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Trade Weighted U.S. Dollar Index - USD/EUR

Euron spricker när dollarn faller
Rolf Englund, Nya Wermlands-Tidningen 8/1 2001

Which is the tail and which is the dog?
The dollar is falling, the oil price is rising, bond yields are rising
and stocks have just endured two uncharacteristically tough days after a prolonged period of exuberance.
John Authers, FT 30 January 2018

It appears to be the dollar dog that is wagging everything else.

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Only the Argentine Peso is weaker against the greenback this year
One of the more remarkable things about this selloff is how broad based it is.
The dollar is weaker in 2018 against all major currencies.
Widening the basket to the extended majors, only the Argentine Peso is weaker against the greenback this year.
Bloomberg 25 January 2018

Greenback weakness would have far-reaching consequences for financial assets in 2018
FT 2 January 2018

Russell Clark, partner at hedge fund manager Horseman Capital Management, has noted how the so-called net international investment position (NIIP) of the US, which in effect measures the net assets of a nation against the rest of the world, has been significantly deteriorating in recent years.

Mr Clark notes how such large changes in a country’s net international investment position “tend to be good signs of potential currency weakness or of potential weakness in bonds where currency cannot make the adjustment”.

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Pundits have been saying last rites for the dollar’s global dominance since the 1960s
– that is, for more than half a century now.
But the pundits may finally be right
Barry Eichengreen, Project Syndiate 11 October 2017

To the consternation of many currency traders, the value of the dollar fluctuates widely, as its rise, fall, and recovery in the course of the last year have shown

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How the dollar’s weakness is the rest of the world’s problem
Forex markets pose a threat to a synchronised recovery needed to validate stock prices
Mohamed El-Erian, FT 13 September 2017

John Connally, when Treasury secretary in President Richard Nixon’s cabinet, famously told his European counterparts in 1971 that the dollar “is our currency but your problem”

Most economies now have to contend with a stronger headwind to growth and, in the case of Europe, downward pressures on an inflation rate that the central bank worries is already too low.

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The value of the dollar index, which tracks the dollar against six major global currencies, has fallen about 10% since January.

The dollar, which surged in 2014 as the US economy gained strength, is hardly in danger territory.
The index is running just a bit lower than it was a year ago.

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President Trump abandons the strong dollar policy
Gavyn Davies, 15 April 2017

President Trump’s remarks last week about the dollar and US monetary policy offer more evidence that
America’s strong dollar policy,
launched in 1995 by Treasury Secretary Robert Rubin when the dollar was near post-war lows, is now changing.

After 2002, the strong dollar policy officially remained intact under successive Administrations,
but the dollar itself refused to listen to the rhetoric, and
the real effective index fell to new all-time lows during the Fed’s programmes of quantitative easing, in 2009-13.

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President Donald Trump triggered a slide in the US dollar
as he complained the currency has risen too high
also revealed a major policy U-turn as he said that the US government would not label China a currency manipulator.
FT 12 April 2017

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Soaring Trump dollar risks global trade war and China currency crisis, warns Posen
Donald Trump will succeed in ramming through radical tax cuts and fiscal stimulus, causing US federal borrowing to balloon.
The Peterson Institute thinks the current account deficit could rise to 5pc of GDP.
Ambrose Evans-Pritchard, 11 April 2017

We expect the dollar to rise by another 10pc to 15pc.

A hawkish Fed could prove painful for investors still hoping that central banks will come to the rescue whenever there is trouble,
be it the 'Yellen Put' in the US, the 'Draghi Put' in Europe, or the 'PBOC Put' in China.

Politicians from the G5 powers ultimately intervened to drive down the Reagan dollar at the Plaza Accord in 1985,
with dire side-effects. That attempt to manipulate currencies in defiance of economic fundamentals led
- by a complex chain of causality - to the Nikkei bubble in Japan, and to the 1987 stock market crash on Wall Street.

Mr Posen is a former rate-setter on Britain's Monetary Policy Committee, best known for his work with former Fed chief Ben Bernanke on Japan's Lost Decade and inflation targeting.

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A modest proposal to save the world
Charles Gave on The End of the Dollar Standard
via John Mauldin 7 February 2017

Read more here

Det går bra för Sverige just nu, med mer än fyra procents tillväxt. De nya BNP-siffrorna för årets första kvartal visar på en snabb tillväxt i ekonomin, som troligen fortsätter ett tag till.
Längre fram kan diskussionen om hur bra det just nu går för Sverige framstå som aningslös och oansvarig.
Johan Schück, DN 10/6 2006

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The biggest single problem, however, is that there are trillions of U.S. dollars outside of the U.S. Unlike Americans, foreigners have no reason to hold them. And at some point very soon, perhaps when the Fed finally hits the wall on its ability to raise rates, these overseas dollars are going to start flooding back home, while the products and titles to real wealth flow out of America. Therefore, when the trade deficit starts turning around--which most people will think is a good thing--that will be the real tip-off the game is over. Trillions coming back to the U.S. will skyrocket long-term interest rates and inflation. The dollar will go into freefall.
Doug Casey, 13/6 2006

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- Det behövs en anpassning där dollarkursen försvagas
Men denna förändring kan komma successivt. Sannolikheten för ett plötsligt dollarras har minskat, säger Stephen Roach.
Jag är optimist om Kina, som gradvis kommer att lägga om sin politik. Kinesernas långsiktiga intresse är bygga upp sitt eget land, inte att köpa amerikanska statsobligationer.
Johan Schück, DN 1/6 2006

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One danger area - shared by his Bush predecessors at Treasury and some in the White House - may be his willingness to fall for the temptation of a weaker dollar.
In the 2004 PBS interview, Mr. Paulson said that "I really believe that the decline in the dollar, the orderly decline in the dollar, will lead to a natural adjustment" in the trade deficit.
Wall Street Journal 31/5 2006

Resolving the massive trade imbalances without a global cyclical downturn can be achieved,
but only if countries approach this challenge in a constructive way.
Instead of seeking to resist the dollar’s shift to a more competitive level, governments in Europe and Asia should focus on developing policies to maintain aggregate demand in their individual economies as their export sales decline.
Martin Feldstein, Financial Times 26/5 2006

Bernanke’s Sophie's Choice:
"The housing market or stock market Mr. Bernanke. You may only be able to try and save one..."
Brady Willett, May 18, 2006

OECD warns on global imbalances
Opening the global think tank's annual forum, Greek finance minister George Alogoskoufis said that the situation posed major risks to global economic stability.
"The large extent of deficits of some countries, combined with the surpluses of their trade partners and the oil-producing countries, can pose considerable risks to global economic stability, so it is crucial that we do something about them," Mr Alogoskoufis said.
BBC 22/5 2006

Markets have recently become worried that the growing US trade gap is unsustainable, and there is concern that a sharp fall in the dollar to boost US exports would unravel Europe's tentative economic recovery.

There is also concern that the US budget deficit is unsustainable in the long-term, and that tax increases are needed both to balance the budget and reduce US consumers' insatiable demand for foreign goods.

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Kan man undvika recession i USA när man måste minska importen
med 600 miljarder dollar?
Rolf Englund på Nationalekonomiska Föreningen 30/11 2004

The market is gripped by two scares: an inflation scare and a dollar scare.
Of the two scares, investors should worry less about US inflation and more about the dollar (though the two are obviously related).
Financial Times editorial 20/5 2006

Huvudfrågan kvarstår: vad händer när USA tvingas minska sitt underskott mot omvärlden, om inte överskottsländer - som Sverige - är beredda att ta ett större globalt ansvar?
Ingen centralbank, varken i USA eller någon annanstans, är villig att släppa fram en snabbt stigande inflation. Hellre låter man ekonomin gå in i en tillfällig svacka, även om den skulle övergå i recession
Johan Schück, DN Ekonomi 20/5 2006

The weak state of the dollar feeds fears of inflation.
Currency trading on Friday and Monday saw the dollar dip below ¥110—the level
below which Hiroshi Okuda, the chairman of both Toyota and the Japan Business Federation, recently said the government might have to intervene in the currency market.
It has also been flirting with one-year lows against the euro.
The Economist 17/5 2006

And even China, which has historically kept its currency cheap in order to subsidise exports, is showing signs that it is ready to let the yuan appreciate. News released on Tuesday that America’s housing market is weaker than expected pushed the dollar down further. Though expectations for higher inflation—and thus interest rates—have stemmed some of those losses, it is still trading near one-year lows.

A weaker currency would help America’s current-account deficit, which currently stands well above $800 billion, but it would also translate into inflationary pressure at home, by raising the price of imports.

This week we look at the links between the US trade deficit, the low savings rate in the US, home prices, and interest rates, all in an effort to answer the question: "Do trade deficits matter?"
"Deficits of US$800bn are perfectly sustainable, not just for many more years and decades but, if necessary, forever."
John Mauldin (An essay by Anatole Kaletsky) 12/5 2006

Charles and Louis-Vincent Gave, along with colleague Anatole Kaletsky answered in their book, Our Brave New World, that trade deficits do not in fact matter at all. It is different this time. They make a persuasive argument that the US trade deficit can last forever and that the deficit is in fact a sign of US strength, not weakness.

"This is one point which almost all economists and policymaking institutions - the Fed, the IMF, the OECD - all absolutely agree on: even if the US deficits were perfectly harmless or even desirable, they would soon have to be narrowed, because borrowing $800 billion a year is simply unsustainable. What I now want to tell you is that all these distinguished experts are exactly wrong.

"I cannot be sure whether the present US deficits are a good or a bad thing; but on their sustainability there is absolutely no doubt. Deficits of US$800bn are perfectly sustainable, not just for many more years and decades but, if necessary, forever. This is a matter of simple and irrefutable arithmetic.

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Analysts said that US policymakers are signalling they are happy for the dollar to decline by not aggressively talking up the currency.
A falling dollar would benefit the US economy by making US exports cheaper. That could help reverse the $700bn trade deficit.
BBC 15/5 2006

The dollar's fall could also increase the cost of US imports, thus fanning inflation and forcing the Fed, the US central bank, to continue to increase interest rates.

Figures last week showed that the total US trade deficit for the first three months of 2006 was $196.2bn, putting it on track to beat last year's record of $724bn.

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The US dollar suffered a severe sell-off on Friday, taking it to its weakest level against a trade-weighted basket of currencies since October 1997, in a tumble that helped to trigger falls across world equity markets.
The dollar ended at $1.293 to the euro
Financial Times May 12 2006

US government bonds also suffered, bringing the yield on the benchmark 10-year bond to its highest level in four years.

The dollar has lost 7 per cent against the euro, yen and sterling since the start of April – a slide that will in turn intensify worries about inflation in the economy. Traders are concerned about the role a weaker dollar will have in correcting the US current account deficit, which is now about 7 per cent of GDP.

In New York, the dollar ended at $1.293 to the euro and at $1.894 against sterling. Against the yen, it stood at Y110.02. Traders thought a correction was likely.

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The Stock Market

Let dollar fall or risk global disorder
Is it possible to reduce the US deficit substantially without exchange-rate changes. The answer is that it would be possible, but catastrophic for all participants, because it would demand a deep US recession
Martin Wolf, Financial Times, May 9 2006

The biggest threat to what was otherwise an “unusually favourable” economic environment
The International Monetary Fund on Wednesday stepped up the pressure for far-reaching shifts in exchange rates, declaring that the dollar will have to depreciate “significantly” over the medium term if global economic imbalances are to be resolved in an orderly fashion.
Financial Times 19/4 2006

By Krishna Guha and Scheherazade Daneshkhu

In its clearest statement to date on this highly-charged subject, the IMF said it was essential that currencies in Asia and of oil exporters were allowed to appreciate as part of the required “realignment of exchange rates”.

The statement came in the IMF’s twice-yearly World Economic Outlook, published on Wednesday, which highlighted global imbalances as the biggest threat to what was otherwise an “unusually favourable” economic environment.

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By Martin Wolf, Financial Times April 19 2006

Many in the US Congress blame China for their country’s huge and growing current account deficits. While the US economy is expanding strongly, protectionist pressure is contained. But what will happen during the next downturn? As Harvard university’s Martin Feldstein has also noted recently, such a downturn is hardly unlikely, since only exceptionally low savings and high borrowing by US households have sustained US domestic demand at levels sufficient to offset the country’s huge trade deficits.
The Case for a Competitive Dollar, www.nber.org

Why is the only workable solution a multilateral one? The first part of the answer is economic: the global balance of payments is inherently multilateral. Even if one focuses, wrongly, on bilateral balances, the US deficit with mainland China accounts for only a quarter of its overall deficit. In the global picture, we find that China’s current account surplus was roughly a sixth of the aggregate surpluses of oil exporters and advanced economies (other than the US) in 2005.

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Market interest in global imbalances waxes and wanes but the economic facts do not change. The US current account deficit is unsustainable in the long run.
To reduce it to manageable proportions by means other than a global recession will require macroeconomic policy changes on the part of surplus countries as well as the US itself.
These will have to be accompanied by big shifts in real exchange rates to alter the relative prices of imports and exports, traded and non-tradeable goods
Financial Times editorial 13/4 2006

To focus narrowly on China is misleading: the increase in its surplus since 1996 is about one-sixth the increase in the US deficit.

Other Asian economies show consistent big increases in reserves, too. These countries need to tackle far more urgently the domestic causes of external imbalances while allowing greater currency flexibility.

This would not eliminate the need for painful changes in the US, including a substantial rise in national savings. But it would provide the best possible global environment for such a necessary adjustment.

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Sveriges bytesbalansöverskott är lika stort som USA:s underskott
Enligt ett diagram hos Danne Nordling april 2006

Läs mer här

Many observers - including myself and the IMF - predicted in 2004 and later that high oil prices would lead to a U.S. and global economic slowdown; but such a slowdown actually did not actually materialize.
http://www.rgemonitor.com/blog/roubini/123823

Current-account deficits
Still waiting for the big one
Today Iceland and New Zealand. Tomorrow the United States?
The Economist print edition, Apr 6th 2006

When average interest rates in the developed world fell to a record low earlier this decade, investors wanted extra yields. They took bigger risks, dragging down risk premiums. Cheap money attracted capital into “carry trades”, where investors borrow short-term at low rates to invest in riskier, higher-yielding bonds, such as those issued by Iceland and New Zealand—or the American Treasury. By underpricing risk, investors have, in effect, subsidised extravagant borrowers, letting them run ever bigger deficits. A correction may be under way.

As yet, the greenback is little affected by Iceland and New Zealand—and not only because they are small. Money is still cheap. The Bank of Japan has ended its “quantitative easing”, but interest rates are still zero. America's bond markets have gained most from the yen carry trade (borrowing in cheap yen to buy American T-bonds), so future increases in Japanese interest rates will spur investors to ask if historically low yields still compensate for the risk of holding dollar assets. This week ten-year T-bonds were nudging 4.9%, up from 4.4% in January.

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Carry trade - Räntearbitrage

Why should we remain concerned about global imbalances? The answer is that they are undesirable, cannot continue indefinitely and the longer they last, the bigger and more painful the adjustment will be.
What is undesirable ought to change. What is unsustainable will change. What is dangerous must change. Yet, if the world is to avoid a serious recession, adjustment must start in the surplus countries.
Martin Wolf, Financial Times 29/3 2006

As Lawrence Summers, former US Treasury secretary, noted in a recent lecture on India: “There is one striking fact about the global economy that belies a predominantly American explanation for the pattern of global capital flows: real interest rates globally are low, not high.

As Charles Dumas and Diana Choyleva of London-based Lombard Street Research explain in a thought-provoking analysis, on lines also argued by Cambridge’s Wynne Godley, the driving force behind the global imbalances is Asia’s structural savings surplus, with China playing an increasingly significant role.** The US cannot safely diminish its excess spending if others do not diminish their excess saving at the same time.

First, the imbalances are the results of bad policies in the capital exporting countries. The global accumulation of $2,340bn (€1,945bn) in additional foreign currency reserves since the beginning of 2000 was the result of decisions to intervene in currency markets. At

The government and, above all the household sector, are in huge deficit. In 1982, the household sector ran a surplus of 5.5 per cent of GDP. Now it runs an unprecedented deficit of close to 7 per cent of GDP.

What is undesirable ought to change. What is unsustainable will change. What is dangerous must change. Yet, if the world is to avoid a serious recession, adjustment must start in the surplus countries.

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Reflections on Global Account Imbalances and Emerging Markets Reserve Accumulation
Lawrence H. Summers, March 24, 2006

Real Interest rates

More by Martin Wolf

America's imports of tradable goods are currently 89% larger than US exports of manufactured products.
Investors are nearly unanimous in dismissing the mounting economic and political tensions of an unbalanced world -
the retort of increasingly smug US fund managers is typically something along the lines of,
"What else are the Chinese going to buy - euros?
Blue-collar workers in factories have long been on the front line in facing global pressures. White-collar workers in services-based enterprises have not. That was then. The rules of engagement on the battleground of globalization have changed.
Stephen Roach, March 2006

America's record $68.5 billion trade deficit in January 2006 says it all: US imports and exports are now so far out of balance, that sustained solid growth in the US economy can only beget larger and larger external deficits. This could well be a major -- yet largely unappreciated - point of vulnerability for the global economy and world financial markets.

In the United States, total imports of goods and services are now 59% larger than exports.

America's imports of tradable goods are currently 89% larger than US exports of manufactured products. This astonishing mismatch between purchases of goods made abroad and overseas sales of American-made products is an important outgrowth of a huge surge in import penetration into the United States over the past 20 years. Goods imports rose to 37% of America's domestic purchases of goods in 4Q05 - up dramatically from readings of 27% in 1995 and 20% in 1985.

The income-based saving of America's asset economy is so low and the import penetration of its real economy is so high, that more growth in US aggregate demand simply begets ever-mounting trade and current-account deficits. This imposes enormous strains on the international financing mechanism to keep the game going. In 2005, the US needed about $3 billion of foreign capital inflows each business day of the year -- up dramatically from the $2 billion daily funding requirement just two years ago in 2003.

