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To: Jim Willie CB who wrote (4708)	6/5/2003 10:00:59 AM
From: 4figureau	Read Replies (5) \| Respond to of 5423

Dollar's fall may not be over yet By Christopher Swann, Economics Correspondent Published: June 4 2003 5:00 >>But some analysts think this moment may come sooner than many expect. "We are heading towards a dollar crisis as soon as this summer," says Mr Persaud. "If the dollar's fall gathers momentum to the point that interest rates start to rise, policy makers will be forced to act."<< Enough is enough, some might say of the dollar's fall. Since February 2002, the greenback has lost more than a third of its value against the euro - which would have been enough to placate all but the fiercest dollar bears just a year ago. Goldman Sachs, HSBC and Deutsche Bank all think that $1.05-$1.18 against the euro is the "fair" or equilibrium value for the dollar. So with the euro now hovering around $1.18, it might be tempting to think that the dollar's decline will soon run out of steam. At the G8 summit, too, President Jacques Chirac hinted on Tuesday at concern over currency gyrations, saying stability was helpful to growth. Financial history, however, suggests the dollar's downward journey may be far from over and the fact that it is thought to be nearing "fair value" is unlikely to break the currency's fall. This is partly because the gravitational pull exerted by fair value - which is notoriously hard to calculate anyway - is extremely weak. Instead a range of automatic destabilisers tend to ensure that exchange rates overshoot. Most banks' fair value figures are a combination of purchasing power parity calculations - the comparative values of a basket of goods in different economies - and relative movements in productivity. These measurements are based largely on the goods markets and on trade. But the size of international trade flows is dwarfed by the cross-border capital flows. Even stripping out dealing between financial institutions, capital flows are about 10 times larger than trade flows, according to State Street, the Boston-based investment bank. "Fair value has tended to exert a very feeble influence in foreign exchange," says Avinash Persaud, head of global research at State Street. "In cross-border flows, momentum is very strong, which is why currencies tend to overshoot." Sustained periods of overvaluation also lead to economic misalignments - large current account deficits and excessive domestic demand - which then demand a period of undervaluation to redress the balance. Following a period of over-valuation in 1985 a large US current account deficit accelerated the fall in the dollar - which slid 54 per cent against the D-Mark by 1987. Now as then, however, it may also be several years before the depreciation of the dollar helps to narrow a current account deficit - which is set to reach $600bn this year. Initially, the current account deficit should actually swell - a phenomenon known as the J-curve effect - since consumers and businesses are often slow to reduce spending on imported goods as prices rise. At the same time, exporters can be slow to gear up production to respond to improvement in competitive position. This was graphically demonstrated after the dollar's dramatic fall in 1985. Between 1985 and 1987 the US current account rose from $124bn to $168bn. Only in 1988 did it fall back to $128bn, reflecting the enhanced competitiveness of the US economy. The vicious cycle of currency depreciation is also exacerbated by financial markets. In the long run the fall in the dollar should help attract foreign capital to fund the current account deficit - serving as a discount on US assets. In the short-term, however, it is a deterrent, since investors may be wary of ploughing funds into a falling asset. Another automatic destabiliser is the hedging behaviour of companies exporting into the US - who are likely to hedge against further falls in the greenback. Since this is done by selling the US currency forward, it has the effect of accelerating the currency's fall. The accumulation of momentum in the foreign exchange markets means that it is often left to policy makers to halt moves that have started to cause significant economic disruption. Currency intervention by leading industrial countries marked the dollar's peak and trough in 1985 and 1987. The nadir of the euro was reached close to the level at which the G7 intervened to protect the currency in September 2000. Despite rumblings of discontent at the G8 conference, the dollar will need to fall significantly to provoke a further policy response. But some analysts think this moment may come sooner than many expect. "We are heading towards a dollar crisis as soon as this summer," says Mr Persaud. "If the dollar's fall gathers momentum to the point that interest rates start to rise, policy makers will be forced to act." news.ft.com