Saturday, December 02, 2006

Weak dollar

The Bush Administration has championed a weak dollar since it took power. This was one of his typical knee jerk reactions to be against anything Bill Clinton stood for. We now stand on a potential economic precipice and there's nary a discussion in the U.S. media about it. Instead, we turn to the UK's Independent Online. As the Independent notes, Brits are enjoying a strong advantage with the pound equating to almost $2 U.S. However, there are troubling issues:

But the fact is that the sharp rise in the pound - up 14 per cent against the dollar this year - is not a vote of approval for the UK economy but a damning verdict on the outlook of the world's largest economy by experts in the financial markets.

The dollar has been falling for much of this year but has taken a nosedive in the past few weeks, losing 4 per cent against the euro in the past month alone.

Experts have been warning that the US and the dollar have been living on borrowed time. Non-stop spending by US households has delivered a record trade and current account deficits. The dollar has held up because overseas investors, especially the Chinese and other Asians governments are keen to buy dollar assets.

But recent comments by the Chinese central bank about the need to move into other currencies helped trigger the start of the dollar's recent slump a week ago. Private investors have also be keen to buy into US Inc but the prospect of further falls in the dollar could encourage them to cash in their chips now, pushing the dollar down further and creating a vicious cycle.

In its most recent forecast the International Monetary Fund (IMF) warned that if that happened there would be a "disorderly unwinding" that would see a rapid fall in the dollar, volatile movements in the financial markets and a "significant hit" to the world economy. A weak dollar would put up the prices of imports, discouraging Americans from spending. It would ALSO drive up inflation and force the US Federal Reserve to raise interest rates. That could transform its stagnant housing market into a financial disaster zone. A consumer-led recession would hit those countries that have done well by selling to Americans.

According to the old adage, if the US sneezes, the rest of the world catches a cold; if the US succumbs to a cold then the rest of the world will get the flu.

Yesterday stock markets fell across the world as fears of a US slowdown stoked worries over the economic outlook.

While on Wall Street the Dow Jones index was down 40 points or 0.35 per cent, stock markets in Germany, France and Spain were all down more than 1 per cent and in London the FTSE 100 dropped 0.5 per cent

"The strong sterling will strengthen the headwinds for the UK economy as UK exporters take a direct hit and the consumer spending, the main driver of the UK economy, will come under further pressure," said Ted Scott, a UK equities fund manager at F&C.

The IMF yesterday declined to comment further. However after five years of issuing warnings over the dollar and the global imbalances, the IMF is taking action. It has launched multilateral talks to allow big players such as the US and China to talk frankly in private about the possible ways to reduce these imbalances without triggering the market reaction they dread.

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