Investors are nearly unanimous these days in dismissing the mounting economic and political tensions of an unbalanced world - arguing that it is in everyone's best interest to keep the game going. The retort of increasingly smug US fund managers is typically something along the lines of, "What else are the Chinese going to buy - euros?

A globalization that moves from the tangible aspects of tradable goods activity to the more intangible functions of the Knowledge Economy is not well understood. But the impacts of this shifting character of cross-border integration could well be more powerful today than they were in the past. Blue-collar workers in factories have long been on the front line in facing global pressures. White-collar workers in services-based enterprises have not. That was then. The rules of engagement on the battleground of globalization have changed. Like manufacturing, the services economy is now on the leading edge of feeling the stresses and strains of an increasingly competitive and open world economy. This is an extraordinary development in the continuum of economic history.

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EMU

Factor-price equalization - Faktorprisutjämning

More by Stephen Roach

New figures coming out of the US economy confirms that in almost every respect
it is doing significantly better than expected. It is impressive.
Former Prime Minister Carl Bildt 6/12 2005

Carlos Gutierrez, commerce secretary, said the US had almost run out of patience waiting for China to take significant steps to reduce its ballooning $200bn trade surplus with the US
Financial Times 16/3 2006

Mr Gutierrez said: "China’s failure to address economic frictions will have consequences. "Without concrete results, the administration, and the American people, may be forced to reassess our bilateral economic relationship.

The /US/ current account deficit hit £224.9bn in the final quarter of 2005, a record 7 per cent of GDP.
Michael Woolfolk, senior currency strategist at Bank of New York, pointed out that the deficit was now twice the 3.5 per cent of GDP that prompted the G7 to devalue the dollar after the Plaza Accord of 1985.
Financial Times 14/3 2006

2005 the current account deficit reached $805 billion, the biggest ever, 6.5 percent of GNP
"It is certainly something to worry about," said Martin Feldstein, at Harvard University and president of the National Bureau of Economic Research.
"Continuing to attract funds when the current account deficit is that large and continuing to rise is bound to become a serious problem"
Bloomberg 14/3 2006

The key to the economy’s strength in 2004 and 2005 was that household saving declined
In dollar terms, saving fell from a $205bn annual rate in the third quarter of 2003 to dissaving at a rate of $159bn two years later.
This shift of $364bn in the annual rate of saving far outstripped the fall in income caused by the higher cost of oil.
Martin Feldstein, Financial Times 3/2 2006

Global imbalances
Issue #1: The quantity of analysis devoted to the so-called "global imbalances" is extraordinary. As is usual with economists, we have reached no conclusion. Yet what is happening is extraordinary enough to merit an attempt at least to clarify the basis of the disagreements. I suggest the discussion needs to be focused around five questions:
first, what is actually happening?
Second, why has the US developed such large current account deficits?
Third, in what sense, if any, are these deficits a matter for concern?
Fourth, what is likely to happen and over what time period?
Finally, to the extent that they are a concern, what actions should be taken to deal with them and by whom?
Martin Wolf, introduction with list of invited economists

US trade deficit widens to record $68.5bn
Overall the deficit deteriorated by $3.4bn, but only $700m of this was due to the rising bill for petroleum imports.
Financial Times 9/3 2006

Although US exporters put in a strong performance, raising overseas sales by $2.8bn to $114.4bn, they were unable to keep pace with the blistering pace of import growth. Imports were up $6.2bn to $182.9bn.

Overall the deficit deteriorated by $3.4bn, but only $700m of this was due to the rising bill for petroleum imports. The deterioration was spread across a range of sectors, from capital goods to consumer goods and industrial supplies. The deficit was around 17 per cent higher than January last year and almost double the deficit for the month period in 2001.

The annual Economic Report of the President
It’s in chapter 6 that the gang really becomes its most imaginative. Why admit to a chronic malady known as the current account deficit when tautologically you can discuss, and in fact label the entire chapter "The U.S. Capital Account Surplus!"
Bill Gross, Pimco, March 2006

A surplus sounds better than a deficit does it not? And if these surplus inflows reflect foreign investor preferences for "higher risk-adjusted U.S. returns," then all the better. You see folks, it’s not that we’re spending too much, it’s that foreigners are "pushing" (yes those are the authors’ words) in these funds because we’re so damned productive and we’ve got no recourse but to reap the rewards and shop ‘til we drop.

Nowhere in the chapter is there a chart on the current account deficit. Instead we are treated to the rosier mirror image appearing in Chart 4 – "Net Capital Inflows." Additionally, we are told that these inflows (deficits) can continue indefinitely as long as we use these investments (spending) to promote economic growth.

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He had presided over the greatest prosperity in U.S. history when Calvin Coolidge announced from the Black Hills of South Dakota, “I do not choose to run for president in 1928.” In March 1929, Coolidge turned the presidency over to Herbert Hoover, the commerce secretary he derided as “The Wonder Boy.” Six months later came the Wall Street crash and Great Depression with which Hoover’s name is forever associated. Coolidge was enjoying retirement.
Is Alan Greenspan the Calvin Coolidge of our time?
Patrick J. Buchanan, february 2006

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The American Conservative

1929

When listening to the mainstream news media report on economic growth, the indifference with which correspondents discuss the economy's dependence on consumer spending never ceases to amaze.
Tim Iacono, 2/2 2006

Consumer spending is the largest component of GDP. It accounts for 70 percent of GDP in the U.S.

In and of itself, consumer spending is not bad. Consumer spending is a necessary and good thing. Only when consumer spending is too much or too little should there be concern.

RE: See also Keynes

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POLICY IMPLICATIONS OF GLOBAL IMBALANCES
The world will be living for a considerable period of time with some risk of large movements in relative prices,
greater volatility in asset prices, and periods of slower growth
Speech by Timothy F Geithner, President and Chief Executive Officer, Federal Bank of New York
Chatham House, 23 January 2006

Using the inflation expectations derived from the TIPS (Treasury Inflation-Protected Securities), along with measures of inflation risk premia, we can conclude with some confidence that a key factor holding down forward nominal rates is a significant reduction in expected future inflation and increased confidence in those expectations. Inflation and inflation risk are not the whole story though, as forward real rates in both the United States and many other countries have declined to unusually low levels.

This raises the interesting question of how these imbalances have persisted on a path that seems unsustainable with so little evidence of rising risk premia.

The trajectory of the U.S. current account deficit has led most observers to conclude the U.S. external imbalance is unsustainably large and will have to come down over time. Beyond this general judgment about unsustainability, there is little consensus on how this adjustment process will unfold or on its implications for economic activity and financial markets. The plausible outcomes range from the gradual and benign to the more precipitous and damaging.

The size of the imbalance and the inevitability of eventual adjustment, however, mean that the world will be living for a considerable period of time with some risk of large movements in relative prices, greater volatility in asset prices, and periods of slower growth in the United States and in the rest of the world.

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Chatham House

ALAN GREENSPAN
has been proclaimed “the greatest central banker who ever lived”. Among ordinary Americans he enjoys almost rock-star status. He has been awarded the Presidential Medal of Freedom, a British knighthood and the French Legion of Honour.
Does he really deserve such uniform praise?
The Economist, 12/1 2006

The US current account deficit increased from $668bn in 2004 to an annual rate of $790bn in the first three quarters of last year and is widely predicted to move much higher in 2006. This unprecedented level is equal to 6.4 per cent of US gross domestic product.
Experts estimate that the real trade-weighted value of the dollar must fall by at least 30 per cent just to shrink the trade deficit to a more sustainable level of 3 per cent of GDP. Much larger dollar declines are also possible.
Martin Feldstein, Financial Times, January 10 2006

In the mid-1980s, current account deficits of less than 4 per cent of GDP triggered a 40 per cent fall in the real trade-weighted value of the dollar.

The current small interest rate differences in favour of US bonds are not nearly enough to compensate investors for the fall in the dollar that is likely over the next few years.

At some point, that will trigger a shift away from the dollar... That that has not happened already reflects investors’ belief that it is still possible to benefit from the interest differentials before the dollar depreciates. That sanguine belief may, however, reflect a serious misunderstanding of the magnitude and nature of the capital flow to the US.

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The U.S. trade deficit improved slightly in November but was still the third highest on record
Economists believe that when December figures are included, the final deficit for 2005 will top $710 billion.
Fox News 11/1 2006

When the euro gains, people in Europe get nervous that it's going to hurt employment, said Robert Mundell, an economics professor at Columbia University in New York and winner of the 1999 Nobel Prize in economics.
I don't see the euro in the $1.40s for long.
Bloomberg 8/5 2007

The currency may decline at least another 10 percent by the end of 2008, say Jay Bryson, an economist at Wachovia Corp., and Kenneth Rogoff, the former chief economist at the International Monetary Fund.
The dollar has only fallen 3.4 percent in the past two years to a 10-year low, according to a Federal Reserve index that weighs trade with 38 countries including China, Mexico, Canada and countries in Europe.
It tumbled 30 percent in the three years ended 1988.

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Robert Mundell

What if Pharaoh had beheaded Joseph for daring to suggest higher taxes during the fat harvest years so people would not starve during the lean ones? Instead, Egypt’s leader cast his lot with the world’s first recorded business cycle theorist and the rest is, well, history.
But are our leaders today preparing for the inevitable downside of the cycle? I wonder.
Kenneth Rogoff, Financial Times, January 2 2006
The writer is professor of economics at Harvard University and former chief economist at the International Monetary Fund

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Many people may not know the name Ben Bernanke.
The huge trade deficit, with its flood of cheap goods, has helped to keep inflation in check. So eventually, the adjustment to the trade gap could involve both a slowdown in consumer spending and at the same time increased pressure on prices
BBC 2/1 2006

Let’s begin with a riddle: Why is the dollar like a Republican president?
Answer: Because the dollar faces incessant predictions of imminent collapse, but in the end it wins out over weaker alternatives.
There are only three currencies in the “global store of value” league: the dollar, the euro, and the yen.
John Makin, American Enterprise Institute, 29/11 2005

One of the most basic explanations for the dollar’s persistent strength in the face of a steadily rising current-account deficit goes beyond the usual fundamentals of economic performance and central bank credibility: that is the ability of dollar-based asset markets, especially U.S. bond markets, to serve as a vehicle to store wealth on a massive scale.

Petroleum exporters need to store tens of billions of dollars’ worth of currency, and they need to have ready access to the funds they choose to store. New Zealand, for example, may offer an attractive rate of return, a solid central bank, and strong economic performance. But ...

There are only three currencies in the “global store of value” league: the dollar, the euro, and the yen.

The European Central Bank faces the difficult task of running monetary policy over an unwieldy currency area. The monetary policy that works for Germany does not work for Italy. However, the fact that both use the euro as their currency means that both must function under the same monetary policy.

A single central bank like the European Central Bank, which faces twelve separate finance ministries, each with its own special problems, is hard-pressed to inspire confidence in its long-run independence.

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EMU

Managing an economy with demand at 107% of income/GDP involves continually stoking up confidence to ensure capital gains to justify rising household debt take-up – without which the economy founders into a deflationary spiral.
Leigh Skene, an independent economic consultant in Lombard Street Associates, December 2005

Since June 1970’s emergency liquidity injection after the Penn Central default, the Fed has been consistently biased toward ease, except for Paul Volcker’s turn-round of inflation in 1979-86. Sustaining asset prices has taken priority over financial balance within the economy. This is the “Greenspan put”, investors’ assumption that the Fed will salve ill-judged financial risks by boosting liquidity to prevent or minimise losses.

The resulting moral hazard has progressively worsened credit quality, as debts rise to progressively higher levels relative to income. Since the 1997 Asian crisis, the US appetite for debt has been satiated by extraordinary burgeoning surpluses in Japan, China, Pacific Tiger economies, Russia, and German-centred north-central Europe. Running deficits and foreign borrowing has moved from being the default option to a global Keynesian necessity.

But the US gets ever less “bang for the buck” from deficit financing. Managing an economy with demand at 107% of income/GDP involves continually stoking up confidence to ensure capital gains to justify rising household debt take-up – without which the economy founders into a deflationary spiral. Managing confidence is hard. It is inherently unstable. Right now it is high. The economy is booming. Higher interest rates will soon result, threatening bust.

Lombard Street Research (Tim Congdon)

The imbalances are now enormous, far more glaring than at any point in the past.
Reducing any one imbalance to zero, or even compressing them all to a more manageable level, appears to be impossible without a major upheaval
Peter Bernstein, cit. by John Mauldin 23/12 2005

Peter Bernstein sent me the following paragraphs which he wrote in 2003, which are even more pertinent today. Peter has a grasp of economic history and investments that those of us who are merely mortal look upon with awe. At 80 plus and still writing and going strong, he is the author of numerous books. If you have not read "Against the Gods, the Remarkable Story of Risk" you are in for a treat. It is easily in the top 2 or 3 books I recommend for anyone to read

"Of one thing we are certain: current trends are not sustainable. The imbalances are now enormous, far more glaring than at any point in the past. Furthermore, the linkages of the parts are so tightly knit into the whole that reducing any one imbalance to zero, or even compressing them all to a more manageable level, appears to be impossible without a major upheaval. A hitch here or a tuck there has little chance of success. When it hits, and whichever sector takes the first blows, the restoration of balance will be a compelling force roaring through the entire economy - globally in all likelihood. The breeze will not be gentle. Hurricane may be the more appropriate metaphor."

They buy our debt. We buy their stuff. They know, as we saw last week from the quote from the Chinese banking official, they are going to get screwed (that is a technical economic term) on their dollar holdings. But what else can they do?

The first of the baby boomers reach 62 in 2007. We are looking retirement in the eye

Saving patterns are going to change. When, not if, we see the next economic slowdown, we will see another drop in the stock market. If we get a full blown recession, the average drop is 43%. I think boomers will begin to slowly panic as they watch their retirement dreams drop faster then the NASDAQ 100. It will be the usual process. Denial, anger, despair and finally reality hits and they re-set expectations and start a new plan which will mean more saving and less spending.

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The late Herbert Stein is famous for saying that what can’t go on forever, won’t.
This then is a world of strong growth.
Martin Wolf, Finacial Times 21/12 2005

This then is a world of strong growth. Yet it is also a world with high corporate profitability, but feeble investment; one with rapid growth, but large fiscal deficits and low real interest rates; and one with fast-growing poor countries that finance household consumption in the richest. It is also, not coincidentally, a world of globalisation, low inflation and credible central banks.

The late Herbert Stein is famous for saying that what can’t go on forever, won’t. The US will not be the world’s spender and borrower of last resort forever. But when will it cease to be so? That question remains for 2006.

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Stein's Law: If something cannot go on for ever it will stop.
Rolf Englund: U.S. Trade Deficit: Causes, Magnitude and Consequenses, May 2001

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The U.S. trade deficit unexpectedly widened to a record $68.9 billion in October
Imports rose 2.7 percent and exports increased 1.7 percent
Bloomberg 14/12 2005

BBC: Earlier this week, China announced its own trade surplus was at $90.8bn for the first 11 months of 2005, three times the level of the previous year.

New figures coming out of the US economy confirms that in almost every respect it is doing significantly better than expected. It is impressive.
Former Swedish Prime Minister Carl Bildt blog 6/12 2005

Sedan 1992 har Sverige haft rörlig växelkurs, vilket i teorin skulle omöjliggöra framtida devalveringar.
Vad som i praktiken skett är att marknaden successivt skrivit ner värdet på våra pengar.
Peter Wolodarski, signerat, DNs ledarsida 9/12 2005

The number of zeros on formal statistics sometimes disguises their real meaning.
The US government currently borrows $5,000 a year on behalf of each US family, which it dares not tax for electoral reasons. This is the source of the budget deficit.
That uncollected money remains in the hands of the family, which currently prefers buying foreign goods and spends $5,000 on them, producing the trade deficit.
Paul Tustain 6/12 2005

The foreign supplier sends the $5,000 back to the US by buying government bonds and American businesses. This money from abroad is the source of the fine-sounding US capital inflow.

The demand which has sustained growth for twenty years has arisen from this money being spent twice, and this duplicated spending is the only explanation that is needed to understand the remarkable strength of the USA's economy. But the legacy of it is this $74,000 tax debt for each of just over 100 million families.

How serious is a $74,000 tax debt? We don't know because it has never happened before, but we do know that in Argentina in 2001 their sovereign public debt was about $12,000 per family, and at that level it triggered the capital flight which was the direct cause of their debt default and subsequent economic crunch.

To resolve the US public debt problem safely is very difficult. Raising taxes to the required level is unthinkable - both electorally and because it would hurt domestic spending and feed back into a deflationary spiral of declining output and demand. Trade protectionism was tried before and it triggered tit-for-tat trade restrictions and global depression. Meanwhile formal debt default is unnecessarily dramatic, but it seems it can be effected without the same national loss of face by a policy which allows the dollar to bleed value: so serious inflation seems much the most likely result.

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New figures coming out of the US economy confirms that in almost every respect it is doing significantly better than expected. It is impressive. Former Prime Minister Carl Bildt 6/12 2005

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The dollar’s surprise strength this year has been partly caused by Opec’s recycling of petrodollars.
The currency has risen 13.5 per cent to $1.17 against the euro when most commentators had forecast a fourth straight year of losses.
Financial Times, 5/12 2005

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Under the placid surface, there are disturbing trends: huge imbalances, disequilibria, risks - call them what you will. Altogether the circumstances seem to me as dangerous and intractable as any I can remember, and I can remember quite a lot.
What really concerns me is that there seems to be so little willingness or capacity to do much about it.
Paul A. Volcker, Washington Post, April 10, 2005

The writer was chairman of the Federal Reserve from 1979 to 1987. This article is adapted from a speech in February at an economic summit sponsored by the Stanford Institute for Economic Policy Research.

