Selling the dollar
Published: August 16 2001 19:09GMT | Last Updated: August 16 2001 19:13GMT
Independence Day had just passed but on July 5 currency market traders were still celebrating all things American. The US dollar reached a 16-year high on its trade-weighted index. How fortunes change.
Since then, the dollar index has fallen by more than 4 per cent and the greenback's value against the euro is hovering about 9 per cent lower. There are those who are beginning to talk about a decisive turn in the market.
No one should count on this in these days of thin summer trading. Other significant euro rallies occurred in July and September 1999 and in May and December last year. They did not last.
But there are two important differences this time. First, the US needs ever-increasing capital inflows to fund its current account deficit, while its attractiveness as an investment location is declining. Second, a falling dollar would benefit the economies in the US, the UK and the eurozone.
The US current account deficit grew to $450bn in 2000, 4.5 per cent of national income. At this historically high level, it absorbs 64 per cent of the world's net capital flows, or 7¾ per cent of the world's gross national saving. It is hard to quarrel with the International Monetary Fund's assessment that this deficit is "not sustainable in the longer term".
The dollar's continued strength relies on attracting net capital flows at least as great as the US current account deficit. That these funds have so far been forthcoming is no guarantee of future flows. The economic slowdown seems more entrenched than at the beginning of the year, casting doubt on future returns.
In addition, the scale of the productivity growth since 1995 is being questioned. Even if the miracle lives, sharp downward revisions to profits figures have raised questions about whether capital (rather than labour) can reap the benefit from productivity gains.
Across the world, the economic benefits of a strong dollar are also on the wane. The US no longer needs to export domestic demand for fear of rising inflation. A rising euro would give the European Central Bank greater scope to cut interest rates. And if sterling followed the dollar down, imbalances in the UK economy would be mitigated.
Only Japan, which would benefit from increased exports, would view a falling dollar with concern.
Currency markets have not yet reached any conclusions about the underlying trend but further falls in the dollar could become self-reinforcing. The US still needs big net flows of capital to fund its current account deficit but a falling dollar reduces foreign investors' return on US assets. What has happened so far, at least, is welcome. |
