The dollars viability and the current account deficit nightmare:
Funding fears add currency to doubts on the US dollar
By Christopher Swann
Published: October 23 2000 20:14GMT | Last Updated: October 23 2000 22:25GMT
Like the proverbial cat the dollar has had many lives.
For more than a year, economists have been predicting that the currency would soon succumb to the bloated US current account deficit, which looks set to reach $440bn this year.
Until now the appeal of its assets has enabled the US to suck in 70 per cent of the world's capital account surpluses.
"Each time international appetite for one class of US asset has started to wane, another has taken its place," says Paul Lambert, director of currencies and bonds at Deutsche Asset Management.
But once again analysts are beginning to ask whether the dollar is running out of lives.
"It is increasingly difficult to see what will come to the rescue of the dollar this time," says Jim O'Neill, head of currency research at Goldman Sachs.
Of particular concern have been the seemingly unrelated problems of Europe's telecommunications companies and technology stocks more generally.
These companies have recently been the driving force behind the boom in cross-border merger and acquisition activity, which has been lifting the dollar ever higher.
Last year $73.6bn - or nearly one-third of cross-border M&A inflows to the US - came from the telecommunications sector.
Now it looks as though this particular source of dollar support is likely to dry up.
"US technology media and telecoms companies are still something of a bargain for their European counterparts," says Paul Meggyesi, senior economist at Deutsche Bank in London.
"The question is whether European telecoms companies in particular can afford to pay even bargain prices any more," he adds.
A spate of merger activity, coupled with the princely sums being paid to governments for third generation licences, have saddled European telecoms companies with huge debts.
Indeed, lending to telecoms companies has reached such proportions that European regulators are examining whether banks are overexposed to the sector.
Credit rating downgrades for Deutsche Telekom and British Telecommunications among others - along with recent falls in share prices - have left European telecom companies less able to make further US purchases.
Morgan Stanley Dean Witter argues that global M&A activity - which funded around 40 per cent of the US current account deficit last year - has finally peaked.
"A lot of these companies have completed their expansion phases and are thinking about consolidation," says John Montgomery, senior global economist at MSDW in New York.
This is not the only cloud on the dollar's horizon.
Corporate bonds - an even more important source of dollar support than foreign direct investment - have also been losing their shine.
A recent stream of warnings from such bellwether companies as Intel, Motorola and Apple, have helped sour the outlook for corporate earnings.
Meanwhile, the National Purchasing Managers index recently fell below 50 - the boom-bust line for the US industrial economy.
Against this backdrop many investors have been selling corporate bonds.
Pimco, the world's largest bond fund manager, has urged investors to avoid corporate bonds at all costs. "Spread product (corporate debt) is in for some grim reapings in the next month and the next few quarters," William Gross, managing director of Pimco, warned investors last week.
"Even a slowdown in the inflow into the US corporate bond market would leave a gaping hole in the funding of the current account deficit," say Mr Lambert, pointing out that flows in 1999 represented around 60 per cent of the deficit.
Nor can the dollar any longer rely on the outperformance of US shares. After several years of outperfor-mance, US stocks have actually lagged behind those in Europe - with the Standard & Poor's index down 5.5 per cent on the year to date, compared with a5per cent fall in Germany's Dax and a 3 per cent rise in the French CAC-40.
Even so, the dollar's recent habit of pulling rabbits out of hats has left economists reluctant to rule out the possibility that it will manage to attract new flows.
"Crisis in the Middle East and rising oil prices - if sustained - would generate continued demand for US Treasuries as a safe-haven asset," says Avinash Persaud, head of global research at State Street, the Boston-based investment bank.
One further possibility, argues Joseph Quinlan, is that Japanese companies - who have recently stood back from the cross-border merger boom - will swoop down on US companies.
"This could be the dollar's tenth life," quipped Mr Quinlan.
But most think these are wild card options.
"It looks like the dollar bull run may have entered the final straight," says Mr Lambert.
With negative factors for the currency continuing to accumulate, the dollar can not be expected to defy gravity for much longer.
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