It's not that it is so difficult intellectually to set out a scenario for a "soft landing" and sustained growth. There is a wide area of agreement among establishment economists about a textbook pretty picture

But can we, with any degree of confidence today, look forward to any one of these policies being put in place any time soon, much less a combination of all?
The answer is no.

A wise observer of the economic scene once commented that "what can be left to later, usually is - and then, alas, it's too late."

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How do we get out of this scenario alive?
By Rolf Englund, Financial Times 4/10 2005
Clyde Prestowitz, like many other commentators, warns us of what could happen: "a decline in the dollar, a rise in interest rates, a slowdown in growth, a rise in unemployment and declining home equity and household wealth - in a word, a recession, if not a depression"

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New figures coming out of the US economy confirms that in almost every respect it is doing significantly better than expected. It is impressive.
Carl Bildt blog 6/12 2005

Jean-Philippe Cotis, Chief Economist:
Worsening fiscal and current account imbalances present policymakers with clear challenges. Addressing them successfully will require substantial policy adjustments.
OECD Economic Outlook No. 78, November 2005
Very Important Article

With price stability being maintained, a powerful impetus arising from the Asian and US economies and the respending of oil exporters’ higher revenues, the case for a prolonged world expansion, finally extending to convalescent European economies, looks plausible. This is indeed the baseline presented in this Economic Outlook.

But the risks surrounding such a forecast are substantial. They include a renewed surge in oil prices, ever-worsening current account imbalances and abrupt exchange rate realignments, as well as long-term interest rate back-ups and asset price reversals.

It is worrying in this context that current account imbalances seem set to widen substantially over the next two years, with the US external deficit exceeding 7% of GDP in 2007 while China and Japan move into extremely large surpluses.

These imbalances largely reflect inadequate macroeconomic policies, notably large fiscal deficits and tax incentives biased against savings in the United States and “mercantilist” exchange rate management geared towards market-share maximisation in several emerging Asian economies.

As stressed in previous Economic Outlooks, such a policy configuration contributes to increasing the probability of a disorderly unwinding of current account imbalances, coupled with an evaporating appetite for dollar-denominated assets.

The economic consequences of such a shift in market preferences seem clear: long-term interest rate back-up and falling asset prices, including house prices, in the United States; steep currency appreciation and strong deflationary risks in those areas outside the United States (Japan, euro area) where core inflation is already low and sometimes falling; and, finally, weakening world growth.

In the United States, where aggregate demand is buoyant, there is a clear need for early fiscal retrenchment and tax reform to redress the saving/investment balance in conjunction with the current tightening of monetary policy.

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Evening in America
Empire of Debt, John Mauldin, December 2, 2005

There are two stories in Empire of Debt. The first is the traditional argument of the Austrian economic school. You cannot forever run trade deficits. Eventually your currency will collapse, as people will not want any more of it. To repeat the quote at the beginning of the letter:

"The economy in its entirety must continue to decline so long as more is being consumed than produced, and some part of consumption therefore takes place at the expense of the existing capital stock." - Friedrich August von Hayek (Nobel Laureate, 1974)

But the evidence of that decline is not yet present. America and its currency seem to continue to prosper, even when no other nation has ever run such huge deficits without seeing a major, if not disastrous, currency revaluation. How can this be?

"As the Anglo-Saxon economies lost their competitive edge in manufacturing, they tried to make up for it by encouraging consumption. This is the biggest fraud of all. At first, higher consumption feels good. It is like burning the furniture to keep warm; it feels good for a moment. But the sense of well-being is extremely short-lived. When people borrow and spend, they feel as though they are getting richer--especially when their houses are rising in price. The increased consumption even shows up, indirectly, in the GDP figures as growth. But you don't really become wealthier by consuming. You become wealthier by making things you can sell to others--at a profit. The point is obvious but, at this stage of imperial finance, it was inconvenient."
- Empire of Debt, page 224.

"The continuous injection of additional amounts of money at points of the economic system where it creates a temporary demand, which must cease when the increase of money stops or slows down, together with the expectation of a continuing rise in prices, draws labor and other resources into employments which can last only so long as the increase of the quantity of money continues at the same rate--or perhaps even only so long as it continues to accelerate at a given rate . . . would rapidly lead to a disorganization of all economic activity."
F. A. Hayek

But how did we get here? How did we get to a place where we run $700 billion(!) trade deficits? How did we arrive at a time when foreigners own an ever increasing percentage of US debt, where savings in the US is negligible and we consume some 70-80% of the rest of the world's saving so that we can continue to consume? We are beholden to the kindness of strangers, and more specifically China and Japan. The authors contend that if they pull the plug - if they stop buying our debt - our currency will collapse, our interest rates soar and our housing market collapse, sending us into a deep recession.

"Primitive people play primitive roles. They are no less intelligent than the rest of us, but they would be out of character if they began doing calculus. They have their parts to play just as we do. Sophisticated people play sophisticated roles. They are no smarter than anyone else, but you still don't expect them to wear bones through their noses. We, citizens of the last great empire, have our roles to play too, and the empire itself, must do what an empire must do.

You can get Empire of Debt at www.amazon.com. You can also get a copy of Our Brave New World at www.gavekal.com. I suggest you get the book which you think will most upset you, if not both.

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Hayek

If the pernicious drift toward fiscal instability in the United States and elsewhere is not arrested
the adjustment process could be quite painful for the world economy
pernicious \pur-NISH-us\, adjective: Highly injurious; deadly; destructive; exceedingly harmful.
Alan Greenspan 2/12 2005

What is special about the past decade is that the decline in home bias, along with the rise in U.S. productivity growth and the rise in the dollar, has engendered a large increase by U.S. residents in purchases of goods and services from foreign producers. The increased purchases have been willingly financed by foreign investors with implications that are not as yet clear.

At some point, foreign investors will balk at a growing concentration of claims against U.S. residents, even if rates of return on investment in the United States remain competitively high

In addition, efforts by U.S. residents to address their domestic imbalances will presumably contribute to a move away from current account imbalance.

Kommentar av Rolf Englund:
Höjda skatter, eller sjunkande huspriser, t ex, leder till minskad disponibel inkomst och minskad import, liksom till minskad produktion och sysselsättning.

If the currently disturbing drift toward protectionism is contained and markets remain sufficiently flexible, changing terms of trade, interest rates, asset prices, and exchange rates will cause U.S. saving to rise, reducing the need for foreign finance and reversing the trend of the past decade toward increasing reliance on it.

If, however, the pernicious drift toward fiscal instability in the United States and elsewhere is not arrested and is compounded by a protectionist reversal of globalization, the adjustment process could be quite painful for the world economy.

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Alan Greenspan

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A method to the dollar madness
So what's going on? Currencies are supposed to tumble in price when trade deficits climb this high.
The dollar's up because the euro is down
Jim Jubak, CNBC 15/11 2005

The U.S. dollar doesn't have to be a perfect currency; it just has to be better than the competition, the euro. (The yen, given Japan's negative real interest rates, isn't a starter in this race.) And it would be hard over the last six months to find a currency that's suffered more body blows than the euro.

4.56%, the yield on the U.S. 10-year Treasury note is significantly higher than investors collect on either European or Japanese bonds.

High oil prices

It's hard to imagine that, in a year, the political and economic chaos in Europe will be worse than it is now.

The global flow of dollars currently goes from real-estate-rich U.S. consumers, via gas pumps, to the portfolios of Middle East (and other oil-exporting) nations and then back into U.S. Treasurys.

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Politicians and pundits explain /US/ current-account deficit by pointing at China.
In fact, the of countries with the biggest surpluses is no longer Asia but oil exporters
This year, oil exporters could haul in $700 billion from selling oil to foreigners.
The Economist, 10/11 2005

Despite the lack of hard data, many economists are sure that a big dollop of petrodollars is going into American Treasury securities. If so, the recycling of money via bond markets could have very different effects on the world economy from the bank-mediated recycling of previous oil booms.

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End of the Oil Era

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The key in part is will people maintain confidence in the dollar
There is a sense that there is no alternative around - That's what supports this. But if the people lose the sense, and they don't want to hold any more dollars, then we have a problem.
Former U.S. Federal Reserve chairman Paul Volcker, The China Post 3/11 2005

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Higher interest rates have produced a rally in the U.S. dollar
The dollar is even up 12% this year against the euro, after falling by almost 50% against the European currency from 2002 to 2004.
Jim Jubak 4/11 2005

Higher interest rates have produced a rally in the U.S. dollar, which makes U.S. exports less competitive in global markets and puts even more downward pressure on U.S. economic growth. I know it's perverse: The U.S. is running enormous trade deficits that leave us dependent on the savings of strangers; no one in Washington gives a second thought to spending billions we don't have; and companies in core U.S. industries such as autos and airlines are flocking into bankruptcy. But the U.S. dollar has rallied against most global currencies. This week the dollar hit a 25-month high against the Japanese yen, after gaining 14% in 2005 against the yen. The dollar is even up 12% this year against the euro, after falling by almost 50% against the European currency from 2002 to 2004. A higher dollar makes U.S. exports more expensive for foreign consumers. U.S. companies can combat that by outsourcing more production to cheaper, non-dollar international economies, and by firing U.S. workers and hiring workers in those same cheaper non-dollar economies. But those adjustments produce lower incomes in the U.S. and cut into U.S. economic growth. The Fed's policy of hiking U.S. interest rates has contributed to this drag on growth, as well, since higher U.S. rates have propped up the U.S. dollar against other currencies.
So why is the Fed pushing up interest rates further when it could be so harmful to the economy?
When all you've got is a hammer, all problems look like nails.

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Euron

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It never fails. Every presentation or speech I have made on the economics of global rebalancing over the past three and a half years almost always ends with the same question:
“When will these adjustments ever occur?”
The history of the past few years is littered with false alarms over the coming US current account adjustment. Call it the “boy-cries-wolf syndrome”. The longer the world endures mounting imbalances without suffering any serious consequences, the more the financial market consensus believes this disequilibrium is sustainable.
Stephen Roach, Financial Times, 1/11 2005

The writer is chief economist at Morgan Stanley

America’s record current account shortfall will account for about 70 per cent of the total deficit positions in the global economy in 2005.

By contrast, the incidence of surpluses is far more diffused: it takes some 10 economies to account for 70 per cent of the total global current account surplus in 2005.

And the situation is likely to go from bad to worse. In large part, that is because America’s national savings outlook is about to enter a new phase of deterioration. In a post-Hurricane Katrina, energy-shocked climate deterioration is likely in all three big components of domestic US saving – for households, for the government sector and for businesses. The impacts of America’s increased draw on the global savings pool are likely to be compounded by recoveries in several key surplus economies. That is true in Japan and could well be the case in Germany.

In the end, the history of economic crises is clear on one important thing: the longer any economy holds off in facing its imbalances, the greater the possibility of a hard landing. In my view, an unbalanced world has waited far too long to face up to the heavy lifting of global rebalancing. I would reluctantly conclude that there is now about a 40 per cent probability of a hard landing at some point in the next 12 months.

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OECD: Economic Survey of the United States 2005
Published on 27 October 2005

Buttonwood was among those early in the year who expected the dollar to go every which way but up.
How wrong can a columnista be? Why didn’t the currency behave as she told it to? Don’t deficits matter? Buttonwood, The Economist 25/10

The currency has gained more than 10% this year, hitting a two-year high against the yen last week and a three-month peak against the euro.

Yet if all this sounds too Goldilocks to be true, it probably is, for a couple of reasons.

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Comment by Rolf Englund:
I never thought that I would argue that Stephen Roach is neglecting the US Trade Deficit. But so be it. What will happen to the US inflation rate when the dollar dips?

Did I hear "New Era" and "This time it is different" ?
end of comment

The New Inflation
it is not clear what type of inflation -- CPI or asset-based -- will arise from excess monetary accommodation.
We've learned a lot about inflation in the past 35 years. From the double-digit price increases of the 1970s to a close brush with deflation in 2003
Stephen Roach, October 17, 2005

It’s often forgotten that when Bush come to power in early 2001 the US economy was in recession. Since then there has been three waves of tax cuts – the last in 2003 – and a remarkable improvement in the performance of the US economy.
More than 4 million new jobs have been created, and unemployment has dropped below 5 %. Productivity has been increasing very fast. And the federal budget deficit has started to shrink as a result of the rapid growth in tax income.
Carl Bildt blog 13/11 2005

Even with the very high rates of increase in federal spending, on present trends the federal budget might well be in balance by 2008.

Few things tend to cause as emotive reactions as proposals to cut taxes. Critics are quick to offer predictions of the likely effect ranging from just bad to truly cataclysmic in their negative consequences.

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Se även: New Era

Cataclysm

Our trade deficit is now roughly the size of the current account deficit, and very large relative to our export base. And our net investment income balances are now likely to move into deficit.
These imbalances matter because at some point they will have to reverse. Market forces will at some point induce an adjustment. And that inevitable process of adjustment will bring with it the risk of large movements in relative prices, greater volatility in asset prices and slower growth in the United States and in the rest of the world. The magnitude of this risk is difficult to measure with any confidence. Past episodes of external adjustment offer some reassurance, but the present circumstances seem sufficiently different from historical precedent that history may not be a particularly useful guide.
Tim Geithner, President of the Federal Reserve Bank of New York, 19/10 2005

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Because the U.S. imports about 50 percent more goods and services than it exports, exports have to grow about twice as fast just to stabilize the trade deficit, economists said.
The U.S. trade deficit widened to $59 billion in August
Bloomberg 13/10 2005

It is little wonder that Mr Greenspan has become an almost legendary figure. Yet how good has his performance been and what lessons does his tenure bequeath?
Mr Volcker had to crush inflation. Mr Greenspan had merely to keep the show on the road.
Another reason for questioning the unique sagacity of the chairman is that low inflation has broken out all over the world.
Surprisingly for a man once known as a gold bug and disciple of Ayn Rand’s libertarian philosophy, Mr Greenspan has emerged as the policymaker closest in spirit to Maynard Keynes.
Martin Wolf, Financial Times, 19/10 2005

You didn't need an oracle to know that Delphi would end up in America's bankruptcy courts
Delphi's future pension obligations alone are valued at $8.5 billion.
Estimates of GM's potential liability to Delphi range from $1.5 billion to $11 billion
The Economist 13/10 2005

The world's biggest maker of car parts has been crushed not least by the legacy of generous pension and health-care promises made in the past to its American employees. Despite Delphi's annual revenues of $28 billion, in a market increasingly served by low-cost workers in places like China and with raw-material costs soaring these benefits are no longer affordable.

Delphi's future pension obligations alone are valued at $8.5 billion. Some $4.3 billion of that is “unfunded”—ie, the firm has failed to put aside enough money to meet its obligations. Its unfunded health-care promises are even larger.

Estimates of GM's potential liability to Delphi range from $1.5 billion to $11 billion. Alas for the carmaker, such numbers are dwarfed by its own existing pension and health-care burden, now so large that there is increasingly talk in Detroit that it too may be driven into bankruptcy.

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U.S. companies have announced plans to repatriate about $206 billion in foreign profits under a special one-year tax break.
A law signed by President Bush shortly before the 2004 election allows companies to transfer profit from overseas operations back to the U.S. this year at a special low tax rate of 5.25%.
Wall Street Journal 5/10 2005

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What is most alarming about the current external trend is that the fall in the exchange rate of the dollar during 2002-04 had no appreciable impact at all in terms of reducing the trade balance.
The 2001 changes pushed tax receipts down toward 16 percent—the lowest level since 1959. The Bush tax cuts of 2001, 2003 and 2005 pushed it out of that safety zone, reducing it to its lowest level as a share of the economy in the modern era.
Marshall Auerback, October 3, 2005

Markets in the 21st century are rife with destabilizing speculation and possess no wisdom whatsoever. As we have explained in earlier pieces, today’s markets are driven to an unprecedented degree by a combination of impulses from an ignorant public and amplifying actions by herding institutional money managers who have left their brains on the doorstep. Trend following portfolio managers have exacerbated a speculative bubble in the US bond market and have lifted the dollar against the euro in the process.

If the trade deficit does not improve (a realistic proposition at this juncture, given $60-plus oil and a strengthening dollar) or, (as is more likely), gets worse, there will be a large further deterioration in the US's net foreign asset position so that, with interest rates rising, net income payments from abroad will at last turn negative and debt trap dynamics will be fully at hand.

Through four decades and through administrations as diverse as Lyndon Johnson's and Ronald Reagan's, federal tax revenue had stayed within a fairly narrow band. From 1962 to 2002, when federal revenues were low they were around 17.5 percent of GDP, and when they were high they neared 20 percent. Once, they went even higher: to 20.8 percent in Clinton's last year, driven there by higher tax rates and by capital-gains revenue from the bubble economy. The 2001 changes pushed tax receipts down toward 16 percent—the lowest level since 1959. The Bush tax cuts of 2001, 2003 and 2005 pushed it out of that safety zone, reducing it to its lowest level as a share of the economy in the modern era. And they did so just when the country's commitments and obligations had begun to grow.

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Austrian economics
Many economic commentators claim that trade deficits are never a problem. They are perfectly correct, just as spots are never a problem when someone gets measles.
My point is that if a trade deficit is being driven by a loose monetary policy then recession tends to be unavoidable.
A monetary-induced deficit by the United States distorts the pattern of international trade as well as internal investment. Many of its enterprises will become excessively oriented toward the domestic market. The opposite holds true for foreign exporters.
Gerard Jackson, 17/10 2005

However, once the monetary brakes are applied and the trade deficit begins to falls, imports will drop off and those foreign firms that became dependent upon American consumers for their welfare could very well suffer severe losses.

At the end of the day, we ought to be able to see that the great economic destabiliser, the creator of the business cycle, the father of international financial crises and the demon behind rampant speculation and “irrational exuberance” is no other than lousy monetary policy caused by a lack of understanding of how money impacts on prices and investment decisions.

