be higher than would 
otherwise be the case. This set of events would tend to 
motivate the Federal Reserve to attempt to fight inflation with 
higher short-term interest rates. This would bring forth howls 
of protest from those who advocate an aggressive Treasury 
policy to lower the value of the dollar because many of the 
``weak dollar'' advocates also tend to embrace ``low'' 
interest rate policies.
                       PREPARED STATEMENT OF THE 
                  AMERICAN FOREST & PAPER ASSOCIATION
                              May 1, 2002
    The American Forest & Paper Association (AF&PA) appreciates the 
opportunity to comment on how U.S. exchange rate policies are 
negatively impacting the forest products industry. The wood and paper 
products business is highly sensitive to exchange rate fluctuations. 
The Committee's long-term engagement on this issue has been helpful in 
focusing attention on trade and exchange rate linkages and their 
effect on the global competitiveness of the U.S. economy. Our statement 
today will recommend additional measures which, we believe are 
necessary to correct unsustainable trade and exchange rate imbalances--
and restore the ability of American manufacturing to fuel U.S. economic 
growth.
    AF&PA is the national trade association representing the forestry, 
pulp, paper, paperboard and wood products industry in the United 
States. This industry accounts for approximately 7 percent of total 
U.S. manufacturing output and employs approximately 1.5 million people 
in 42 States, with an annual estimated payroll of $64 billion. Industry 
sales exceed $250 billion annually in the United States and 
export markets. AF&PA's membership encompasses the full spectrum of 
U.S. businesses ranging from small family owned manufacturing and tree 
farm businesses to large integrated companies.
    Many of the leading economists, including several represented at 
today's hearing, believe the U.S. dollar is currently overvalued 
relative to a basket of major currencies--and that the extent of the 
imbalance is somewhere around 25-30 percent. We agree that it is 
substantial.
    At these levels, U.S. industry is, in effect, paying a 30 percent 
``overvalued dollar tax'' on all shipments--whether they are going to 
foreign or domestic customers. Few U.S.-based producers can compete for 
long under those circumstances. Just a few of the devastating effects 
of this ``tax'' are described in the following examples:

 Our companies have had to exit export markets they have served 
    for decades. For example, United States kraft linerboard exports to 
    Europe have plunged by 48 percent in the 1997-2001 period, to 
    $207.6 million. At the same time, U.S. hardwood exporters have lost 
    key European markets based solely on the price differential caused 
    by the value of the dollar. The U.S. product is of a higher quality 
    and its delivery is more reliable than other competitors who are 
    now taking market share based on price alone. And, new Eastern 
    European production facilities are now being constructed to ensure 
    that U.S. manufacturers do not retake that market share when the 
    Euro-dollar exchange rate returns to balance.

 Simultaneously, competitors have been taking advantage of 
    their relatively cheap currencies to capture an ever-widening share 
    of the U.S. domestic market. Over the period 1997-2001, United 
    States imports of European coated printing paper soared by 50 
    percent, to $730.6 million. In the 1997-2000 period, imports took 
    more than 90 percent of the growth in the U.S. paper market. 
    (Exhibit 1)

 Similarly, the wood products sector has also been battered by 
    cheap imports, which has resulted in a ripple effect across 
    manufacturing interests. The domestic furniture industry, one of 
    the largest traditional users of hardwood lumber and veneer, has 
    been contracting rapidly as a result of substantial lower priced 
    furniture imports. (Exhibit 2)

 As a result, the U.S. net imports of paper and of wood 
    products have more than 
    doubled from a negative $6 billion in 1997 to a negative $13.6 
    billion last year. 
    (Exhibit 3)

