Feldstein: Dollar to Fall, More Rate Cuts No Help

Martin Feldstein, former chairman of President Reagan’s Council of Economic Advisors, predicts that the dollar will fall further and that European banks will see the same turmoil as their American brethren.

He also maintains that another Federal Reserve interest-rate cut will do little to restore stability in credit markets.

"I don’t know how fast the dollar will fall,” Feldstein, now a Harvard economics professor, told Bloomberg TV recently.

"It has fallen 15 percent against the yen, 15 percent against the euro and almost 10 percent against the Chinese renminbi in the last 12 months. We’re on a pretty fast fall, and I see that continuing.”

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The dollar’s weakness and the Fed’s rate cuts have sent private investors to European bonds, Feldstein said.

"Say you’re a private investor who has a choice between dollar securities and euro securities,” he stipulates.

"You get a higher interest rate in Europe than here, and odds are certainly that the dollar will continue falling. So you would lose doubly by investing in a dollar bond rather than a euro bond.”

The U.S. is able to finance its huge current account deficit by selling bonds to foreign governments, "who don’t care so much about exactly how much yield they get,” Feldstein tells Bloomberg.

"In effect, we’ve been getting a gift from the rest of the world. They send us more stuff than we send them -- last year to the extent of about $800 billion.”

The dollar needs to fall to shrink the U.S. current account gap, Feldstein said. "And Europe will lose some of its current account surplus as part of that adjustment,” he said.

But that shouldn’t be a major threat to Europe, because it’s also sending many exports to Eastern Europe and Asia, he notes.

He believes European banks will soon suffer the same problems as U.S. banking giants like Citigroup.

"I think Europe has taken on more risk than we see,” he said. "A lot of the securities that have gotten our financial institutions in trouble also have been acquired by their financial institutions.”

"We’ve seen a little bit coming out in the news. But there’s a lot more there that hasn’t surfaced. They haven’t been as tough bringing out the facts about that as our regulators and accounting firms.”

Feldstein anticipates the Fed will cut the federal funds rate, now 3 percent, by another 50 or 75 basis points at its next meeting, March 18.

But he doesn’t think Fed rate cuts will have as much positive influence as in the past.

"In the past, we saw lower Fed rates help the housing market,” Feldstein points out. "The housing market has so many problems now, that rate cuts won’t help much there.”

As for the freeze-up in the credit markets, "Lower interest rates have helped, because we’ve seen spreads shrink against LIBOR,” he said.

"But there is still so much that isn’t happening because of dysfunction in the credit markets, that another 50 basis points won’t change that,” he said.

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