Fond memories of the successful 1980s adjustment of global trade imbalances have shaped much of the thinking about escape routes this time round. In 1985 the US “twin” current account and fiscal deficits consumed global economic discussions. Just as now, the worry was that a disorderly adjustment would derail the global economy. Yet by 1990 the US current account had been reduced from its peak of 3.4 per of gross domestic product to a manageable 1.4 per cent.
Europe and Japan cannot again repair US deficits
Tomorrow: Martin Wolf asks whether global imbalances will end smoothly or with a bump for the world economy Special report on world economy, separate section
Financial Times 7/10 2005
Good links

But the imbalances are, in fact, extremely different from the 1980s, when Japan and Germany's surpluses accounted for a large proportion of the US deficit. This year the two countries' surpluses will add up to about $300bn, compared with the Organisation for Economic Co-operation and Development's $800bn estimate of the US deficit.

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Dear Ben, Congratulations on your nomination as chairman of the Federal Reserve
Do not believe for a moment that targeting inflation is all there is to being a successful Fed chairman
You will need to react strongly to low probability, high cost dangers.
Martin Wolf, Financial Times, October 26 2005

You will need to react strongly to low probability, high cost dangers. You have shown your willingness to do just this with your contributions, in 2002, to the analysis of the risks of deflation. As important, you will need to act as lender of last resort in times of financial panic. The Greenspan Fed was outstanding in its response to such crises, from the stock market crash of 1987 to the aftermath of the Russian default of August 1998 and the terrorist attack of September 2001. Similar tests will lie ahead, if not more so.

In seeking internal balance – or the maximum level of employment consistent with stable inflation – the Fed has had to offset the contractionary impact of the net private and official capital inflows, now running at over 6 per cent of US gross domestic product.

If the Fed had not taken this action, the world would have been at risk of a deep recession, if not of something even worse.

The willingness of US monetary and fiscal authorities to sustain demand in this way has been highly desirable. But, at some point, probably on your watch, there will be a correction

Most analyses suggest that this will require a very large depreciation of the real exchange rate, to shift output towards – and domestic demand away from – tradeable goods and services.

Such a depreciation would require a big fall in the dollar and rise in domestic prices of tradeables.

It would also, almost certainly, entail a jump in long-term interest rates.

I do hope you are a success.

This is partly because I want first-rate economists to show they can be effective in the real world. But it is mainly because failure would be devastating. For 25 years the world has enjoyed competent central banking. But the Fed bears responsibility for the two macroeconomic catastrophes of the 20th century – the great depression of the 1930s and the great inflation of the 1970s

Mismanagement of money threatens both economic and political stability. This is why the Fed is such an important institution. As a student of economic history, you understand this.

Enter Ben Bernanke and His Helicopter Printing Press
Click here

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Ben S. Bernanke
Essays on the Great Depression
Princeton University Press May 2000
Click here

We do know, however, that a very substantial correction of the US external deficit, including via a very large decline of the exchange rate of the dollar, is inevitable unless all economic history is repealed.
C. Fred Bergsten, Peterson Institute,
Testimony before the Budget Committee of the United States Senate February 1, 2007

United States has compiled a net foreign debt that reached $2.7 trillion at the end of 2005 (the latest date for which full data are available).
An even more important number is our gross foreign debt of almost $14 billion because this measures the huge stock of dollar assets held around the world, most of which could be converted into other currencies or assets at almost any time.

Our external deficit has risen by an average of $100 billion annually over the past four years. It has climbed by an annual average of $80 billion for the past nine years. The trajectory, as well as the level of the imbalances, is clearly unsustainable.

Steins Law: "If something cannot go on for ever, it will stop.
Rolf Englund 2001-05-21

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Five major risks threaten the world economy.
US; renewed sharp increases in the current-account deficit leading to a crash of the dollar; a budget profile that is out of control; and an outbreak of trade protectionism.
China, which faces a possible hard landing from its recent overheating.
oil prices
Fred Bergsten, The Economist, 9/10 2005

Fred Bergsten is director of the Institute for International Economics in Washington, DC. His book, “The United States and the World Economy: Foreign Economic Policy for the Next Administration” is forthcoming.

There is still time to head off each of these risks. Decisions made in America immediately after this year's elections will be pivotal.

The most alarming new prospect is another sharp deterioration in America's current-account deficit. An immediate resumption of the gradual decline of the dollar, as in the period 2002-03, cumulating in a fall of at least another 20%, is needed to reduce the deficits to sustainable levels. If delayed much longer, the dollar's inevitable fall is likely to be much larger and much faster.

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Institute for International Economics

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It cannot go on forever. The question is how and when it will stop
There are risks of a much more abrupt reversal, triggered by a big increase in protectionism in the US, a sudden decline in the world's demand for US assets or, more probably, both together. This could generate a sharp slowdown in the US and the rest of the world, possibly even a world recession.
We do know that the explosive increase in US current account deficits cannot continue indefinitely. It is possible that a smooth adjustment will indeed occur. It is also quite likely that the ultimate adjustment will be both swift and brutal.
Martin Wolf, Financial Times 8/10 2005

So what will happen? Nobody knows.

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How do we get out of this scenario alive?
By Rolf Englund, Financial Times 4/10 2005

Sir,
Clyde Prestowitz, like many other commentators, warns us of what could happen: "a decline in the dollar, a rise in interest rates, a slowdown in growth, a rise in unemployment and declining home equity and household wealth - in a word, a recession, if not a depression" ("The risk of rebuilding New Orleans in a deluge of debt", September 29).

Fine. But he, like most - one dare say all - commentators who warn us, stops the analysis there, where the really important thinking should start. How horrible will it be? And where could you hide? A fall in the dollar and a US recession, to use a mild word, would hit the global economy and the Emu countries and, foremost, Germany very, very hard. And if that should happen? What then? How do we get out of it? The question is, how do we get out of this alive?

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Stein's Law: If something cannot go on for ever it will stop.

The entire US economy is on life support from the People’s Bank of China and the Bank of Japan.
Any slowing of this flow could cause a decline in the dollar, a rise in interest rates, a slowdown in growth, a rise in unemployment and declining home equity and household wealth – in a word, a recession, if not a depression.
Clyde Prestowitz, Financial Times 29/9 2005
The writer is author of Three Billion New Capitalists: The Great Shift of Wealth and Power to the East. He is president and founder of the Economic Strategy Institute and was counsellor to the secretary of commerce in the Reagan Administration

The cost of rebuilding New Orleans is estimated at more than $200bn (€167bn) but the White House insists it will not increase taxes. That means the entire cost will be added to the $350bn federal budget deficit, driving it close to $600bn.

The nation’s overall savings rate is negative and the deficit is funded by foreigners. In fact, more than 75 per cent is financed by foreign central banks, among which the People’s Bank of China will soon pass the Bank of Japan as the biggest lender.

In 2004, according to the Bank for International Settlements, central banks funded 75 per cent of the US current account deficit. This year, the PBoC alone is likely to cover nearly 40 per cent of it.

These banks now hold so many dollars ($800bn for the PBoC and close to $850bn for the BoJ), that any fall in its value would cause large capital losses on their own balance sheets.

Paul Volcker, the former Federal Reserve chief, has predicted a 75 per cent chance of a global financial crisis within five years.

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Economic Strategy Institute

Kan man undvika recession i USA när man måste minska importen med 600 miljarder dollar?
Rolf Englund på Nationalekonomiska Föreningen 30/11 2004

A floating threat
China - With floating exchange rates you do not need such a big currency reserve
Rolf Englund Financial Times 8/12 2004

As the latest World Economic Outlook from the International Monetary Fund notes, analysts have advanced two contrasting views of what is driving the global pattern of surpluses and deficit.
If the postponed adjustment ultimately proves painful, however, let nobody dare say they were not warned.
Martin Wolf, Financial Times 21/9 2005

Desirable adjustment would then see higher investment in many parts of the developing world, higher savings in the US and a smooth shift in the global pattern of deficits, all without a significant recession.

The WEO itself analyses three scenarios: a benign market-led adjustment, a malign adjustment and a policy-driven adjustment.

Under the first, US savings rise and the dollar depreciates by a further 15 per cent, in real terms.

The more abrupt market-led adjustment assumes rising protectionist pressures, a loss of confidence in US assets and abandonment of exchange-rate pegs. This generates a significant slowdown in the US.

Finally, the WEO explores policy options. Greater exchange flexibility in Asia, it argues, would facilitate a smoother adjustment, by stimulating domestic consumption and containing inflationary pressures.

A benign adjustment needs changes in policies in several places at once, significant movements in real exchange rates, higher savings in the US and higher spending in the rest of the world.

Is this benign outcome likely? No, is the short answer

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IMF World Economic Outlook, September 2005

Comment by Rolf Englund:
Most, one dare say all, commentators conclude that it might be "a more abrupt market-led adjustment and a significant slowdown in the US". But there the analysis usually stops, where the really important thinking should start. How horrible will it be? And where could you hide? A fall in the dollar and a US recession, to use a mild word, would hit the global economy and EMU-countries and foremost Germany very very hard.
And if that should happen? What then? How do we get out of it?
"The question is, how do we get out of this alive?"
Gregg Rob, Market Watch 24/8 2005

"Stålbadet i skuldfällan"
Om regeringen inte låter kronan flyta är risken alltmer överhängande för att marknaden kommer att se till den saken.
Det blir genant för de ansvariga i nuvarande och tidigare regeringar men är ingen nationell katastrof.
Rolf Englund på DN Debatt 26/8 1992

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I am a bit more cautious than most about projecting a massive boom if Germany implements efficiency enhancing reforms.
The link between reform and growth is not obvious in the short-run. The dislocations associated with efficiency enhancing reforms (efficiency enhancing reform is economese for making it easier to fire people among other things ... ) can dampen consumer spending, as workers worry that they may lose their job and start to save more.

I do think Germany needs to do more to prepare for a world where the US no longer supports global demand growth, and to make sure the German government's future commitments are commensurate with its resources.
Brad Setser blog 15/9 2005

There are those dollar bears who just keep wondering when will the dollar crash? The answer, of course, is when people stop buying it.
Contrary to an overwhelming consensus view in late-2004 that central banks were diversifying wholesale from USD assets, the latest report from the IMF points to exactly the opposite: the share of USD assets in total reserve holdings increased in both nominal and real terms, while there were signs of diversification from EURs in relative terms.
Understand, I am long-term bearish on the dollar, but this view has the potential to be a long drawn out march.
John Mauldin 23/9 2005

I am going to use Ray Kurzweil's new book "The Singularity is Near" as the launching point for our discussion.

Kurzweil has a team of ten who track the progress of technology and predict where it will be in ten or twenty or one hundred years. It helps that he has been right more often than not. This was written in 2001:

"The first technological steps--sharp edges, fire, the wheel--took tens of thousands of years. For people living in this era, there was little noticeable technological change in even a thousand years. By 1000 A.D., progress was much faster and a paradigm shift required only a century or two. In the nineteenth century, we saw more technological change than in the nine centuries preceding it. Then in the first twenty years of the twentieth century, we saw more advancement than in all of the nineteenth century. Now, paradigm shifts occur in only a few years time. The World Wide Web did not exist in anything like its current form just a few years ago; it didn't exist at all a decade ago.

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The extraordinary importance of American interest-rate policy.
Buttonwood, The Economist 15/11 2005

Capital markets—especially fixed-income markets—are becoming one around the globe. Because interest rates in America have been higher than in almost any other developed country, foreign investors have been happy to hold American assets, the dollar has stayed stronger than it had any right to do, and the United States has been able painlessly to finance its large and growing current-account deficit. All that may now be up for grabs, especially if a dovish Mr Bernanke stops raising rates just as Europe and Japan begin to increase their own.

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Conundrum

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Eventually, global balance must be restored through slower spending-growth in America compared with that in the rest of the world.
But no one is sure where the limits lie, nor how painful the ultimate adjustment will be.
Will American consumers slow their spending first, or will foreigners first tire of lending America money?
Will the shifts be sudden or gradual? And will spending elsewhere pick up the slack?
The Economist 22/9 2005

The impact of this on the world economy depends on whether foreign demand picks up the slack. In fact, some big economies, particularly China's and Germany's, are becoming more, not less, dependent on exports. With its domestic economy moribund, Germany's current-account surplus is likely to top 4% of GDP this year. Despite the messy outcome of its election this week, Germany's need for growth-inducing economic reforms is more urgent than ever.

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"Världsekonomin på väg mot avgrunden"
USA:s underskott mot omvärlden blir allt större, samtidigt som överskotten stiger i Asien och de oljeexporterande länderna. Detta är ohållbart, men ingen lösning är sikte.
Utan mer flexibla växelkurser, där dollarn får flyta fritt mot övriga valutor, blir det svårt att komma till rätta med både underskott i USA och överskott i Asien.
Johan Schück, DN 19/11 2005

USA:s bytesbalans väntas i år visa ett underskott på ofantliga 666 miljarder dollar, främst beroende på att importen är betydligt större än exporten. Underskottet, som har fördubblats sedan slutet av 1990-talet, motsvarar nu sex procent av landets BNP och två procent av världsproduktionen.

Enligt Harvardprofessorn Kenneth Rogoff leder denna stigande obalans sannolikt till en kris inom de närmaste åren.

Utan mer flexibla växelkurser, där dollarn får flyta fritt mot övriga valutor, blir det svårt att komma till rätta med både underskott i USA och överskott i Asien. Men en lägre dollarkurs, som förr eller senare måste komma, räcker inte ensam särskilt långt. Viktigast är att de amerikanska hushållen förmås att återuppta sitt sparande, i stället för att i allt högre grad leva på kredit.

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About Maurice Obstfeld and Kenneth Rogoff, The Unsustainable US Current Account Position Revealed
Martin Wolf Financial Times 1/12 2004

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My conversations quickly exposed a deep fault among the conference attendees. Those who analyzed or forecast the U.S. domestic macroeconomy agreed that a steep decline in the value of the dollar sometime in the next five years was overwhelmingly likely, but by and large they did not think that such a decline would pose a big problem for the U.S. economy.
By contrast, those who analyzed or forecast the international economy as a whole were typically terrified by the prospect of a steep (30% or more, perhaps much more) decline in the value of the dollar: they thought a severe U.S. recession was a definite possibility, and that the situation would require exceptionally skillful handling to keep from becoming a serious economic problem.
Brad DeLong's Semi-Daily Journal, 15/9 2005
Very important article

Some said that the falling dollar would create inflation--with imports at 1/6 of GDP, a 40% fall in the dollar would, if fully passed through to import prices, add 6% to the U.S. price level.

Others said that the adjustment to the fall in the dollar would require that ten million workers shift out of construction, retail, and consumer services occupations and into export and import-competing manufacturing industries. You cannot move ten million American workers from one sector to another in a matter of a year or two without creating lots of structural unemployment.

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The dollar, said John Connolly, treasury secretary to Richard Nixon, "is our currency, but your problem".
Gerhard Schröder, Germany's chancellor, knows what he meant
Martin Wolf, Financial Times 1/3 2004

John Connally
Wikipedia

Rolf Englund:
Connolly hade varit marinminister och därvid avslagit Lee Harvey Oswald överklagande av sitt vanhedrande avsked ur Markinkåren. Det var kanske C. som O. siktade och inte JFK??

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1) If output in the US grows fast enough to keep unemployment constant between now and 2010 and if there is no further depreciation in the dollar, the deficit in the balance of trade is likely to get worse, perhaps reaching 7.5 per cent by the end of the decade. 2) If the trade deficit does not improve, let alone if it gets worse, there will be a large further deterioration in the US's net foreign asset position so that, with interest rates rising, net income payments from abroad will at last turn negative and the deficit in the current account as a whole could reach at least 8.5 per cent of GDP.
Wynne Godley et al, Levy Economic Institute, September 2005

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The rising balance of payments deficit implies that the budget deficit must get progressively worse from now on if stagnation is to be avoided.
Wynne Godley and Alex Izurieta Financial Times December 3 2004

Remember Plaza?
Twenty years after the Plaza Agreement agreed co-ordinated intervention among the leading economies to reduce the value of the US dollar
The world’s largest banks and financial institutions on Wednesday urged the leaders of the global economy to act together to reduce “increasingly worrisome” global economic imbalances.
The tone of the IIF’s letter indicates that private sector financial institutions are increasingly concerned about rapidly growing trade deficits in the US with corresponding surpluses in Europe, Asia and among oil exporters.
Financial Times 15/9 2005

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Plaza Agreement in 1985 and Louvre Accord 1987

The Institute of International Finance, Inc. (IIF)

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The Coming Collapse of the Dollar and How to Profit from It:
Make a Fortune by Investing in Gold and Other Hard Assets

The runaway budget deficits are compounded by the persistent and growing imbalance in our trade accounts -- jeopardizing the inflow of foreign funds we have used to finance our debt.
At a private dinner the other evening where many of the men and women who have steered economic and fiscal policy during the past two decades were expressing their alarm about this situation, one speaker summarized the feelings of the group:
"I think it's 1925," he said, "and we're headed for 1929."
David S. Broder, Washington Post 11/9 2005

China daily is reporting that China's exchange rate will fluctuate more widely
"In line with the change in control method, the range of the renminbi's exchange rate fluctuation should expand. So there is no need to rely on administrative adjustments"
Michael Shedlock blog 9/9 2005

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Rörliga eller fasta växelkurser?
Rolf Englund i Svenska Dagbladet 16/12 1968
Man kan så här i efterhand vara mer eller mindre stolt över vad man gjorde 1968...

The Great Proletarian Cultural Revolution in China, 1966-1976
http://www2.sjsu.edu/faculty/watkins/cultrev.htm

If the dollar dives, what will happen to America's interest rates?
When policymakers and pundits debate America's current-account deficit, the phrase “hard landing” is never far from their minds.
If inflationary expectations are falling, the link between tumbling currencies and rising bond yields may be weakened.
The Economist print 8/9 2005
Rolf Englund: But if the dollar falls, inflation will probably rise as import prices increase, or...?

