Mr. Chairman and 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 Americans 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 didn’t happen because U.S. producers became less productive or efficient. And it didn’t 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 sixteen 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 1982-85 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 U.S. 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 Statistic’s 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 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 was overvalued. The Chairman of the President’s Council of Economic Advisors, Glenn Hubbard, told the press that the strong dollar was 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% at most…." And Morgan Stanley currency expert Joachim Fels, stated flatly to Fortune Magazine that, "The dollar is overvalued, and everybody knows it."
And 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 the most accurate indicator 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 agrees 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’ve 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’d 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 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 thousand 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 fourteen 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 import prices fell 17 percent, reflecting the rising dollar.
This is strongly reflected 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, and 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 on Asian imports, had been able to hold its own until 1997. Since the dollar began to rise in that year, dollar import prices 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 was a subordinate cause, and the principal cause was 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 one 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 is 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 were strong and could sustain a large trade deficit. 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 detrimental aspects to it. 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 U.S. and global economy.
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. The historic support for free trade policies was threatened in the 1980 overvaluation, and the current overvaluation and trade deficits are the principal reason why public support for further trade opening is so 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 nearly 10 percent in 1998 – nearly doubling. With 95 percent of the world’s consumers outside our country’s borders, small manufacturers 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 fourth quarter of 2002, 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%, 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 fundamentals. 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 1997-98 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 of 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 ½ 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 1990s, 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 favors our trading partners overseas after the 1st quarter of 2002. Clearly, the impressive growth disparity between the United States and economies abroad in the late 1990s has been changed. 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 hasn’t. 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 manipulating the market and preventing market forces from working. It is time to end this outmoded policy and to trust the market.
Accordingly, we believe the Administration should stop take the following steps:
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, broke the back of the rising protectionism, and fueled a U.S. and global economic boom. 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 policy and exchange rate policy. Section 3005 of the Omnibus Trade and Competitiveness Act of 1988 requires the Secretary of the Treasury, after consultation with the Chairman of the Federal Reserve Board, to provide Congress with periodic reports on exchange rates and economic policies, including the effect of exchange rates on production, employment and growth in the United States.
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 no, 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 policy-makers and for the public. The NAM, therefore, recommends that the Commerce Department and the Agriculture Department be required by the Congress to begin preparing semi-annual reports directly analyzing the effect of exchange rates on U.S. trade, production and employment. These reports would be separate from the Treasury’s macro economic 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.
Companies All Over the United States Are Being Injured
by the Overvalued Dollar
Selected Examples Provided by Members of the
NATIONAL ASSOCIATION OF MANUFACTURERS
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 in recent months, 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%, and some have lost almost all their export business.
Some of the 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.
Consider, for example, the following excerpts from letters NAM members sent to Secretary O’Neill:
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."
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