Commentary: Bush's U.S. dollar policy jeopardizes economy

While the war on terrorism has insulated President Bush from confronting critical domestic economic policy issues, the rising voice of economic discontent coming from the foreign trading partners of the United States is something that he may no longer be able to ignore.

As if calming foreign

markets are not daunting enough, how Bush navigates U.S. fiscal policy through these treacherous economic waters will go a long way toward convincing Federal Reserve Board Chairman Alan Greenspan to hold steady short-term interest rates. The Fed has increased the rate five times in the past six months. The fate of the domestic economy hangs in the balance. These issues loom large as Bush begins his second term and require him to do more than just hold his ground about not raising taxes.

Bush's adamancy on making his tax cuts permanent, when combined with the economy's sluggishness over the past several years, has expanded the federal deficit and increased the nation's borrowing. This makes the option of spurring new economic growth by issuing new federal debt difficult, because increasing debt as a component of any economic growth strategy can result in inflation.

Up until now, inflation has been relatively benign. Foreign currency markets have accumulated dollars and used those dollars to purchase U.S. bonds and Treasury bills, which have kept domestic interest rates low. This has allowed Americans to borrow cheaply for everything from real estate, automobiles and credit card-financed holiday purchases.

With foreign currencies growing in value as compared to the U.S. dollar, this has not been lost on our foreign trading partners and those investing foreign currencies in U.S. debt. Continued support of the dollar requires foreign trading partners to forgo arbitrage profits on transactions in European currencies such as the euro, which has grown in strength against the falling dollar.

Foreign currency traders may dump the dollar if their profits are crimped by the greenback's falling value. This could push the dollar's value down even further.

Currency traders could also liquidate their investments in American bonds and invest the proceeds in currencies and debt of other nations that generate a better return. This can't be overlooked, considering that Japan, China, South Korea and Taiwan traders, unhappy about the falling dollar, hold more than 40 percent of America's public debt.

Today's generally rosy economic climate may not last, especially if the dollar continues to erode and foreign traders seek more profitable investments. To attract back those investments in the dollar, the United States will have to raise interest rates, thus increasing the federal budget, requiring additional borrowings or spending cuts to avoid further deficits.

Compounding the potential woes could be more rounds of interest- rate increases from the Fed. A wrong decision could bring on a recession, with higher consumer borrowing costs eroding after-tax earnings normally spent on merchandise. This will cause a falloff in product demand and a buildup in inventories, resulting in job cuts.

Ironically, U.S. foreign trade partners are preventing this by creating a market floor for the U.S. dollar's value. They have held off rapid sales of the dollar, fearing that such a move would diminish the market value of their own inventory of U.S. dollars and other investments faster than they can profit by trading in other currencies.

President Bush, by ignoring the role of domestic fiscal policy on global economic stability, and the importance of global economic health on the domestic economy, can no longer minimize the fact that his policies have placed the domestic economy in jeopardy.