    During this period, none of the factors which shape the underlying 
competitiveness of the U.S. forest products industry have changed--
except the value of the 
dollar. On the contrary, our companies have scrapped uneconomic 
capacity and 
upgraded technology to significantly improve competitive performance. 
Nevertheless, a report by Salomon-Smith-Barney states that the exchange 
rate is robbing U.S. paper companies of their long-held competitive 
advantage vis-a-vis European producers. (Exhibit 4) The report further 
states that companies will not return to profitability unless and until 
exchange rates are adjusted to more appropriate levels.
    The combined effect of weakening export markets and surging imports 
has put unprecedented downward pressure on paper and wood product 
prices. Faced with this kind of challenge, the only option available to 
many of our companies is to close mills. Since 1997, American paper 
companies have had to close 72 mills or an average of 14 mills per 
year-- compared to an average of less than four in the early 1990's. 
(Exhibit 5) Employment at paper industry mills has declined by 32,000 
jobs since 1997. (Exhibit 6) In the last year alone, more than 20 wood 
processing facilities with a capacity of 1.7 billion board feet were 
shutdown permanently. In the last 3 years, the wood sector has lost 
51,000 jobs. (Exhibit 7) These were high paying jobs in rural 
communities where wood and paper manufacturing mills serve as the 
backbone of small-town economies.
    Data prepared by the National Association of Manufacturers (NAM) 
shows an estimated 500,000 jobs lost since mid-2000 as a result of the 
drop in manufactured goods exports. This job loss was principally due 
to the overvalued dollar and makes clear that this pattern is not 
unique to the forest products industry but is repeated in sectors as 
diverse as automobiles, aerospace, steel, textiles, and machine tools 
to name a few.
    Looking ahead, there are no signs of future improvement. U.S. 
producers of wood and paper products are closing capacity here in the 
United States while foreign competitors--especially in Europe and East 
Asia--are rapidly building more, often with their government's 
financial support.
    The real long-term danger is a hollowing out of American industry 
as a result of the persistence of an overvalued dollar. This is what 
adds a compelling urgency to our call for action today.
    The American Forest & Paper Association supports policies that 
encourage exchange rates to be set by market fundamentals. But, when 
other countries are 
purposely taking action to keep their currencies artificially low, the 
United States must step in to ensure that the dollar is not overvalued 
as a result of these nonmarket actions by foreign governments. We 
believe U.S. exchange rate policy must address two major sources of 
dysfunction in currency markets:

 A widespread perception in exchange rate markets that there is 
    no upper boundary to United States support for the dollar.

 Manipulation of currencies by U.S. trading partners for 
    competitive advantage.

    In currency markets, rhetoric matters. The statements by U.S. 
Treasury officials 
indicating a totally hands off attitude toward the value of the dollar 
have resulted 
in a widespread belief that there is no point at which the U.S. 
Government will 
consider taking any action to stop the rise. Signals from the U.S. 
Treasury that it 
supports a sound dollar consistent with the competitive fundamentals of 
the U.S. economy would go a long way toward erasing the current 
expectation that the dollar will continue to rise in value.
Currency Manipulation
    Ambassador Ernest Preeg has provided solid empirical evidence of 
currency manipulation by U.S. trading partners--and its effect on the 
U.S. economy. In a recent 12 month period, East Asian economies had a 
cumulative current account surplus of $218 billion, while their central 
banks together added an aggregate $165 billion in foreign exchange 
reserves. Japan alone has accumulated $95 billion in foreign 
reserves. This means that about three-quarters of the net foreign 
exchange inflow 
resulting from Asian current account surpluses was taken off the market 
through central bank purchases, with the result of lower exchange rates 
and larger trade surpluses than otherwise would have been the case. The 
dollar share of the aggregate foreign reserve accumulation was 
estimated at 80 to 90 percent.
    Japanese officials also have been actively talking down the yen. In 
recent months, China has become more outspoken in calling attention to 
the effect Japanese policies could have on the global economy, by 
triggering a race to the bottom among key Asian countries that compete 
with Japan for export markets.
    Provisions in the Trade Act of 1988 requiring surveillance of 
exchange rate policies by U.S. trading partners have undoubtedly had a 
positive effect in addressing more egregious practices. However, the 
data cited above make it clear that further action is needed. The 
Senate version of Trade Promotion Authority recognizes that significant 
or unanticipated changes in exchange rates can negate U.S. market 
access gains in trade agreements. The legislation provides for the 
establishment of consultative mechanisms among parties to trade 
agreements to protect against currency manipulation by foreign 
governments. We believe this step is necessary to ensure that, in 
future trade agreements, the balance of benefits USTR negotiates--and 
the U.S. Congress approves--cannot be upset by subsequent exchange 
rate manipulation. We strongly support this provision of the bill.