Mr Gagnon /Joseph Gagnon, an economist at the Federal Reserve/, has not refuted the idea that America could have a hard landing; but he has exposed some loose thinking on the subject.
"Currency Crashes and Bond Yields in Industrial Countries". August 2005.

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Currency Crashes and Bond Yields in Industrial Countries Joseph E. Gagnon

Dollar crashes, interest rates fall?
Alan Greenspan's legacy may hinge on whether that headline is written, or whether the headline reads:
"Dollar crashes, interest rates surge."
Brad Setser's Web Log, 26/8 2005

Few debates are likely to be more important. At some point - though it is hard to know when - the dollar will fall. That is what happens to the currencies of countries with large trade deficits. The interest rate path most likely to accompany that the dollar's decline, though, is far from clear.
Greenspan - in some sense - is betting big on a relatively benign adjustment. The fabled soft landing.

Greenspan expects housing prices to stall, making it more difficult for Americans to borrow against their home -- and bringing down consumption, imports and the current account deficit.

From comments: What Krugman says (in the column to which you refer above) makes no sense. The collapse of the housing boom, he seems to think, will cause an economic slowdown without reducing the trade deficit. How is that possible? Does he expect that the people who lose jobs in the construction and service industries will happily continue buying imports at the same rate as before?

Comment at Setser site by Rolf Englund:
If, or rather when, the dollar falls, import prices will go up. US firms will find it easier to raise prices, inflation goes up. Real rates are already low. Why should that not lead to rising bond yields and collapsing bond markets? But what else should you buy?
Euros? When European export industries will face sharply lower profit margins in the US?
Interesting times are ahead of us. Rolf Englund, 2005-09-12

Interesting times ahead for all
Rolf Englund, Letters to the Editor,
Financial Times, November 6, 2000

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Vad förklarar att USA de senaste 15 åren haft dubbelt så hög årlig produktivitetsökning per timme som EU, samtidigt som USA skapat 18 miljoner nya arbetstillfällen mot EU:s 2,2 miljoner?
Peter Stein, Timbros Smedjan, 1/9 2005

I The power of productivity tar William Lewis läsaren jorden runt för att jämföra tillväxtens grundläggande förutsättningar.
William Lewis, The Power of Productivity - Wealth, Poverty and the Threat to Global Stability The University of Chicago Press 2004

För Sverige, där mycket kretsar kring ersättningsnivåer i socialförsäkringar, är budskapet synnerligen relevant. Det nya arbetarpartiet låter ibland som ett eko av den så kallade nya vänsterns politiska ekonomi från 1970-talet med sina föreställningar om att utbudet ”manipulerar” sin efterfrågan. En vänlig tolkning är att detta är en ny version av den berömda ”Says lag” enligt vilken utbud skapar sin egen efterfrågan. Men Says lag var avsedd att gälla för ekonomin som helhet, inte för en enskild produktionsfaktor. Det må vara bra att främja ökat arbetsutbud, men Lewis skulle försynt påpeka att det behövs företagare som efterfrågar arbetskraften.

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Tillgång och efterfrågan

The idea that there was substantial, uncounted immigration is supported by another statistical mystery that occurred during the 1990s. If you ask all the employers in the economy how many new jobs they gave people during the 1990s, the answer is 22m. But if you ask all the people in the economy how many new jobs they took, the answer is only 16m.
Everett Ehrlich, a former undersecretary of commerce for economic affairs, Financial Times, Mar 7, 2001
http://www.internetional.se/toft/missingmillions.htm

Peter Stein om Hayek

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A drop in the U.S. savings rate by 1.7 percentage points, while seemingly small, actually represents a substantial contribution to consumption growth of about $175 billion or 2 percentage points.
More broadly, about one-third of the 3.9 percent growth rate in gross domestic product (GDP) over the past year was accounted for by the elimination of what was already low U.S. saving.
John Makin, American Enterprise Intstitute, September 2005

The American consumer has been the primary source of demand growth, a spending hero, in a global economy plagued with excess capacity. In the process, foreign lenders have acquired claims on the United States worth about $2 trillion.

With heavy spending on transportation equipment concentrated on fuel-inefficient, incentive-laden light trucks, American households have accumulated an unusually large, fuel-inefficient stock of transportation capital.

They have also purchased additional living space that must be heated and cooled with more expensive energy.

Sometime during the next year the stock of durable goods and housing will probably be seen as too large (above desired levels) as energy costs and interest rates rise. Purchases will drop sharply, and the wealth creation that has accompanied rising real estate prices will be reversed unless the Fed ceases tightening and reverses the rise in interest rates. Such a Fed reversal is an unlikely event,

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Det finns skäl att oroas över USA:s ekonomi
Det har nästan bara varit investmentbanken Morgan Stanleys chefsekonom Stephen Roach som tagit på sig domedagsprofetens roll.
Dagens Industri ledare 30/1 2006

Fredagens rapport om att BNP-tillväxten under fjolårets sista kvartal blev väsentligt lägre än förväntat underströk att USA-ekonomin är den stora osäkerhetsfaktorn i de globala marknadskalkylerna. Därmed är det sannolikt slut på den ytliga konsensus som rått om ett scenario med en knappt märkbar inbromsning.

Även om nästan alla sett det ohållbara med den lånefinansierade köpfesten och de dubbla underskotten, i bytesbalansen och den federala budgeten, har ”de globala obalanserna” blivit en närmast rituell reservation utan praktisk betydelse i de flesta framtidsbedömningar. Marknaden är bränd av erfarenheterna från fjolåret, då dollarn vände uppåt igen trots förväntningar om en fortsatt nedgång mot den nivå som krävs för att minska obalansen i utrikesaffärerna.

De flesta har gett sig på nåd och onåd inför en till synes urstark och dynamisk ekonomi som stått emot både stigande oljepriser och orkanen Katrinas härjningar.

Det har nästan bara varit investmentbanken Morgan Stanleys chefsekonom Stephen Roach som tagit på sig domedagsprofetens roll.

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In the macro world, strikes, wars, and natural disasters have long been thought of as classic exogenous shocks -- those out-of-the-blue disruptions that jolt economies and markets.
But the energy shock of 2005 may be of a very different breed. It could well be an endogenous shock -- an unfortunate outgrowth of excesses that have been building in the macro system for a long time.
Stephen Roach, 5/9 2005

The Federal Reserve has set the stage for this endogenous shock. As it has supported the US economy from bubble to bubble, it has fostered a climate of excess demand and excess liquidity. First equities in the late 1990s and now property -- the Fed has nurtured the steady transformation of an income-based US economy into an asset-dependent spending machine.

In America's deregulated financial market environment, liquidity-related impacts show up less in the various gauges of the money supply and credit flows and more in the form of movements in real interest rates.

With the Fed maintaining a long period of unusually accommodative policy -- a negative real federal funds rate from late 2001 to late 2004 that has gone only barely positive since -- financial assets have been supported by a steady stream of "carry trades." This, in turn, has created excess demand for a wide range of fixed-income assets in recent years -- further depressing intermediate- and longer-term interest rates and thereby boosting property prices and wealth-dependent consumption.

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More by Stehpen Roach

Real Interest rates

Carry trade

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Unctad expressed concerns about the international impact of a slowdown in US growth
China accounts for only 8% of the combined $890bn world trade surpluses, while the eurozone and Japan make up over 30%
Instead it said a better policy would be one in which major economies tried harder to stimulate domestic demand.
BBC 2/9 2005
RE: Perhaps Saudi has the rest 70% ???

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One way or another, the economy will eventually eliminate both imbalances.
But if the process doesn't go smoothly - if, in particular, the housing bubble bursts before the trade deficit shrinks - we're going to have an economic slowdown, and possibly a recession.
In fact, a growing number of economists are using the "R" word for 2006
Paul Krugman, New York Times, August 29, 2005

By Andrew Balls In Jackson Hole, Wyoming
Another challenge for the next Fed chairman will be dealing with the US's unprecedented current account deficit, which stands at 6 per cent of GDP and rising.
Sebastian Edwards, of the University of California Los Angeles, said in a paper presented at Jackson Hole that it was evitable that at some point there would be a sharp contraction in the current account deficit.
Financial Times, August 26 2005

It's nice to see that Stephen Roach is back from his summer vacation. In the first paragraph of his first missive since returning to his duties at Morgan Stanley, he reminds us once again, why he is our favorite economis
"On the surface, the global economy seems to be doing just fine. Yet just beneath that seemingly tranquil surface, the imbalances and tensions are only getting worse."
Tim Iacono 16/8 2005

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Stephen Roach

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Bill Gross, July 2005:

America’s trade deficit of $700bn is nine times China’s trade surplus.
Unless domestic investment goes down or domestic savings go up, the trade deficit will persist, unabated. The trade deficit could diminish but if it does, it will not be a pretty picture.
Joseph Stiglitz, Financial Times, July 27 2005

The writer is University Professor at Columbia University and was awarded the Nobel Prize in economics in 2001

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Cataclysm

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Watershed in global markets
The decision by China to abandon the renminbi-dollar peg in favour of a managed float marks the beginning of the end of the dollar recycling process whereby a large US current account deficit is substantially financed by Asian official reserves.
John Plender, Financial Times, July 25 2005

On January 3rd I argued against the then near universal assumption that dollar decline was inevitable and suggested that the unstable equilibrium in the new dollar area would last longer than markets assumed. That logic now goes into reverse.

It follows, as Charles Dumas of Lombard Street Research points out, that the US will be progressively more dependent on private capital to fund the deficit. Forced Asian central bank funding will be smaller. The dollar and US interest rates will thus have to fall to levels at which private capital sees good value. Bond market vigilantes, no longer overwhelmed by the flow of official capital, may stage a comeback.

it seems plausible that the current account deficit will shrink as a result of a reduction in domestic demand brought about by a bigger rise in interest rates than hitherto expected. That, incidentally, sounds a pretty unappealing signal for equities.

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More by John Plender

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Einstein and the US Dollar: Is the US Currency Rewriting the Laws of Gravity?
The simple answer is not and I will try to explain why.
Nouriel Roubini's Blog, Nov 21 2005

100 years ago, 1905 was the "annus mirabilis", the miraculous year when Albert Einstein made some of his major and most revolutionary scientific discoveries, some of which - especially the special theory of relativity - later led to the general theory of relativity; thus, a new view of the laws of gravity emerged that radically challenged the traditional Newtonian laws of gravity. 100 years later, in 2005, it appears that the US dollar is defying the economic laws of gravity and putting them into doubt: while the US current account deficit has grown larger and larger - from $665b in 2004 to a predicted $800b plus this year - the US dollar has been strengthening throughout the year. Does this mean that we should rewrite the laws of economic gravity, i.e. the idea that - over time - a large current account deficit will be associated with a falling currency value?

The simple answer is not and I will try to explain why.

So, at the end you cannot fight the laws of gravity as the cyclical forces that have defied such gravity are temporary while the forces that will cause a gravitational fall of the US dollar are as strong as ever.

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Stein's Law: If something cannot go on for ever it will stop

The U.S. current account deficit is on track to reach seven percent of GDP in 2005. That figure is unprecedented for a major economy.
Yet modern-day Panglosses tell us not to worry: the world's greatest power, they say, can also be the world's greatest debtor.

"Our Money, Our Debt, Our Problem"
by Brad Setser and Nouriel Roubini, Foreign Affairs, July/August 2005

Rolf Englund: The dollar, said John Connolly, treasury secretary to Richard Nixon, "is our currency, but your problem".
Click

But in fact, the economic and financial risks that arise from the U.S. current account deficit (and the resulting dependence on foreign financing) have not been exaggerated. If anything, they have received too little attention -- and are set to grow in the coming years.

U.S. external debt is now equal to more than 25 percent of GDP, a high level given that exports are a small fraction of U.S. GDP. More important, the United States is adding to its debt at an extraordinary pace. The U.S. current account deficit is now comparable to those of Thailand and Mexico in the years leading up to their financial crises.

A 20 percent increase in the value of the yuan against the dollar would reduce the value of China's roughly $450 billion in dollar reserves by about $100 billion - 6 percent of China's GDP.

Foreign central banks do not need to dump their existing stocks of U.S. dollars to cause financial distress in the United States; they only need to slow their new purchases of dollar debt. If central banks decide that $2.5 trillion in dollar reserves is enough, the result will be a sharp fall in the dollar and a sharp rise in U.S. interest rates.

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The increasing attention paid to growing U.S. current account deficits has bred nightmare scenarios of a sharp decline in the foreign-exchange value of the dollar and rising U.S. interest rates.
Financial markets, by contrast, appear more sanguine. Inflation-indexed bonds in the U.S. are yielding only about 1.5% in real terms, and the IMF's estimate of the long-term world real interest rate is about 2%.
Glenn Hubbard, dean of Columbia Business School, was chairman of the Council of Economic Advisers under President George W. Bush,
Wall Street Journal, 23/6 2005

Coming in at $3 billion less than some had feared, today's release of April's $57 billion trade deficit is being heralded as good news. The fact that the fourth worst monthly deficit ever is considered good news is startling evidence of just how far the bar has been lowered when it comes to America's deteriorating trade imbalance.
While China enjoys an enormous trade surplus with the United States, it enjoys a significant trade deficit with the rest of the world.
If America's monthly trade deficits continue at the "benign" level of 57 billion for the rest of the year, the annual 2005 deficit will top $685 billion, 11% higher than last year's record $617 deficit, and approximately 6% of GDP.
Peter Schiff June 13, 2005

Peter Schiff is C.E.O. and Chief Global Strategist at Euro Pacific Capital, Inc.
www.europac.net

On a per capita basis, that equates to about $2,300 per person, or $9,200 per family of four.

However, the most interesting aspect of China's trade statistics is that while China enjoys an enormous trade surplus with the United States, it enjoys a significant trade deficit with the rest of the world.

Since nothing is being done to improve this situation, and since American consumers continue to convert house price appreciation into current consumption, expect America's trade balance to continue to deteriorate, until either the housing bubble bursts or the rest of the world comes to its senses at stops financing it.

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U.S. exports advanced 3.0%
The U.S. trade deficit widened to $57 billion in April as Americans paid record prices for oil and bought more goods from China
Imports rose 4.1%
10/6 2005

Strange things are happening in the world economy: falling interest rates on long-term securities, declining spreads between returns on safe and riskier assets, large fiscal deficits and huge global current account “imbalances” should not, in normal circumstances, coincide. So what is going on?
The answer, in a nutshell, is a global excess of desired savings against the background of weak investment, low inflation and ever more integrated economies.
To understand the present we need to go back to the 1930s. The “paradox of thrift” was the most counterintuitive and, to the classically trained economist, morally, theoretically and practically objectionable idea in John Maynard Keynes’ General Theory of Employment, Interest and Money, published in 1936, in response to the Great Depression.
Martin Wolf Financial Times June 13 2005

The US Trade Deficit is Unsustainable, Bud Conrad

The current-account deficit, now more than $1.8 billion a day,
or $2,250 per man, woman and child per year
Europeans and Asians tell us that the global economy would be safer if we saved more and imported less.
The U.S. replies that the economy would be safer if Europeans and Asians saved less and imported more
David Wessell Wall Street Journal 12/5 2005

It's bizarre that a country like China with so much thirst for improving the lot of its people is pouring money into the U.S. so that Americans can save a few bucks a month on their mortgages.

When that day comes, the dollar will fall and interest rates will rise... The challenge to the U.S. is what to do now to reduce the risk that inevitable belt-tightening will cause a recession.

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Kan man undvika recession i USA
när man måste minska importen med 600 miljarder dollar?
Rolf Englund på Nationalekonomiska Föreningen 30/11 2004

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Sverige uppvisar ett jättelikt sparöverskott i form av ett överskott i bytesbalansen på hela 8 procent av BNP.
Skillnaden mot USA:s underskott på 6 procent är enorm.
Klas Eklund DN Debatt 15/5 2005

The interest rate conundrum is challenging enough. But now the dollar is springing back to life in the face of America’s record current account deficit.
In my view, this defies both the history and the analytics of the classic current account adjustment.
Stephen Roach 3/6 2005

Today’s current account problem is easily twice as bad as it was back in the 1980s but the US currency has fallen by less than half as much as it did back then. On that simple basis, alone, the dollar has plenty more to go on the downside.

I have long maintained that the dollar can’t do the job alone in correcting America’s current account imbalance. Two reasons come to mind -- the first being that the impact of currency fluctuations on real trade flows and inflation seems to have diminished over the past decade.

But the second and far more important reason that the dollar can’t solve America’s trade and current account problem is that it doesn’t get directly at the most critical ingredient of the imbalance - excess imports, which are, in turn, an outgrowth of excess US domestic demand.

One number says it all: In March 2005, US imports were fully 54% larger than exports. In my view, there is no conceivable dollar adjustment -- or should I say no politically acceptable dollar adjustment -- that would eliminate America’s excess import problem.

America’s current account adjust requires a combination of currency and real interest rate adjustments - both a weaker dollar and a normalization of real interest rates.

If I’m wrong and the dollar continues to defy gravity in a low interest rate climate, you can forget about global rebalancing. In that case, global imbalances will continue to mount and asset markets could become all the frothier. Sadly, the endgame would then be ever more treacherous.

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More about Conundrum

More by Stephen Roach

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I am not a believer in conspiracy theories. But
In all my years in this business, never before have I seen a central bank attempt to spin the debate as America's Federal Reserve has over the past six or seven years.
From the New Paradigm mantra of the late 1990s to today's new theories of the current-account adjustment, the US central bank has led the charge in attempting to rewrite conventional macroeconomics and in making an effort to convince market participants of the wisdom of its revisionist theories
It is a concentrated effort on the part of the Fed to exonerate itself from the Original Sin of failing to address asset bubbles. The result is an ever-deepening moral hazard dilemma that poses grave threats to financial markets.
Stephen Roach - Morgan Stanley Global Economic Team - April 25, 2005

Very important article
Earlier this month, the US Senate voted by 67 to 33 to consider a bill that would impose a 27.5 per cent tariff on all Chinese imports if the latter did not revalue within six months.
In a multilateral trading system, bilateral deficits and surpluses are of no significance.
This is a global challenge, requiring global solutions.
Martin Wolf Financial Times 27/4 2005

First proposition: current trends are unsustainable and undesirable.

