Dollar demise much exagerated

Blast this guy for not knowing what he is talking about!

Perhaps the most surprising development over the last three months has been the surging value of the currency at the heart of the crisis. It is almost as if investors have responded to a fire alarm by running towards the source of the fire.

From a recent low on July 15, the U.S. dollar’s trade-weighted value has risen 19 percent. The dollar has been broadly stable against China’s yuan (+1 percent) while posting massive gains against the Swiss franc (+20 percent), the euro (+26 percent), the British pound (+35 percent) and the Australian dollar (+52 percent). Only against Japan’s yen has the currency slipped marginally (-6 percent).

Since 1997, commentators and policymakers have openly worried about America’s gaping trade deficit, resulting dependence on foreign capital inflows, and the risk of a sharp correction in the value of both U.S. government bonds and the currency if investors started to balk at financing the resulting payments gap.

The economy’s expansion witnessed a large decline in the dollar’s value by almost 40 percent between Feb 2002 and March 2008. As the crisis intensified and the U.S. slipped towards recession, commentators and policymakers raised a renewed alarm about a possible currency collapse.

Instead, the dollar has witnessed its most broad-based and sustained appreciation since the late 1990s. In the last month, the currency has traded at its highest level against the euro for two years.

ADJUSTMENT BY RECESSION

For 10 years, the widening deficit in the current account of the U.S. balance of payments has been the main source of perceived dollar risk. The deficit ballooned from $125 billion in 1996 (1.6 percent of GDP) to $788 billion by 2006 (6.0 percent of GDP).

Persistent deficits in the trade balance could not be covered by a moderately positive net inflow of profits, interest and dividend earnings from abroad. So the United States resorted to massive sales of government and private debt (including U.S. Treasuries and securitized mortgages), corporate equities, whole companies, and other forms of real property to foreigners to fund the import surge.

The financing requirement absorbed more than half of all funds that investors worldwide made available for investing outside their home country. The net external debt of the United States quintupled in just a decade from $456 billion in 1996 (5.8 percent of GDP) to a staggering $2.442 trillion in 2007 (18 percent of GDP).

It is a moot point whether the deficit in the current account spurred the issuance of record quantities of often poor-quality debt (as critics of the Federal Reserve have charged); or whether a global savings glut coupled with strong overseas appetite for U.S. assets created a capital account surplus and forced the United States to run a large trade deficit (as Fed Chairman Ben Bernanke has claimed).

In reality, the balance of payments is an integrated whole and part of the wider international flow of funds. China’s willingness to lend (by accumulating reserve assets) found ready willingness to borrow in the United States (mostly to fund consumption and a massive build out of new homes). The end result is that China has ended up owning a lot of U.S. government paper, and the U.S. has ended up owing a lot of money.

Policymakers have warned for more than a decade that these “global imbalances” were unsustainable and would eventually need to be reversed. The hope was adjustment would come about mainly through a significant but orderly devaluation of the dollar and rise in U.S. exports, rather than a deep recession in the United States that would cut import demand.

In the end, policymakers have been spared the choice.

The unfolding credit crisis is producing a deep recession, cutting U.S. demand for imports, and forcing the long-overdue adjustment in the trade deficit. Because the recession is centered on the United States, U.S. import demand is falling more rapidly than the demand for the country’s exports in Europe, Asia and the rest of the world, producing the necessary current account adjustment.

It is a bitter irony that recession has removed one of the main sources of downward pressure on the U.S. currency.

http://blogs.reuters.com/great-debate/2008/12/02/dollar-demi...