Analysts fear dollar decline could spin out of control

Global Finance, Nov 2003

FOREIGN EXCHANGE

THE AMERICAS

The Bush administration is seeking an orderly decline in the dollar ahead of the US presidential election in 2004 in the belief that a weaker dollar will mean more exports, more jobs and more votes, analysts say. They warn, however, that the dollar's slide could accelerate to the point that it becomes difficult to control.

President Bush himself has called for a level playing field in the currency market, and there is no indication that US policymakers are even remotely concerned about a potential problem in funding the current-account deficit, says David Gilmore, partner and economist at Essex, Connecticut-based Foreign Exchange Analytics.

"By assigning a low probability to a current-account funding problem for the US, the Bush administration is, in effect, elevating the risk of a dollar crisis," Gilmore says.

To be fair, the administration has achieved an orderly dollar decline in the last year since the policy was put into place, he says. "But our problem is, What happens if the dollar decline spins out of control and becomes disorderly?" he asks.

In periods of strong directional trades like the present, with the dollar marching steadily lower, the foreign exchange market usually keeps pushing the trend until official opposition is flushed out, Gilmore says. The market has a strong tendency to overshoot once a trend has set in.

"A dollar crisis is looming on the horizon," says Michael Rosenberg, global head of foreign exchange research at Deutsche Bank in New York. "The US current-account deficit will reach such high levels that it will be difficult to finance," he says. As the US economy recovers and capital spending picks up, the trade deficit could widen further.

According to Rosenberg, the meeting of finance ministers and central bank governors of the Group of Seven major industrial nations in Dubai in late September might prove to be a watershed event for the foreign exchange markets.

"The G-7 recognized that the dollar needs to weaken to facilitate a narrowing of the current-account imbalances," Rosenberg says. "The G-7 communique made it clear that the major policymakers would like to see less intervention and more emphasis placed on freely floating exchange rates."

What this implies, he adds, is that not only will private capital inflows to the US remain weak, but official capital flows from foreign central banks should moderate as well, as authorities around the world intervene less aggressively than in the recent past.

Foreign official buying of US Treasury securities has kept a lid on US interest rates until now, but if this buying diminishes, it spells trouble for the US bond market, Rosenberg says.