Proposition two: it takes two to tango.

Proposition three: global adjustment requires a move into current account deficit by countries in receipt of long-term capital inflows.

Proposition four: exchange rate changes are needed to ensure that adjustment occurs at minimum cost to global real output.

Conclusion: start talking.
The US cannot achieve what it seeks just by screaming at China. What is needed, instead, is a wider agreement on macroeconomic policies, structural reforms and exchange rate regimes. This discussion must start now. Global economic stability cannot be sustained indefinitely by driving the US ever deeper into debt.
However comfortable this may now seem, it is a road to ruin.

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RE: See also: U.S. Trade Deficit: Causes, Magnitude and Consequenses
Stein's Law: "If something cannot go on for ever it will stop"
Rolf Englund, May 2001

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It is in US long-run interests to avoid an explosive build-up of net external liabilities.
However big the crisis if a sudden correction were to occur now, it would be nothing compared with what would happen after another decade of rising net liabilities.
Group of Seven communiqué: "we emphasise that more flexibility in exchange rates is desirable for major countries and areas that lack such flexibility".
Martin Wolf Financial Times 20/4 2005

The requirements for such a correction are clear. There needs to be a reduction of spending, in relation to potential output, in the US and an increase in spending in its creditors. A reduction in the US structural fiscal deficit will be r

China is a significant player. Its current account surplus was 18 per cent of the emerging market total in 2004, its net inward direct investment was 28 per cent and its reserve accumulation was 40 per cent.

At this weekend's meeting of the Group of Seven leading industrial countries. The communiqué remarked that "we emphasise that more flexibility in exchange rates is desirable for major countries and areas that lack such flexibility to promote smooth and widespread adjustments in the international financial system, based on market mechanisms".

RE:Euron perhaps
Among the participants in the Group of Seven meeting were Finance Ministers and Central Bank Governors of France, Germany, Italy, United Kingdom, and EU and ECB.
After the meeting they went home to administer the Single European Currency and to try to persuade their voters to accept the EU Constitution, including the Euro.

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Full communiqué

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Beijing Youth Daily, a popular newspaper in China's capital, relies on a diet of starlets and sports to attract readers.
So it was a telling moment when it gave its front page over to exchange rate policy one day last month and announced in blazing tabloid headlines that a revaluation of the renminbi was in the works
2005

As the attention of the popular press attests, China's leaders are preparing their people for an end to the policy of pegging the renminbi at Rmb8.28 to the US dollar, the bedrock of economic policy for a decade.

Some economists wonder if US lawmakers know what they are wishing for. China and other Asian countries have - because of massive dollar purchases to prevent their currencies appreciating - emerged as the financiers of the US's current account and fiscal deficits, providing cheap capital that has kept the dollar's decline orderly and helped bring economic growth and low interest rates.

The longer the pattern continues, however, the bigger the imbalances and the larger the costs of eventual adjustment for all parties. Academic economists forecast that, at present trends, the US current account deficit will rise from 5.5 per cent of GDP to more than 10 per cent within the next decade, while its ratio of foreign debt to GDP will rise from just under 25 per cent to more than 100 per cent.

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Roubini Global Economics

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Brad Setser, Oxford University
Lest anyone think the U.S. trade deficit is made in China, or just the product of an undervalued renminbi, consider this:
the U.S. trade deficit with the Eurozone continues to grow.
WSJ 12/5 2005

U.S. imports from the Eurozone grew by 13.2% in the first two months of 2004, U.S. exports to the Eurozone grew by only 9.9%

That led the U.S. bilateral deficit with the Eurozone to widen from $10.6 billion in the first two months of 2004 to $12.6 billion in the first two months of 2005 (a $76 billion annual deficit). And no one can accuse old Europe of having an unfair cost advantage because of an undervalued currency.

Euron

In the early 1990’s, Foreign Affairs devoted an entire issue to an article written by political science professor Samuel Huntington titled the “Clash of Civilizations,” which predicted a terror war between Islam and the west.
And now Peter Peterson just wrote an article about the deficit crisis facing the United States and the almost inevitability of a dollar crisis.
Peterson succeeded David Rockefeller as the Chairman of the Council for Foreign Relations in 1985.
He had been the CEO of Lehman Brothers. He served as Secretary of Commerce in the Nixon administration.
Mr. Swanson 11/4 2005

What I want to underscore in this article is the point that the people in the know all recognize the reality of the deficits our country faces and the high possibility of a full-blown dollar crisis. They know the dollar will drop.

Riding for a Fall, Peter G. Peterson From Foreign Affairs, September/October 2004
This article is adapted from "Running on Empty: How the Democratic and Republican Parties Are Bankrupting Our Future and What Americans Can Do About It,"

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This week both the World Bank and the International Monetary Fund (IMF) have come out with reports warning that America’s fiscal irresponsibility poses serious risks to the world economy.
America’s 12-month current-account deficit now stands at $665.9 billion, or 5.7% of GDP.
The Economist 6/4 2005

Since a negative balance in the current account must be complemented by a positive balance in the capital account, this means that foreign funds are streaming in. America is mortgaging its future to pay for current spending.

With interest rates low, consumers have been tapping into their home equity and taking on credit-card debt—the latest figures from America’s Bureau of Economic Analysis show individuals’ savings were just 0.6% of their income in February.

Meanwhile, even after massive tax cuts, the Bush administration has forged ahead with ambitious spending programmes. Thus, in 2004 the federal government’s budget deficit hit $412 billion, a worrying 3.6% of GDP. It is projected to fall only to $365 billion, or 3% of GDP, in 2005.

Given all these reasons to worry, it might seem surprising that both the IMF and the World Bank are broadly optimistic about the world economy.

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The World Bank;
The severity of the coming slowdown will depend on the extent to which foreign investors lose their nerve about buying U.S.-dollar-denominated assets.
"A reduction in the pace at which central banks are accumulating dollars, a weakening in investors' appetite for risk, or a greater-than-anticipated pickup in inflationary pressures could cause interest rates to rise farther than projected, providing a deeper-than-expected slowdown or even a global recession
Wall Street Journal 6/4 2005

Skandia Liv, med VD:n Urban Bäckström spekulerar i en starkare krona och svagare dollar.
Urban Bäckström och hans stab är så oroade över obalanserna i USA att hela Skandia Livs amerikanska obligationsinnehav sålts.
Cecilia Skingsley, DI, 5/4 2005

Who cares if the euro is now worth $1.33 instead of the $1.28?
Well, we all should. One of the thorniest economic questions of our time:
Can the world economy thrive without the massive stimulus of ever-increasing U.S. trade deficits?
Robert J. Samuelson, Washington Post 8/12 2006

It's no secret that Asia, Europe and Latin America have feasted on the U.S. trade gap. In 2006 the deficit will reach about $800 billion - bringing the cumulative total since 1996 to $4.4 trillion.

Economists talk glibly about "rebalancing" the world economy. That means that export-dependent nations would rely more on domestic growth, and deficit countries - mainly the United States - would shift to more exports.

It's unclear whether these changes can be made. If not, a weak dollar might herald a weak global economy - which would be bad for everyone.

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The doomsday scenario, considered unlikely by most economists but not impossible
a recession in the United States and abroad might follow.
To paraphrase former Treasury secretary John Connally: the dollar may be America's currency, but it's the world's problem.
Robert J. Samuelson Newsweek 21/3 2005

For 15 years the American economy has been the engine for the world economy through ever-increasing trade and current-account deficits

Americans' consumption binge is propping up global trade and employment, but it's also threatening a financial upheaval that could hurt global trade and employment. ... The doomsday scenario, considered unlikely by most economists but not impossible, is that a crash of the dollar would trigger a broader panic. Foreigners would sell their U.S. stocks and bonds, driving down those markets and bringing massive losses to everyone. They would sell because a dropping dollar would make their American investments worth less in their own currencies. Consumer and business confidence would drop; a recession in the United States and abroad might follow.

What's especially unnerving is that no one knows how to disarm the dilemma. If you think that some economist—or even Alan Greenspan—has a realistic solution, think again. We've entered an unmapped forest; no one has been here before. "We've never had the leading economic power with [such an international] debt," says economic historian Barry Eichengreen of the University of California, Berkeley.

One camp insists that it can survive, because it serves strong national interests. Asian countries and particularly China need to create millions of jobs for political and social stability

Not so, say other economists. The present situation is inherently unstable. "The problem is that too many countries are required to prop up the United States," says Desmond Lachman of the American Enterprise Institute.

One disappointment is that the dollar's recent depreciation hasn't yet stopped the trade deficit from growing. In theory, it should have: a cheaper dollar should make our exports less expensive and our imports more expensive. Greenspan has offered one explanation. Foreign exporters to the United States have reduced their profit margins rather than raise prices and lose U.S. sales, he said.

To paraphrase former Treasury secretary John Connally: the dollar may be America's currency, but it's the world's problem.

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In an appearance before the Council on Foreign Relations earlier this month, Federal Reserve Chairman Alan Greenspan warned that the federal budget shortfall is "a significant obstacle to long-term stability." Foreign central banks' readiness to buy up U.S. bonds, he said, is keeping interest rates artificially low, masking the dangerous market potentials and making it easy to ignore the deficit. And all this foreign buying adds to the current-account deficit, the shortfall on all trade and investment income between the U.S. and the rest of the world.But not all economists agree with Mr. Greenspan. WSJ.com invited economist bloggers Nouriel Roubini and David Altig to duke it out over the potential perils of the current-account deficit.
Wall Street Journal (free) 29/3 2005</p>

Ten Reasons why China should move its peg and pull the plug on the US reckless policies
Nouriel Roubini's Global Economics Blog March 11, 2005

Wait until China decide to move its currency and see how the current hypocritical US policy makers' statements about wanting China to flexibilize its exchange rate lead to a US hard landing (as Chinese and Asian intervention is propping the US bond market bubble).

it will get ugly for the US, the needed reality check the US policy makers have avoided so far by living in their delusional bubble.

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Which can be reached also from European University Institute - The Robert Schuman Centre for Advanced Studies
"The European University Institute was founded in 1972 by the European Community Member States. Its main objective is to provide advanced academic training to PhD students and to promote research at the highest level"

Important, if true
The dollar has fallen enough
No doubt some financial wizards will jump at this to construct a model to forecast short- and medium-term exchange rate movements. Good luck to them. For the rest of us, the important point is that the much-predicted crisis in the euro/dollar exchange may already have occurred.
Wolfgang Munchau 21/3 2005

The economists Pierre-Olivier Gourinchas, of University of California at Berkeley, and Hélène Rey, of Princeton University /International Financial Adjustment, CEPR discussion paper 4923/, make two brave claims. First, they argue that the dollar's depreciation between 2002 and 2004 may have been sufficient to redress the imbalances in the US economy.

Second, and most outrageously, they claim to have constructed a model that is better at predicting exchange rates than the "random walk" - under which the best forecast of the future exchange rate is today's exchange rate.

How do the authors come up with such different conclusions about the dollar's level? The US calculates the current account, including the trade balance, investment income and financial transfers, at historic cost. This calculation, however, may understate the return on net foreign assets - the difference between foreign assets held by the US and US assets held by foreigners.

US foreign liabilities run close to 100 per cent of GDP, almost all of it denominated in dollars. US foreign assets are about 70 per cent of GDP. Of those, about 70 per cent are held in foreign currencies. If the dollar devalued by 10 per cent, the net wealth transfer from the rest of the world to the US would be about 5 per cent of US GDP. This would more or less cancel out the trade deficit.

(RE: I really do not understand...)

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The U.S. current account deficit 2004 widened to a record $665.9 billion, equivalent to 5.7 percent of GDP
Bloomberg 16/3 2005

Whom to believe - Buffett or Greenspan?
The Oracle of Omaha foresees dire consequences for our debt-ridden ways.
The Fed chairman predicts a soft landing and says the debt is no big deal. Who's right?
Jim Jubak, CNBC 15/3 2005

The Oracle versus the Chairman. In terms of heavyweight bouts, they don’t get much bigger than this. What these two champions of capitalism are slugging it out over is no less than the future of the U.S. economy

Warren Buffett, the Oracle of Omaha and the CEO of Berkshire Hathaway, charges the United States is headed for a massive dollar crisis caused by a trade deficit running at better than $600 billion annually. Bam!
Alan Greenspan, chairman of the U.S. Federal Reserve, counters the economy is headed for a soft landing and the debt owed to foreign investors and savers is no big deal. Smack!

One of these guys is wrong. Before telling you who I’m putting my money on, let me put the two head to head so you can make your own call.

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The resolution of our current account deficit... does not strike me as overly worrisome
Chairman Alan Greenspan cit at BBC 11/3 2005

Warren Buffett has warned that the US trade deficit risks creating a “sharecropper’s society”
Financial Times 5/3 2005

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Many economic commentators argue that the trade deficit somehow results from low saving and the federal budget deficit.
But reducing the budget deficit can't really help the trade deficit. To shrink the budget deficit, the government must either spend less or tax more, withdrawing demand from the U.S. economy.
Frank Newman and Dan Newman, Wall Street Journal, March 14, 2005

Frank Newman is chairman emeritus of Bankers Trust Corporation, a former deputy secretary of the U.S. Treasury Department, and a director of Dow Jones. Dan Newman is a research consultant.

Purchases of all goods, foreign and domestic, would fall. Since imports make up only about 15% of GDP, the biggest decline of purchases would be domestic, resulting in only a marginal decline in imports relative to the drop in GDP.

Trying to increase household saving (i.e., reduce consumer spending) would help no more. To meaningfully lessen the trade deficit by saving, Americans would need to focus their spending reductions specifically on foreign goods -- highly unlikely in a nation with 85% of its spending on domestic goods and services.

Nor does the dollar need to fall -- and the trade deficit doesn't necessarily fall when the dollar does.

If the dollar falls by 20% and the number of goods imported falls by 20%, the sum of dollars sent abroad remains the same: Americans purchase fewer imported goods, but spend more on the ones they do buy. Not one new U.S. job is created, while prices rise for American consumers and businesses.

All dollars lead to home. They can't be eaten, and no one stuffs them into pillowcases. Foreigners either use them to buy U.S. goods, or they invest them in dollar assets.

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Kudlow On The Trade Deficit
Mr. Kudlow's rhetoric typifies an ongoing Wall Street, government, and media propaganda effort that would even amaze George Orwell.
Peter Schiff 11/3 2005

The resolution of our current account deficit... does not strike me as overly worrisome
Chairman Alan Greenspan cit at BBC 11/3 2005

Federal Reserve chairman Alan Greenspan used a speech to the Council on Foreign Relations think-tank in Washington DC on Thursday to stress that the falling dollar would help it diminish naturally, as would globalisation and free trade.
"The resolution of our current account deficit... does not strike me as overly worrisome," he said.

Remarks by Chairman Alan Greenspan at the Council on Foreign Relations, March 10, 2005

Full text at BBC

More about Chairman Greenspan

The Economist

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One of my deepest concerns is that the current complacency with the trade deficit which stems from the relative stability of the US economy and markets will lead to an event as dramatic as the fall of the NASDAQ.
The US economy is growing handily, thank you very much, and unemployment is slowly beginning to drop. The trade deficit has caused no problems.
John Mauldin 11/3 2005

Let's start this letter by noting that this week is the anniversary of the all- time high of the NASDAQ. Five years ago this week the NASDAQ topped at 5,048. It eventually dropped to around 1100 before "recovering" to today's close at 2,041.

There is simply no way to know how far along the process we are. Is it 1996, and Greenspan is muttering "irrational exuberance" or is it 1999 and a New Paradigm?

There are many who now suggest we are in a New Paradigm. This time, we're told, things are different.

Mauldin's Fourth Rule: It is almost never different. And if it really is different, we won't know it is until long after. You can't alter the basic economic equations of mankind.

The argument for a New Paradigm goes something like this: It's in everybody's interest, and especially that of Asia, to keep the game going. They would be risking political instability if they did not fund the US trade deficit

Further, the United States is still the best place in the world to invest money. Our assets far outweigh our liabilities, and our companies are the most profitable and highest margin companies in the world. While many who make these arguments would concede that some adjustment needs to be made, they think that the adjustments will be mostly of a benign nature and not roil the economy.

The Trade Deficit End-Game

In my opinion, over the long term the dollar has nowhere to go but down, although over the short term the dollar could give us a head fake and strengthen. Interest rates, at least until we are in a recession, will be heading higher. Please understand this is not the end of the world

Life will go on and eventually we will work through this process, just like we worked through stagflation in the 70s.

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Stagflation in the 70's

New Era

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Dollar sinks on trade gap worries
Currency traders fret about the possibility of disappointing numbers on Friday
CNBC 8/3 2005

Economists expect the U.S. trade deficit to have widened to $56.8 billion from $56.4 billion in January, according to Briefing.com.

Stabilitetspakten

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Warren Buffett has warned that the US trade deficit risks creating a “sharecropper’s society”
Mr Buffett’s bet against the dollar also grew. Foreign exchange contracts – mostly short positions against the US dollar – nearly doubled over the year to $21.4bn
Financial Times 5/3 2005

Berkshire’s holdings of cash rose from $36bn in 2003 to $43bn by the end of December – equivalent to nearly all the “float”, or excess cash, generated by its insurance businesses.

Mr Buffett’s bet against the dollar also grew. Foreign exchange contracts – mostly short positions against the US dollar – nearly doubled over the year to $21.4bn, generating $1.8bn in gains as the greenback fell against other major currencies.

