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Last Updated: Jun 25th, 2007 - 17:07:26 |
By Liam Halligan
The Telegraph, London
Sunday, May 14, 2006
On Friday the dollar plunged to a 12-month low. With sterling close
to $1.90 and further dollar falls likely, we could soon see a $2
pound.
Good news, then, if you have booked a holiday in America. But that
is where the good news ends. The dollar -- after a period of
sustained decline -- is now dangerously fragile against all major
currencies. That presents serious risks.
Friday also saw a one-year low against the euro. The dollar has, in
fact, sunk by almost 7 percent in just six weeks against America's
main trading partners. A slip of just 1 percent more, on the same
measure, will mark a 33-year low.
At the centre of this story is the large and widening US current
account deficit. Since 1995, as America has sucked in imports, this
trade gap has grown eight-fold. It now exceeds £800 billion --
almost 7 percent of the national income of the world's largest
economy.
Inevitably, this record-breaking "global imbalance" puts the dollar
under pressure. But in recent weeks its decline has been more
pronounced.
One reason is that while interest rates are rising around the world,
they are set to go up relatively more in Europe and Japan than in
the US. That makes the dollar less attractive.
The US Federal Reserve increased rates to 5 percent last week -- its
16th rise in less than two years. But the dollar kept falling
anyway, in part because of narrower "rate differentials."
But there is something far more significant. The dollar is
resolutely heading south, and will continue to do so, because of
what you might call "regime change."
Central banks around the world -- led by the Fed -- are tacitly co-
operating to bring about a managed dollar decline. The first signs
of this came at last month's Group of Seven finance ministers'
meeting in Washington.
That was followed by an unusually stark statement to Congress by Ben
Bernanke, the new-ish Fed chairman, who said
America's "international debtor" status "cannot continue forever."
The International Monetary Fund chipped in too, warning that
the "resolution of global imbalances" may require a "substantial"
dollar decline.
An even weaker US currency is the least painful way to address
America's yawning deficit. A cheaper dollar helps US exporters while
pushing import prices up.
But previous attempts to lower the dollar have been frustrated in
Asia. Reluctant to give away competitive advantage, countries in the
region -- notably China, but others too -- have intervened to stop
their currencies rising too far against the dollar.
But there are signs that the mood is shifting. This latest dollar
selloff has seen the greenback fall against the yen and the South
Korean won. Also, the US government, in its semi-annual currency
report, last week stopped short of accusing China of "manipulating"
the yuan. That paves the way for Beijing to revalue without losing
face.
The markets are referring to this perceived "deal" to weaken the
dollar as "Plaza lite." Back in 1985, faced with a similarly bloated
America, the industrial nations united to manage a smooth dollar
decline. That agreement was called the Plaza Accord -- after the New
York hotel where the meetings took place.
Speaking to Congress last month, Bernanke outlined the dangers of
defusing America's deficit. "While it is likely that current account
imbalances will be resolved gradually over time," he said, "there is
a small risk of a sudden shift in sentiment that could lead to
disruptive changes in the value of the dollar and other asset
prices."
In other words, the dollar could collapse -- causing more systemic
concerns that spread into equity markets. Could such a scenario
happen?
Well, with the markets becoming more convinced of "Plaza lite,"
traders are already quitting the dollar in droves. The currency's
sharp fall in recent days, in turn, has sparked fears about US
inflation. We are now seeing the result -- shares on Wall Street
have dived, a trend now affecting the City.
The dollar desperately needs to come down. But if Plaza lite goes
wrong and the currency becomes a one-way bet, we will be in serious
territory.
Last week Mervyn King, the governor of the Bank of England, did his
bit to convey that Plaza lite would work, precisely because it is
not explicit. "As the global imbalances start to unwind," he
said, "I think you'll find the major countries want to talk to each
other." I hope he's right. Because if this much-needed adjustment
goes wrong, it will be no holiday.
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