G-8 Collaboration
    Concerted action by major economies worked in 1985 with the Plaza 
Accord and we believe it can work again today. The G-8 meeting in 
Canada next month offers an opportunity for action to address the twin 
imbalances--the overvalued U.S. dollar and the U.S. trade deficit--
which are widely recognized as posing a major threat to global economic 
stability. Indeed, the just released IMF World Economic Outlook 
concluded that the overvaluation of the U.S. dollar and the large U.S. 
current account deficit pose significant risk to the sustainability and 
durability of the incipient economic upturn, both in the United States 
and globally. There are also mounting indications that some of our 
trading partners share this concern about trade and currency 
imbalances, and might be prepared to work with us to ensure a ``soft 
landing'' which minimizes the real economic pain associated with an 
unmanaged or ``hard landing'' adjustment.
    Such a concerted approach, combined with enhanced Trade Promotion 
Authority provisions, would improve the prospects for long-term market-
sustainable exchange market rate equilibrium.
    Agreement on a joint plan of action would represent a substantial, 
positive G-8 outcome. Alternatively, failure to deal with the issue at 
the G-8, in the face of the clear warning signals, risks exposing the 
still fragile United States and the global economic recovery to an 
unpredictable and potentially unmanageable market adjustment.

The Time for Action is Now
    There is a striking similarity between the situation in 1985 and 
today in terms of the impact of the overvalued dollar on the U.S. 
economy and the forest products industry's trade balance. But there is 
also an important difference: Today, the U.S. economy is more dependent 
on trade than ever before. An indication of this is that U.S. trade 
exposure (i.e., total imports and exports) was 17 percent of GDP in 
1985, while today it accounts for 24 percent. The forest products 
industry reflects this trend as well. In 1985, the trade exposure for 
paper was 23 percent, but reached 33 percent in 2001. (Exhibit 8)
    Notwithstanding the challenges of the past year, the American 
economy is sound. There are increasing signs that the economy is coming 
out of recession. The incipient recovery will not thrive without a 
robust and sustainable rebound in U.S. manufacturing. For the U.S. 
forest products and other manufacturing industries, this will require 
exchange rate policies which ensure that the value of the dollar is 
consistent with the underlying economic fundamentals. It will also 
call for action to prevent future currency misalignment, which rob our 
companies of the competitiveness they and their workers have built.
    We appreciate the opportunity to present these views and look 
forward to working with the Committee and the Administration in 
reaching solutions that will ensure a strong and vibrant U.S. forest 
products industry.



















                       PREPARED STATEMENT OF THE
            AMERICAN TEXTILE MANUFACTURERS INSTITUTE (ATMI)