Mr Buffett stepped up his warning about the US trade deficit and the need to finance it with foreign investment, devoting more than two full pages of the annual report to the topic.
“This force-feeding of American wealth to the rest of the world is now proceeding at the rate of $1.8bn daily, an increase of 20 per cent since I wrote you last year,” he said. “Consequently, other countries and their citizens now own a net of about $3,000bn of the US”
In particular, he warned that this meant a sizeable portion of what US citizens earned in future would have to be paid to foreign landlords.
“A country that is now aspiring to an “Ownership Society” will not find happiness in – and I’ll use hyperbole here for emphasis – a “Sharecropper’s Society,” added Mr Buffett. “But that’s precisely where our trade policies, supported by Republicans and Democrats alike, are taking us.”

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If I believed in Austrian business cycle theory
I would think that the U.S. economy is due for a dollar plunge, and a massive sectoral shift toward exports. Furthermore I would think it will not handle such an unexpected shock very well.
I would buy puts on T-Bond futures and become rich.
Tyler Cowen on January 19, 2005

If I believed in Austrian business cycle theory1. I would think that Asian central banks, by buying U.S. dollars, have been driving a massive distortion of real exchange and interest rates.
2. I would think that the U.S. economy is overinvested in non-export durables, most of all residential housing.
3. I would think that we have piled on far too much debt, in both the private and public sectors.

Dress rehearsal for a dollar deluge
Tuesday's sell-off was a test run of the problems that will erupt when foreign investors refuse to finance our debt binge and home owners stop their own binge.
Bill Fleckenstein CNBC 28/2 2005

Prerequisite to current events: Bubble 101

It's important to take a step back and recognize that in the wake of the biggest mania in the history of the world, which ended in March 2000, it would have been reasonable to expect a fairly severe recession and a radical decline in many asset markets. That occurred in the stock market, to some degree (principally Nasdaq stocks). But the bear market was temporarily arrested, as was the recession, by the fact that 13 interest-rate cuts (plus a couple of tax cuts) jumpstarted the housing market - and ultimately created a new bubble.

CPI will never show inflation of any consequence. The CPI has been engineered specifically not to. Housing-price increases have essentially been removed, via the way in which owner-equivalent rents are calculated, and they cannot possibly reflect what's happened to house prices. Then, when one adds in hedonics (which strips out many price increases by assuming they are quality improvements) and factors in the substitution allowances in the data, it is clear that the CPI is not going to ring any sort of alarm bells.

South Koreans appeared to yell fire there last Monday night, when they announced plans to diversify their foreign-reserve holdings away from dollars. (They are not the first to do so, as the Indians, the Russians and others have said the same thing.)

The real news, of course, was the foreign-currency market's reaction last Tuesday -- as the announcement itself was really just evolutionary, not revolutionary. What we saw was a dress rehearsal for the day when everyone realizes that they might be the rotten egg stuck holding a currency in serious decline.

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European Sado-Monetarism
"What could Europe do to protect itself in the face of a narrowing US deficit. The obvious answer would be to stimulate domestic demand by cutting interest rates and taxes. But...
Anatole Kaletsky of GaveKal research Cit by John Mauldin 25/2 2005

"What, then, could Europe do to protect itself in the face of a narrowing US deficit, especially with both Japan and China refusing to budge from their present currency regimes? The obvious answer would be to stimulate domestic demand by cutting interest rates and taxes. But the sado-monetarism of the ECB rules this out.

China is simply not listening to the US or Europe about the value of their currency. They will revalue when they are ready and not one minute before. But expect a lot of pressure on the rest of Asia, from especially Europe and the US, to gradually allow their currencies to rise.Such a move is inevitable, in my opinion. But I am not as persuaded or as confident as Alan Greenspan. Earlier this month, while speaking at a conference in Europe, he told the audience that a flexible economic system could "facilitate adjustment to a smaller US deficit without significant costs."

Frankly, I /John Mauldin/ hope Roubini and Setser are wrong in their prediction that the Bretton Woods 2 accord will collapse within two years. I hope it takes much longer. I want my pain in slow, moderate (dare we say measured?) amounts.
There is a recession at the end or maybe even the middle of the process, and we all want it to be as mild as possible. But that is not the way I would bet it unfolds.

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Will the Bretton Woods 2 Regime Unravel Soon?
The Risk of a Hard Landing in 2005-2006
Nouriel Roubini and Brad Setser February 2005

Stability Pact

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Remember these names. Toshihiko Fukui. Zhou Xiaochuan. Perng Fai-Nan. Park Seung. Joseph Yam. And Yaga Venugopal Reddy.
They are the central bank governors of Japan, China, Taiwan, South Korea, Hong Kong and India respectively. They are also arguably more important for US monetary policy than Alan Greenspan, the Federal Reserve chairman, or his successor who will take on the role next year.
Chris Giles, FT's economics editor, Financial Times 25/2 2005

If the mere hint that South Korea might stop buying US dollar assets can move edgy markets more than Mr Greenspan's most trenchant comments to date on US deficits, it signifies how far the balance of power in the global economy has changed.

The US must attract roughly $2bn capital a day to finance its current account deficit. This has to come either from private investors or foreign governments. If not, the dollar would fall. In the past two years, the reliance on official purchases of US assets from Asian central banks has been enormous, and Asian central bank foreign exchange reserves have swelled.

Japan's official exchange reserves now exceed $800bn; China holds more than $600bn; Taiwan and South Korea each holds more than $200bn; and Hong Kong and India are not far behind

The situation is not sustainable. It resembles a giant pyramid selling scheme. The US current account deficit is unlikely to shrink in the next few years so, unless foreign private investors have a change of heart, Asian central banks will have to keep buying dollar-based assets to prevent their currencies rising and avoid the consequent capital losses on their reserves.

As their exposure rises, the incentive to seek an exit will also grow.

After this, all bets would be off. If a crisis ensued it would be a disaster for Asia, which would suffer huge capital losses and possibly an uncontrolled appreciation of local currencies. The US would suffer higher interest rates and possibly a sharp slowdown in growth as cheap finance dried up and the US consumer began to save again. And Europe would not escape, as it is too dependent on the rapid growth of the US and Asian economies.

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Forget trade deficits: go for growth
Daniel Griswold, director of the Center for Trade Policy Studies at the Cato Institute, Financial Times February 24 2005
America's trade deficit is essentially an accounting abstraction.
FT 24/2 2005

The UN study acknowledges what has long been true of the US economy: the trade deficit tends to expand along with the economy and contract when the economy slows. In fact, an analysis of economic data from the last quarter century shows that a growing current account deficit (as a percentage of gross domestic product) is associated with faster, not slower, economic growth, as well as rising manufacturing output and falling unemployment.

Consider the most fundamental measure of economic health, the growth of real GDP. In those years since 1980 when the current account deficit declined, real GDP grew a sluggish annual 1.9 per cent on average. When the current account deficit grew moderately, real GDP grew at an annual average of 3 per cent. And when the deficit rose the most rapidly, real GDP grew by a robust average of 4.4 per cent - a rate more than double the growth in years when the deficit was "improving".

Those who seek the Holy Grail of a trade surplus should be careful what they wish for. Germany last year racked up a global surplus of almost $200bn. Not entirely coincidentally, its unemployment rate reached 11.4 per cent in December and the number of unemployed reached a post-unification high of 5m people.

The last time America's jobless rate was that high was 1982 - when its own current account deficit was a measly $5bn.

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Rolf Englund: Keynes would probably agree. When you increase total demand both production, umployment and net imports increases.
The conclusion seems to be that a decrease in the US trade deficit can anly occur when US in in recession, or perhaps depression.

- Jag vill fästa uppmärksamheten på årtalen 1982 och 1992 i Klas första diagram över det amerikanska handelsunderskottet. Det visar att dessa märkesår i svensk ekonomisk politik var de enda år som USA hade balans i sin utrikeshandel.
Rolf Englund på Nationalekonomiska Föreningen 30/11 2004

Tyskland

Keynes

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Sir, Daniel Griswold is certainly correct in asserting that there is a relationship between the US trade deficit and economic growth. However, he is mistaken as to the causality of that relationship.
Desmond Lachman, American Enterprise Institute, Washington, FT 1/3 2005

Sir, Daniel Griswold is certainly correct in asserting that there is a relationship between the US trade deficit and economic growth ("Forget trade deficits: go for growth", February 25). However, he is mistaken as to the causality of that relationship. Rather than large trade deficits causing rapid economic growth, as Mr Griswold seems to believe, it would appear more plausible that it is rapid economic growth that causes large trade deficits. Rapid economic growth does so by sucking in imports to meet the increased level of domestic demand that is associated with such growth.

Mr Griswold overlooks the fact that, at around 6 per cent of gross domestic product, the US external current account deficit is not sustainable. The US has already moved from being the world's largest creditor nation to being the world's largest debtor nation, with net external liabilities of around 30 per cent of GDP.

If the mighty dollar can be rocked by a single paragraph in a report to the Korean parliament something is amiss.
That something is the dependence of the dollar on a handful of Asian central banks, which between them control $2,400bn reserves.
Financial Times editorial 24/2 2005

The first mid-sized country to bail out of the dollar might be able to get a good price for its assets and maintain its bilateral exchange rate, encouraging others to follow.

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Det avgörande för vad som kommer att hända med världsekonomin är om det låga amerikanska hushållssparandet kombineras med ytterligare stigande räntor i USA. Då kan vi se en dämpning av fastighetspriser och privat konsumtion i USA som får starka negativa effekter för hela världsekonomin.
Optimister har ju lika rätt som pessimister men har roligare under tiden. Ändå väljer jag att sälla mig till pessimisterna.
Olle Wästberg nyhetsbrev 16/1 2005

Olle Wästberg home page

Om Olle Wästberg hos Rolf Englund IntCom

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Sustaining Global Growth while Reducing External Imbalances
Michael Mussa IIE January 2005 (pdf)

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U.S. wholesale prices rose 0.3 percent in January.
Excluding food and energy, prices rose the most in more than six years.
Bloomberg 18/2 2005

The truth of the matter is this:
Across three decades, only one economic event has been guaranteed to produce balanced US trade: a recession.
Marshall Auerback,February 15, 2005

Debt Trap Dynamics: Time To Think The Unthinkable

When the economy is contracting, people naturally buy less of everything, including imports. Historically, on the four occasions when the line of exports briefly converged with the line of imports in the post-war period, the country was in recession. Each time economic growth was restored, the trade deficits resumed. A more ominous contradiction occurred during the 2001 recession: The trade gap was so enormous it persisted throughout. Again, in 2004, despite a significant fall in the dollar’s trade weighted index, the external account continued to haemorrhage. This suggests that American dependency on foreign producers has advanced to a dangerous new level.

As we have noted many times before, there is a danger that over time, the US economy will find itself in a “debt trap”, with an accelerating deterioration in its net foreign asset position and its overall current balance of payments (as net income paid abroad begins to explode).

Because the US is such a vast economy, it cannot eliminate its current account deficit as readily as a smaller economy. When it tries to improve its trade balance through devaluation or through restrictive demand management, its sheer size affects the economies of its trading partners adversely and to an appreciable degree.

If a full-blown crisis does occur, the macroeconomic challenge would be unlike anything the United States has faced in more than half a century.

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Kan man undvika recession i USA när man måste minska importen med 600 miljarder dollar?
Rolf Englund på Nationalekonomiska Föreningen 30/11 2004

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Will the Bretton Woods 2 Regime Unravel Soon?
The Risk of a Hard Landing in 2005-2006
Nouriel Roubini and Brad Setser February 2005

Nouriel Roubini Stern School of Business New York University, NBER and CEPR and
Brad Setser Research Associate Global Economic Governance Programme, University College, Oxford University
First Draft: February 2005

The defining feature of the global economy right now is the $660 billion US current account deficit. The world’s largest economy – and the world’s preeminent military and geo-strategic power – is also the world’s largest debtor. The current account surpluses of most other regions of the world are the mirror image of the US deficit. The US absorbs at least 80% of the savings that the rest of the world does not invest at home. Barring an economic slump in the US or a major fall in the dollar, the US current account deficit looks set to expand significantly in 2005 and 2006.

The defining feature of the current international financial and monetary system is that it finances the United States’ enormous external deficit – and the associated fiscal deficit -- at low interest rates.

If the US does not take policy steps to reduce its need for external financing before it exhausts the world’s central banks willingness to keep adding to their dollar reserves – and if the rest of the world does not take steps to reduce its dependence on an unsustainable expansion in US domestic demand to support its own growth -- the risk of a hard landing for the US and global economy will grow.

The basic outlines of a hard landing are easy to envision: a sharp fall in the value of the US dollar, a rapid increase in US long-term interest rates and a sharp fall in the price of a range of risk assets including equities and housing. The asset price adjustment would lead to a severe slowdown in the US, and the fall in US imports associated with the US slowdown and the dollar’s fall would lead to a global severe economic slowdown, if not an outright recession.

Full text (pdf)

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A consequence of the contraction in profit margins of exporters to the United States, and thus low pass-through of dollar depreciation to U.S. import prices, has been minimal pressure on U.S. consumer price inflation in recent years.
A corollary is that the adjustment of U.S. real imports--that is, the quantity of imported goods and services--has been negligible.
Chairman Greenspan 4/2 2005

From early 2002 to early 2004, the dollar's exchange rate against the euro and sterling, on average, declined about 30 percent, yet dollar prices of imported manufactured goods from the European Union rose by only 9 percent, slightly more than dollar prices of U.S. manufactured goods during the same two years.

The consequence of the relatively small rise in the dollar price was a significant compression of gross operating profit margins on European exports to the United States. In recent years, exporters, not only in Europe but in many other trading partners of the United States as well, have tended to increasingly absorb declines in prices denominated in their own currencies when their currencies rose and to fatten profit margins when their currencies fell.

But, long-term hedging is expensive, and therefore, most currency futures contracts are short-term. Once hedges expire, export revenues are no longer protected from past and future changes in exchange rates, and any new hedges must reflect the new exchange rates. Thus, successful currency hedges can at best delay but cannot prevent the ultimate effects of changes in exchange rates on trade.

A consequence of the contraction in profit margins of exporters to the United States, and thus low pass-through of dollar depreciation to U.S. import prices, has been minimal pressure on U.S. consumer price inflation in recent years. A corollary is that the adjustment of U.S. real imports--that is, the quantity of imported goods and services--has been negligible.

However, we may be approaching a point, if we are not already there, at which exporters to the United States, should the dollar decline further, would no longer choose to absorb a further reduction in profit margins.

To understand why the nominal trade deficit--the nominal dollar value of imports minus exports--has widened considerably since 2002, even as the dollar has declined, we must consider several additional factors.

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Cutting the budget deficit won't do much to shrink the gaping U.S. trade deficit, a Federal Reserve study has found
When the budget deficit increases by one dollar, the trade deficit increases by less than 20 cents.
RE: 80 procent påverkar således den inhemska efterfrågan
Wall Street Journal 2/2 2005

The U.S. trade deficit is estimated to have hit a record of more than $600 billion last year, or more than 5% of gross domestic product. Click here

Full text of Fed Study "Expansionary Fiscal Shocks and the Trade Deficit"

Prices, when freely set, bring order and concord to the unplanned activities of market economies — as if by an invisible hand.
But three of the most important prices in the world economy — the price of oil, the price of capital and the price of the dollar — are nudged this way or that by the very visible hands of the Organisation of the Petroleum Exporting Countries (OPEC), the Federal Reserve and the G7.
The Economist 31/1 2005
Very Important Article

Treasuries are pricey because anyone who wants to buy one must compete with China’s central bank. The People’s Bank of China (PBoC) is, in effect, a “forced buyer” of Treasuries. To keep the yuan pegged at 8.28 to the dollar, it must buy as many dollars as people want to sell at that rate. Despite the controls it maintains on capital inflows, dollar sellers are legion. In the last quarter of 2004, the PBoC added another $100 billion to its foreign-exchange reserves. It stores the bulk of these reserves in the official liabilities of America’s government.

China accounts for less than a tenth of America’s trade. If the Chinese were to revalue the yuan by 10% it would reduce the dollar’s trade-weighted value by only 1%. Even if China’s Asian rivals and partners followed its lead, revaluing their own currencies by a similar amount, the dollar’s trade-weighted value would fall by only 3.7%.

According to Brad Setser, a former Treasury official now at the University of Oxford, a dearer yuan would have a more significant effect on capital flows. At the moment, foreign capital is finding its way into China in anticipation of a yuan revaluation. Speculators want to be holding Chinese assets when the currency in which they are denominated jumps in value. The PBoC soaks up this foreign money and recycles large portions of it back into American Treasuries. Once the long-anticipated revaluation actually occurs, the speculation will ebb, and the PBoC will find itself with less money to throw at American assets.

As a result, the price of those assets will fall and American interest rates will rise, encouraging Americans to live within their means.

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About Brad Setser

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US Short-term interest rates and inflation are both rising, the current-account deficit is huge and widening, the dollar has fallen and the fiscal outlook has worsened.
Surely investors looking over the next ten years will want a better return than 4.2%?
Economists are genuinely puzzled by all this.
The Economist print edition 27/1 2005

Alternatives

The most gloomy theory is that America's economy is, in fact, rather more fragile than the current statistics suggest
A more hopeful argument for Mr Bush is that there has been a deeper “structural” change in the investment markets in favour of bonds.
A third theory is that investors are so convinced by the Fed's record as an inflation-slayer that they don't need higher rates on long-term bonds.
Which leaves the last possibility: that the financial markets have temporarily mispriced the risks involved. Investors are too complacent about inflation and about America's enormous budget and current-account imbalances. If that theory is correct, long-term interest rates could rise sharply and suddenly.

Just how the interest-rate puzzle will be resolved is unclear. But the chances are that either America's economy will do worse than many now expect or interest rates will head much higher.

