Loving the weak U.S. dollar

Business Times - 18 Oct 2007
US happy with falling value of the greenback

NOTWITHSTANDING the rhetoric coming out of the Bush Administration about Washington's steadfast commitment to a 'strong' US currency, it is not a secret that most of this city's policymakers seem to share the view that the falling dollar is good news and that it should stay that way for quite a while.

Hence, a friend and long-time critic of the Bush Administration admitted during a recent conversation that 'one of few things that the Bush team did right was not to talk it up as much as the Clinton Administration did'.

Many Americans who associate a strong US economy with a strong US dollar 'just don't get it', he explained. 'Strangely, while it is common knowledge in China, Japan, Malaysia, Argentina, and many other countries that an overvalued currency is a curse, in the US this is much less understood, even among opponents of current trade policies and globalisation, many of whom seem unaware that the overvalued dollar has cost the US economy millions of manufacturing jobs over the last decade,' he added. He said that 'it is also not good for the world economy to have the imbalance of the United States' huge current account deficit, and of course, this is not going to adjust without the dollar falling - unless one prefers a steep and prolonged recession'.

I assume that my friend is delighted now that the US currency's decline is gathering pace, as it dives not only against the euro and yen, but even against the Canadian dollar.

European finance ministers are concerned that a strong euro is harming their nations' exporters and are likely to demand during the meeting in Washington on Friday some coordinated intervention by the G-7 central banks to strengthen the US dollar.

Nicolas Sarkozy, France's president, recently declared that the currency's rise above US$1.40 was a 'problem' for the competitiveness of France and the other European economies. But US Treasury Secretary Hank Paulson is opposed to any move by the G-7 to support his nation's currency whose decline has helped US exporters and helps to narrow the US trade deficit.

But a weak US dollar does raise concerns among officials and investors here: Will central banks and investors start dumping their dollars? There aren't any signs that they are doing that.

Will it ignite inflationary pressures and make it difficult for the US central bank to continue cutting interest rates? But perhaps inflation will not be triggered in the short run since exporters to the US are not going to immediately raise their prices and may accept a profit squeeze as a way of maintaining their continuing presence in the American market.

Or will Saudi Arabia break its peg to the US dollar, to be followed by Qatar and the UAE? Indeed, it's important to remember that more than 70 per cent of the world's oil is denominated in the US dollar and that this link forces central banks to maintain stockpiles of greenbacks to pay for steady rising price of oil. Iraq under Saddam Hussein switched to euros and Iran and Venezuela have been threatening from time to time to do the same, while Russia has already made the conversion to euros and rubles.

But the Saudi central bank governor reiterated a commitment to the dollar peg on Sept 26 and denied that the Saudis are planning a revaluation against the US or are considering a link to a basket of currencies (which is the system that Kuwait is now maintaining).

Moreover, there are indications that the petrodollars being accumulated in recent years are being reinvested in US Treasury securities by up to US$123.8 billion this year.

Or to put it differently, the rising oil prices should be seen as good news in the sense that they are making it more likely that the oil-producing economies would continue to finance US debt despite the fall in the value of the US dollar.

From that perspective, the inflationary pressures that could be produced by rising energy prices that may follow a possible military confrontation between the US and Iran could be mitigated by the willingness of the Arab oil producing states - who oppose Iran - to continue use their petrodollars to finance US debt and allow the Fed to continue cutting interest rates.

At the same time, notwithstanding last December's warning by the Chinese central bank about the risks of the expanding US current account deficits and the weakening US dollar, there are currently no serious worries in Washington about Chinese plans to sell their holdings in US Treasuries.

The view in Washington is that the Chinese now have a serious problem of currency undervaluation, and that their global surplus is fuelling inflation in their economy and they need, in their own interest, to accelerate the appreciation of their own currency.

Copyright © 2007 Singapore Press Holdings Ltd. All rights reserved.


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