                              May 1, 2002

    The American Textile Manufacturers Institute (ATMI) submits this 
statement to the Senate Committee on Banking in regards to the May 1 
hearing on the release of the Treasury Department's Foreign Exchange 
Report. ATMI is the national trade association of the U.S. textile 
industry, one of the largest manufacturing sectors in the United 
States.
    ATMI is writing to describe the devastating impact that the 
overvalued dollar, now at a 16 year high, is having on the U.S. textile 
sector and to urge the Committee and the Administration to take 
immediate steps to bring the dollar back down to normal, historic 
levels.
    The U.S. textile industry is suffering its worst economic crisis 
since the Great Depression. Since the dollar began to surge in value in 
1997, over 175,000 textile workers have lost their jobs and over 215 
textile plants in the United States have closed.
    The Asian currency devaluation in 1997-1998 and the ``strong U.S. 
dollar'' policy instituted at that time are the root cause for this 
devastation. As of last year, the dollar had increased in value by an 
average of 40 percent against the leading Asian textile exporting 
countries. Prior to the dollar's surge, the U.S. textile industry was 
enjoying some of its best years in history and recording new highs for 
shipments, profits, and exports.
    Since that time, the strength of the dollar has allowed Asian 
exporters to cut their prices by an average of 23 percent and caused 
Asian textile and apparel exports to the United States to increase by 
an astonishing 6 billion square meters, an increase of 65 percent.
    As a result, U.S. textile profits have virtually disappeared, 
shipments have declined by 25 percent or $12 billion, exports have 
fallen by $2 billion and a swath of misery has spread across the 
Southeast.\1\
---------------------------------------------------------------------------
    \1\ We have attached a one-pager on the impact of the dollar on 
textiles for your review.
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    This impact has hit not only domestic textile manufacturers but 
U.S. cotton and wool growers, textile machinery suppliers and man-made 
fiber manufacturers. It has also devastated small towns across the 
Southeast that have depended for generations on domestic textile 
manufacturing.
    In addition, the problem of the overvalued dollar impacts virtually 
every manufacturing and agriculture sector in the United States. The 
National Association of Manufacturers estimates that half a million 
manufacturing jobs have been lost in the last 18 months just from lost 
export orders. That figure does not include hundreds of thousands of 
jobs lost because of a surge in artificially low-priced imports.
    We also note that the International Monetary Fund (IMF), the 
Organization for Economic Development (OECD), the European and Canadian 
Central Banks and even members of the Federal Reserve in the United 
States have all expressed alarm over the continuing rise in the 
dollar's value.
    In February, despite stagnant economic activity, rising imports and 
a dramatic jump in the current accounts deficit, the Federal Reserve 
reported that the dollar had hit a new high, with a 31 percent increase 
in value against the world's major currencies since 1997.
    It is clear that economic fundamentals are being overridden by a 
belief in the market that the U.S. Treasury will act to support a 
``strong dollar.'' This policy is now having a devastating impact on 
the textile sector.
    The last time the dollar surged to such heights was in the mid-
1980's during the Reagan Administration. At that time, Treasury 
Secretary Jim Baker took strong 
action, in concert with other major trading nations, to restore the 
dollar to sound, 
stable levels. That action set the stage for a decade of dollar 
stability and U.S. export growth.
    ATMI firmly believes that for the textile crisis to end and for the 
industry to return to health, the U.S. Government must act to return 
the dollar to its normal, historic range. We strongly urge the 
Committee and the Administration to act quickly to accomplish this.



