Falling Down, Falling Down

It looks like the United States continues to think that the best way to tackle its current account deficit is to let the dollar fall.  The yen has risen to seven month highs, while the Euro is now at an all-time high against the U.S. dollar. Besides the current account deficit, the U.S. budget deficit and high energy prices also are heavily weighing on the currency.

U.S. Treasury Secretary John Snow still pays lip service to a "strong" U.S. dollar, acknowledging that "nobody has ever devalued
their way to prosperity." Yet we have not seen any actions to counter the market’s view that U.S. policy is now "benign" neglect of the country’s currency. Additionally, the currency markets believe that the reelection of George Bush
means more unchecked spending and tax cuts, a combination that hardly signals that the United States is seeking to put its financial house in order.

The U.S. view seems to be that the Asian governments and Central Banks are going to have to continue recycling their dollars back into the United States: keep buying U.S. securities (primarily U.S. Treasuries) to keep this largest of customers floating, and it will keep importing and consuming Asian goods. (Some commentators have snidely but rightly described this situation between Asia and the United States as the "largest-ever vendor finance scheme.")

U.S. officials seem to think that they can orchestrate an orderly decline in the dollar. Snow’s retort to the idea that Asian and other foreign investors could dump U.S. Treasuries wholesale is a non sequitur: "Our debt markets are the deepest, broadest and most liquid anywhere," he said. "We are readily able to market U.S. Treasuries."

Jim Rogers has warned before where such hubris can lead: the loss of the dollar as the world’s reserve currency "and medium of exchange." When are foreign investors going to decide that they no longer want to recyle their U.S. dollars into the securities of a country with deepening budget and trade deficits? Some investors have been warning about "U.S. dollar hegemony" and foretelling of its doom for years. Until that day, bearish traders will focus on the twin deficits as signs that U.S. fiscal health is poor. Richard Duncan (we revisited his book Dollar Refrain in the Asian Review of Books earlier this year) has warned that: "It really is only a matter of time before the United States will not be creditworthy" and that "a dollar crisis is inevitable."


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