Strong Dollar Is Killing U.S. Economic Growth and Putting Fed Rate Hikes on Hold

NEW YORK (TheStreet) -- The strong dollar continues to drag down U.S. growth, complicating the Federal Reserve's plans to raise interest rates, and casting serious doubts on President Obama's proposed free trade agreement with Asian nations.

The Commerce Department reported first quarter GDP was down 0.7%. The severe winter put the skids on new home construction, and falling oil prices nixed investments in structures and equipment. Those issues, as well as the now-ended West Coast port strikes, will impose less drag on the economy in the second quarter.

However, the relative strength of the dollar -- precipitated by aggressive monetary policies in Japan, South Korea, China, and Europe that are pushing the values of their currencies down -- will have enduring and substantial negative consequences for U.S. growth.

In the first quarter alone, lost exports subtracted 1.0 percentage point from growth, and increased imports stole another 0.9.

The Federal Reserve has already decided to postpone raising interest rates until the autumn, and built into my forecast is a first move toward normalizing rates in the third quarter.

 

Stronger household balance sheets, a robust interest in new automobiles with better gas mileage and other advanced features, and a pickup in new home construction should boost growth to about 2.8% by the third or fourth quarter. However, that would be well short of the 4% or 5% growth the economy could accomplish given the large numbers of underemployed recent college graduates and the 7 million men ages 25 to 54 who are jobless and not seeking employment.

The headwinds created by beggar-thy-neighbor foreign monetary policies and a strong dollar will persist and complicate Fed efforts to gradually "normalize" interest rates, which it currently views as raising the overnight bank borrowing rate (federal funds rate) from its current 0.125% to 3.75%.

More likely, efforts to raise interest rates, however gradually, will stall at about 2% or less without some kind of international effort to more reasonably revalue the dollar. A good start would be a currency agreement within the proposed Trans-Pacific Partnership.

Unless new free trade agreements significantly reduce the United States' $400 billion trade deficit with Asia, it is tough to see the deals benefiting growth domestically. Asian participants can simply overwhelm the benefits to U.S. businesses from lower barriers to trade and investment by printing money to cheapen their currencies.

President Obama's economic policy has emphasized income redistribution -- for example, through the expansion of the Medicaid and Food Stamp programs, and the Obamacare health insurance subsidies for many middle class families -- and the recent recovery has averaged only 2.2% annual growth. By contrast, during the Reagan and Clinton years, greater emphasis was placed on keeping the dollar fairly valued and redressing trade imbalances -- for example, with Japan -- and the economy grew at a 3.4% pace.

The president has flat out rejected addressing currency issues in TPP negotiations, and dismissed recommendations from economists on the right, left and in the center to more fairly value the dollar and boost growth. The Fed has refused to comment on the limitations imposed on its policy options by the administration's recalcitrant attitude, which rejects basic tenets of modern international macroeconomics.

The country must wait for a new president and a new Fed chairman to see a substantial improvement in growth. Meanwhile, wages and real incomes for ordinary working Americans will languish.

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