         PREPARED STATEMENT OF THE COALITION FOR A SOUND DOLLAR
                              May 1, 2002

    Mr. Chairman, we the undersigned organizations comprising the 
Coalition for a Sound Dollar appreciate the opportunity to submit a 
statement for the record for the Committee's May 1, 2002 hearing on the 
release of the Treasury Department's Foreign Exchange Report.
    The Coalition represents a broad array of manufacturing and 
agricultural interests which employ millions of U.S. workers and which 
have been deeply impacted by the overvaluation of the U.S. dollar over 
the past 5 years. As of this date, job losses from the overvalued 
dollar are almost certainly in excess of three-quarters of a million 
U.S. workers.
    Indeed, the damage caused by the dollar's prolonged surge has 
become so great that U.S. manufacturing and agriculture, two 
fundamental legs of the U.S. economy, are unlikely to rebound as a 
result of the economic recovery. Recent statistics show that despite a 
surge in first quarter GDP, durable goods orders and business 
investment remain down and that the bump up caused by inventory 
restocking was a one time event. In addition, despite increased 
economic growth overseas, both manufacturing and agricultural exports 
have continued to decline.
    The Coalition members believe that a sound dollar is a fundamental 
prerequisite for maintaining a healthy United States and global 
economy. A sound dollar is one whose value relative to other major 
currencies is determined by market forces that reflect fundamental 
economic trends, such as trade balances, interest rates, GDP growth, 
and other objective indicators of a country's performance.
    The disturbing reality is that for several years the dollar has not 
been reflecting economic fundamentals. In 1997, after 8 years of 
stability, the dollar began to appreciate sharply against other major 
currencies. The appreciation has continued despite a U.S. economic 
downturn, a yawning current accounts deficit and, in many cases, higher 
comparable GDP growth overseas. Today, the dollar stands 30 percent 
higher than in 1997--its highest level in 16 years. The dollar is now 
approaching the calamitous levels last seen in 1985, which provoked 
intervention on an international scale.
    As a result of the 30 percent dollar ``tax,'' many U.S. made goods 
have been literally priced out of markets at home and abroad. For 
example, U.S. manufacturing exports have dropped by an annual rate of 
more than $140 billion over the past 18 months. The National 
Association of Manufacturers estimates that half a million 
manufacturing jobs have disappeared simply as a result of the export 
decline, principally due to the fact that the dollar has taxed U.S. 
exporters, rightly proclaimed by the U.S. Government as the most 
productive in the world, out of market after market.
    Indeed, the conventional wisdom that the U.S. advantage in high-
technology products is a key to future U.S. economic growth has been 
gutted by the dollar's impact. U.S. Government statistics show that 
over the past 5 years, a healthy U.S. surplus in these products has 
vanished into a deficit of $20 billion.
    Winners of the President's vaunted ``E-awards'' given to top U.S. 
exporters have not been spared either. In letters sent to Secretary 
O'Neill, these E-award winners, among many other top exporters, said:

 ``The value of the U.S. dollar now makes us uncompetitive in 
    almost all world markets . . . The 30 percent change in currency 
    value is making us uncompetitive even in our own home market. We 
    are a small business with our only manufacturing facility in South 
    Dakota. We have been forced to make substantial layoffs of 
    production and support personnel to adjust to this catastrophic 
    problem.''

 ``The strength of the dollar has had a profound effect upon 
    our business, especially in the area of employment. A year ago at 
    this time we employed 1,625 people in the Green Bay area. Today 
    that number is down by over 500 people . . . As this environment of 
    a strong dollar has continued, we have been forced to consider 
    relocating our manufacturing capabilities offshore.''

    U.S. agriculture, which suffers from the same ``Made in the 
U.S.A.'' dollar tax, estimates that nearly 100,000 agricultural workers 
have been displaced because of the overvalued dollar. From cotton to 
rice to wheat, the U.S. breadbasket is seeing its major export markets 
dwindle and imports increase because of the dollar's sustained rise.
    The damage extends to industries where there have been significant 
import surges with the overvalued dollar acting as an enormous import 
subsidy. Sectors such as textiles, paper and forest products, 
automobiles, nonferrous castings, steel and furniture have, in total, 
lost hundreds of thousands of workers as imports have ridden the 
currency wave by cutting prices or increasing incentives. Many of these 
jobs have been lost in rural communities that often depend on local 
manufacturing or agricultural as their major source of employment.
    In particular, textiles have seen Asian prices drop by an average 
of 23 percent since 1997--prior to 1997, Asian prices were showing 
moderate growth. Since the dollar's rise, job losses in the textile 
sector have totaled more than 175,000.
    U.S. automakers are being forced by the dollar penalty to pay out 
billions of dollars in incentives in an expensive effort to slow a 
sharp decline in market share. At the same time, they are being treated 
to reports of record profits by Japanese automakers who have tacked 
billions of dollars in currency-generated profits to their bottom 
lines.
    Paper mills, many with state-of-the-art equipment, have been closed 
by the dozen as dollar-cheapened imports now take 90 percent of the 
growth in the U.S. paper market.
    The truth is that the overvalued dollar is increasingly forcing 
manufacturing permanently off-shore as well as displacing increasing 
numbers of farmers. Jobs, not goods, are now being exported as a result 
of the dollar tax.
    Long term, a 30 percent dollar tax on goods produced in this 
country is simply not by the majority of U.S. companies and farmers. A 
key policy question for this Committee and the Government is whether 
shrinkage of the U.S. manufacturing and agriculture base is an 
acceptable cost for supporting the out-of-kilter dollar.
    The Coalition contends that the U.S. Treasury's policy of a 
``strong dollar'' regardless of economic fundamentals or the dollar's 
cost to U.S. workers and their families is not good or sound policy. 
Indeed, this policy has already led to an increase in the current 
accounts deficit to new record highs, now almost 4.5 percent of U.S. 
real GDP, more than triple the deficit's level before the dollar began 
to rise in 1997.
    The Coalition notes that Secretary O'Neill, in his previous 
incarnation as President of International Paper during the 1980's run-
up in the dollar's value, complained that the dollar ``had turned the 
world on its head.'' Today, when the dollar is now reaching the very 
heights it did during 1980's, the Secretary calls U.S. manufacturers 
``whiners,'' expressing ``no sympathy'' for the burdens the overvalued 
dollar policy has created. This is not the message that hard-working 
American families should be hearing.
    We firmly believe that sound currency values can be restored and 
that manufacturing and agriculture can again thrive in this country. To 
do this, the Treasury should:

 State publicly that the dollar is out of line with economic 
    fundamentals.

 Firmly state that its policy is to seek a market-determined 
    dollar that is consistent with underlying global economic 
    fundamentals, including the competitiveness of America's farms and 
    industries.

 Seek cooperation with other major economies in obtaining 
    common agreement and public statements that their currencies need 
    to appreciate against the dollar.

 Make clear that the United States will resist, and take 
    offsetting action as necessary, foreign country interventions 
    designed to retard movement of currencies toward equilibrium.

    The Coalition notes that when the Treasury faced a similar 
situation more than 15 years ago, it took decisive and successful 
action. In crafting the ``Plaza Accord'' of 1985, Treasury Secretary 
James Baker was able to restore currency equilibrium and launched 
renewed global growth. It was possible then, and is possible now.

    Sincerely,

    Aerospace Industries Association
    American Brush Manufacturers Association
    American Cotton Shippers Association
    American Fiber Manufacturers Association
    American Forest & Paper Association
    American Furniture Manufacturers Association
    American Hardware Manufacturers Association
    American Iron and Steel Institute
    American Paper Machinery Association
    American Pipe Fittings Association
    American Textile Machinery Association
    American Textile Manufacturers Institute
    Associated Industries of Florida
    The Association for Manufacturing Technology
    Automotive Trade Policy Council
    Business and Industry Association of New Hampshire
    The Business Council of New York State
    The Business Roundtable
    The Carpet and Rug Institute
    Composite Can and Tube Institute
    Copper and Brass Fabricators Council
    Fiber Box Association
    Industrial Fabrics Association International
    IPC--Association Connecting Electronics Industries
    Mississippi Manufacturers Association
    Motor and Equipment Manufacturers Association
    National Association of Manufacturers
    National Cotton Council of America
    National Marine Manufacturers Association
    New Jersey Business and Industry Association
    Non-ferrous Founders' Society
    North Carolina Citizens for Business and Industry
    North Carolina Manufacturers Association
    Ohio Manufacturers Association
    Packaging Machinery Manufacturers Institute
    Paperboard Packaging Council
    Precision Machined Products Association
    Process Equipment Manufacturers' Association
    Secondary Materials and Recycled Textiles Association
    Southern Forest Products Association
    Steel Manufacturers Association
    Textile Distributors Association
    Tooling and Manufacturing Association
    USA Rice Federation
    Utah Manufacturers Association
    Virginia Manufacturers Association
    Waste Treatment Technology Association
    Wheat Export Trade Education Committee
    Wood Component Manufacturers Association
    Wood Machinery Manufacturers of America

    For more information about the Coalition for a Sound Dollar, 
contact Frank Vargo at 202-637-3182 or visit the Coalition's website at 
www.sounddollar. org.











































































































































































































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