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The economic crisis 2004, predicted by many, has not materialised.
Not so fast, say the economic experts at the World Economic Forum in Davos.
"The good news of 2004, the past performance is not indicative of future returns," quips Stephen Roach, chief economist at investment bank Morgan Stanley.Fair enough, Mr Roach is a notorious "Davos bear", well-known for his economic pessimism.Trouble is, many people here are happy to agree with him, even his old sparring partner, the perennial optimist Jacob Frenkel, vice-chairman of insurance giant AIG.
BBC 27/1 2005

Even the stock markets still look suspiciously overpriced, says Robert Shiller, economics professor at Yale University and author of the book 'Irrational Exuberance' in which he correctly predicted the stock market slump of 2001.

So what will happen "when the music stops", as Mr Roach puts it.
Worryingly, the first session to be oversubscribed in Davos was entitled: "Spotting the next bubble before it bursts".

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China's overall trade surplus was a modest $32 billion last year, peanuts compared with America's trade deficit of over $600 billion
The Economist 20/1 2005

In a new paper, “To Be a Rock and Not to Roll”, Stephen King, the chief economist of HSBC bank, exposes several myths behind the conventional arguments for a revaluation of the yuan.
The first is that China's large and growing trade surplus with America proves that the yuan is undervalued. China's surplus with America is offset by a deficit with other Asian countries from which it imports capital equipment and components.
As a result, China's overall trade surplus was a modest $32 billion last year, smaller than in the late 1990s and peanuts compared with America's trade deficit of over $600 billion.

Perhaps the biggest myth of all, says Mr King, is that the yuan's value is the only stumbling block to reducing America's current-account deficit. China accounts for less than 10% of America's total trade so a 10% revaluation of the yuan—as much as might be reasonably expected—would reduce the dollar's trade-weighted value by only 1%.

The real blame for America's current-account deficit lies with its lack of saving, not the Chinese yuan.

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The great question is whether the US will be able to reduce the deficit through a gradual manufacturing revival or, dramatically, through a domestic spending recession
What pundits have not noticed is that the US does not have adequate manufacturing capacity to eliminate the external deficit.
David Hale FT 26/1 2005

The other way for the US to revitalise manufacturing is to promote foreign direct investment. After a wave of takeover bids, FDI shot up to $250bn-$300bn during 1999 and 2000 before slumping back to only $50bn during 2002 and barely $30bn last year.

Foreign companies use their American manufacturing plants to satisfy both domestic demand and export back to their home countries. Intra-corporate trade accounts for 33 per cent of US exports and 40 per cent of imports. The cheap dollar should enhance the attractiveness of American investment for international companies.

The decline of the dollar is only the first step in the process of adjusting America's balance of payments. There will also have to be a significant reallocation of resources from domestic consumption to tradeable goods manufacturing. The great question is whether the US will be able to reduce the deficit through a gradual manufacturing revival or, dramatically, through a domestic spending recession. But the basic direction of the US economy is clear. There will have to be a significant expansion of output in tradeable goods industries to reduce the large current account deficit.

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Kan man undvika recession i USA när man måste minska importen med 600 miljarder dollar?
Rolf Englund på Nationalekonomiska Föreningen 30/11 2004... läs mer här

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Moderate growth in the presence of substantial policy stimulus during the recovery phase of a U.S. business cycle raises some serious questions about the level of interest rates that is consistent with long-term U.S. growth.
In a world that has essentially been driven by U.S. demand growth, a slowdown in U.S. consumption will add to the global slowdown and produce negative feedback effects, especially on export-driven economies such as Germany...
John H. Makin January 21, 2005

If a weaker dollar can’t do the trick, what can?
The answer, in my view, is real interest rates
The only way America can ever get a handle on its trade and current account conundrum is on the import side of the equation. After all, imports are currently 52% larger than exports (in real terms), making it almost mathematically impossible for the US to export its way out of its trade deficit.
In looking at real US interest rates over the broad sweep of history, there’s nothing but upside from current levels. The real federal funds rate remains around “zero” and the real rate on a 10-year Treasury note is down to its post-1986 low of 0.7%.
Stephen Roach 14/1 2005

Vad är det för land där bara knappt 13 procent av BNP investeras i företag och bostadsbyggande? Där bytesbalansöverskottet blev 206 miljarder kronor eller 8 procent av fjolårets BNP?
Det är inte riskkapital det är brist på – det som saknas är investeringsobjekt i Sverige som klarar lönsamhetskriterierna.
Dagens Industri ledare 23/2 2005

Svenskt Näringslivs chefsekonom Stefan Fölster upprepade sitt budskap om den låga investeringskvoten i Sverige jämfört med exempelvis övriga EU-länder.
Ingemar Hansson menade att det var vilseledande av Fölster att påstå att den låga investeringskvoten beror på dåligt näringslivsklimat i Sverige. – Den låga investeringskvoten beror på att vi har lägre bostadsinvesteringar i Sverige. Om de räknas bort ligger vi på en genomsnittlig investeringsnivå, förklarade Ingemar Hansson.
SvD Näringsliv, reporter Leif Petersen 12/1 2005

Fölster kontrade med att vi inte ska nöja oss med att ligga på snittet utan att vara i topp investeringsmässigt.

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Mer av Stefan Fölster

Dollarn måse falla ytterligare för att rätta till obalanserna i den amerikanska ekonomin
Stefan Fölster 2005-01-12: Nyhetsbyrån Direkt

Mycket talar för att dollarns aktuella växelkurs ligger nära ett jämviktsläge om det skulle råda balans i den amerikanska ekonomin, men enligt flera modellberäkningar måste dollarn falla ytterligare för att rätta till obalanserna.Det sade Stefan Fölster, chefekonom vid Svenskt Näringsliv, SN, vid en SNS-debatt på onsdagen.

Med en fortsatt fallande dollar kan Federal Reserve fortsätta att höja räntan, och enligt Stefan Fölster kan det leda till att "bubblan i huspriserna bryts".

Debattledaren Olle Rossander påpekade att bedömningen att husbubblan "bryts" var en mjuk formulering, men Stefan Fölster förklarade att effekterna av fallande huspriser i en uppåtgående konjunktur inte blir så stora. Det kan inte jämföras med när aktiebubblan brast i en vikande konjunktur 2000."Det är först när man har fallande huspriser och hög arbetslöshet som det får stora effekter", sade Stefan Fölster.

Olle Rossander undrade om inte sjunkande huspriser ändå inte får en effekt på hushållskonsumtionen, men enligt KI-chefen Ingemar Hansson är det inget att oroa sig för i ett större perspektiv."Det är helt i sin ordning, det är till och med önskvärt, att huspriserna faller om ekonomin annars riskerar att överhettas", sade han.

Cecilia Hermansson, prognoschef på Föreningssparbanken, var mer orolig över den amerikanska hushållskonsumtionen. Hon konstaterade att USA går från ett läge med en "starkt expansiv" finans- och penningpolitik till ett "kanske neutralt" läge, och det kan bli en "chock för konsumenterna"."Om hushållssparandet bara går från noll till 2 procent så kommer det få en stor effekt på konsumtionsutvecklingen", sade hon.

Jan Häggström, chefekonom på Handelsbanken, ser en inbromsning i den amerikanska ekonomin, men han bedömer att den kommer att ledas av företagens investeringar, inte hushållskonsumtionen

Nästa bubbla - huspriserna

Klas Eklund: USA har världens mest framgångsrika ekonomi

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The future of the dollar seems today to be the most important issue for the world economy in 2005.
Is it overvalued or undervalued? Will it rise or will it fall?
The dollar's ride will be a bumpy one but the fundamental reasons why the trend is downward remain in place.
John Kay FT 4/1 2004
Highly recommended

Purchasing power parity works well in explaining long-run currency movements and, over a decade or more, changes in exchange rates are mostly attributable to differences in inflation rates.

A good rule of thumb is that the dollar is cheap when a German can obtain sauerkraut and lederhosen more cheaply in New York than in Munich and expensive when an American can buy hamburgers and plaid pants more cheaply in Paris than in Chicago. On that criterion, the dollar was slightly expensive in 2001 and is today slightly cheap.

But currencies are a store of value and a unit of account as well as a medium of exchange. Dollar assets are popular because people trade in dollars even if they are not buying or selling American goods. And dollar assets are popular because people have been optimistic, even irrationally exuberant, about growth prospects for the US economy. For years, this demand for dollars as assets enabled the US to run a trade deficit and still maintain an exchange rate broadly consistent with purchasing power parity.

But there are limits to foreign demand for American assets, and they have been reached. Today, the only class of investors making net additions to their dollar balances are Asian central banks. Not because they love to see their vaults stuffed with US government securities, but because the only way they can sustain their own very competitive exchange rates is to keep selling their own currency for the dollars that Americans use to buy their exports.

The recent fall in the value of the dollar increases the demand for American goods, but not necessarily the demand for dollars, either as an asset or as a medium of exchange.

Devaluation can reduce a trade deficit only if it is accompanied by lower demand for goods and services. But private consumption and government spending in the US continue to grow and there is no intention of adopting policies that will change it.

And so the dollar can be undervalued as a medium of exchange and overvalued as an asset. Does that mean it will go up or down?

The dollar's ride will be a bumpy one but the fundamental reasons why the trend is downward remain in place.

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Clearly, import demand needs to decrease. Which policy levers could bring this about?
The US government is unlikely to use fiscal policy to push the economy into recession to reduce consumer demand
Lex FT 30/12 2004

US exports have responded to a weaker dollar rising 16 per cent in value terms in the third quarter compared with the previous year. Unfortunately, imports for the same period increased by 20 per cent and were worth 40 per cent more than exports. Part of the problem is the usual lag before the volume of imports declines as part of the current account adjustment process. But the low level of substitutability between US exports and imports may exacerbate the required dollar decline. The long-term decline of the manufacturing sector as a percentage of GDP and the shrinking US share of world trade will also make it difficult for America to export its way out of the problem.

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US net foreign debt-service payments will reach 4% of GDP by 2020
The Economist 29/12 2004

Since early 2002 the dollar has lost 37% against the euro and 24% against the yen. But it has shed only 16% against the Federal Reserve's broad basket of currencies, because many Asian currencies are pegged or closely tied to the greenback.

So far, America's mounting foreign liabilities have not harmed its economy because the rise in its debt in recent years has been offset by lower interest rates.

Goldman Sachs estimates that, if America's current-account deficit remains steady as a share of GDP and interest rates average 5% in future, net foreign debt-service payments will reach 4% of GDP by 2020

The pundits who have been predicting higher interest rates based on large U.S. budget and current account deficits have some explaining to do.
It is odd that the broad field of U.S. deficit bemoaners, including a former Treasury secretary, an immensely successful investor, and the manager of the world's largest bond fund, have chosen to mislead the public on the major determinants of interest rates.
John Makin 21/12 2004

Beyond the fact that very little systematic empirical evidence exists of a close link between deficits of any kind and interest rates, many high-profile commentators such as Robert Rubin and Pete Peterson, not to mention Pimco's Bill Gross, have consistently warned that long-term interest rates would rise as America's budget and current account deficits rose. Actually, U.S. long-term interest rates have been falling--from 4.8 percent in early June to 4.1 percent at year-end. Despite this stellar performance, Gross has even gone so far as to suggest that U.S. government liabilities should be downgraded from their top rating of AAA to AA.

For the benefit of this distinguished group and the rest of us who need to have some idea where interest rates are going, I offer here a basic primer on the determinants of interest rates.

The U.S. government does offer Treasury notes that are protected against inflation. By comparing the yield on ten-year Treasury inflation-protection securities (TIPS) with the yield on regular Treasury notes, it is possible to infer the inflation rate expected by investors over the life of the ten-year note and the expected real return on Treasury notes.

Currently, the expected inflation rate over the next ten years implied by the TIPS yield is about 2.5 percent. The remainder, 1.75 percent on a bond paying a nominal yield of 4.25 percent, is the expected real return on the ten-year notes. Based on past history, 1.75 percent is somewhat low but probably reflects the fact that rates of return on invested capital have been driven down over the past several years by the widespread search for ways to store wealth in a world where wealth is rising rapidly

A national debt of $3.5 trillion, the current level, is not excessive for an $11 trillion economy like that of the United States. Nor is an additional $2 trillion in debt issued over ten years to restore solvency to the Social Security system as the economy grows to $18 trillion.

When all is said and done, it is the search for ways to store wealth that drives interest rates and not some hazy notion of unsustainable twin deficits. Markets clear every day. Today, everyone knows what the outlook is for U.S. inflation, issuance of Treasury securities, and economic growth relative to the same variables in the rest of the world.

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Real interest rates

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The great housing boom of the early 21st century is looking shaky. Governments are growing nervous about whether prices will hold, and what will happen if they do not.
A nightmare for the Fed would be that it finds itself under pressure to raise interest rates to support the dollar just as a weakening housing market needs lower rates to avoid big declines.
Floyd Norris International Herald Tribune 24/12 2004

Hervé Gaymard, France's new finance minister, on Thursday warned of a global "economic catastrophe" if the US, Europe and Asia did not work together to stem the decline of the dollar against the Euro.
"If we stay as we are, with no co-ordination, one can imagine a catastrophic economic situation at the global level," he said.
Financial Times 24/12 2004

"His outburst is regarded as toothless. Co-ordinated intervention strikes the market as off the radar screen at the moment," said Mark Cliffe, chief economist at ING Financial Markets.

The dollar is set to record a third straight year of losses for the first time since 1987, when the world's leading nations signed the Louvre Accord to bring stability to exchange rates.

French concern over the dollar reflects worries about export and growth prospects as the country struggles to meet its eurozone obligation to keep its budget deficit below 3 per cent of gross domestic product. In spite of calls from politicians for intervention in foreign exchange markets, Jean-Claude Trichet, president of the European Central Bank, has not gone further than saying recent currency moves are "unwelcome". On Thursday, the US dollar fell to a record low, reaching $1.3502

Euron

Welcome to the vicious cycle
Every dollar increase in the price of a barrel of imported oil increases the size of the U.S. trade deficit, which puts more pressure on the value of the U.S. dollar,
which makes OPEC countries want to raise the dollar-denominated price of a barrel of oil to make up for the dollar’s fall, and so on.
Jim Jubak CNBC 10/12 2004

Because we import so much of the oil we use, the huge jump in petroleum prices has added to the growing U.S. trade deficit in goods and services with the rest of the world. That deficit -- the difference between the cost of what we import and what we export --climbed to $51.6 billion in September 2004.

Contrast that with the $29.6 billion monthly U.S. trade deficit in January 2002, before the price of oil spiked.

Ending this one will require a drop in U.S. energy imports sufficient to decrease the U.S. energy bill, thereby shrinking the U.S. trade deficit and decreasing the supply of dollars sloshing around OPEC.

(A little fiscal discipline on the part of the U.S. government, a revaluation of the Chinese yuan and a pickup in global growth so that overseas consumers could buy more cheap U.S. exports wouldn’t hurt, either.)

And this is where the vicious cycle kicks in. Every dollar increase in the price of a barrel of imported oil increases the size of the U.S. trade deficit, which puts more pressure on the value of the U.S. dollar, which leads to a weaker dollar, which makes OPEC countries want to raise the dollar-denominated price of a barrel of oil to make up for the dollar’s fall, and so on.

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A significant decline in both consumption and investment will mean a recession in the US.
This conclusion is so obvious that the only question is why the markets are not forecasting it already.
Barry Eichengreen Financial Times 20/12 2004

The writer is professor of economics and political science at the University of California, Berkeley

Congenital optimists see the dollar's fall as part of a necessary rebalancing of the world economy. Without a change in exchange rates, the US current account deficit is on an explosive path. It could widen from its current 5-6 per cent of US gross domestic product to 8 per cent in 2008 and 12 per cent in 2010.

A smooth and moderate decline in the dollar that narrows the US current account now is preferable to a sudden and potentially catastrophic fall later.
The question is whether or not it is already too late for a smooth adjustment

As the dollar falls, there will be upward pressure on US import prices and more inflationary pressure generally. In response, the Federal Reserve will have to raise interest rates faster than currently expected. Higher interest rates will make borrowing more expensive and slow investment growth. They will have a negative impact on asset valuations, including house prices. US households, no longer living off capital gains, will have to start saving again. With investment down and saving up, the current account deficit will narrow.

Unfortunately, this happy observation is not the end of the story. A significant decline in both consumption and investment will mean a recession in the US. This conclusion is so obvious that the only question is why the markets are not forecasting it already.

The answer, presumably, is that investors do not believe that the dollar's decline will produce a significant increase in inflation. The historical data say that a 10 per cent fall in the dollar produces 3 additional percentage points of inflation, which in turn implies a 450 basis-point increase in the discount rate. Clearly, we have not seen anything like this yet.

Treasury inflation-protected securities spreads - the difference between yields on conventional Treasury securities and Tips - suggest only a modest increase in inflationary expectations. Maybe the "new economy" has rendered the US economy more flexible and resilient so that the traditional relationship between dollar depreciation and inflation no longer holds. Perhaps, then, fears of significantly higher interest rates are exaggerated.

But even if this observation is correct, it just means that the dollar will have to fall further to generate enough inflationary pressure to force the Federal Reserve to raise interest rates. At the root of the dollar's decline is the view that the US current account deficit is unsustainable. Foreigners will therefore keep selling dollars until it narrows. This in turn means that the dollar will keep falling until US inflation heats up to the point where the Fed does indeed have to raise interest rates. The implication, that the US economy will slow or more likely succumb to recession, is unavoidable.

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Kan man undvika recession i USA när man måste minska importen med 600 miljarder dollar?
Rolf Englund på Nationalekonomiska Föreningen 30/11 2004

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The first step towards an answer is deciding what a sustainable US current account deficit might be
Now turn to the required changes in real exchange rates.
Martin Wolf Financial Times 22/12 2004

The aim is to reduce the rest of the world's reliance on the spillover of excess demand from the US and from a few other high-income countries, while sustaining global economic activity.
To achieve this, we need two changes:
a reduction in aggregate demand, relative to potential supply, in deficit countries (and offsetting increases in surplus ones);
and a depreciation of the real exchange rate in deficit countries, to switch output towards - and demand from - tradeable goods and services.

The first step towards an answer is deciding what a sustainable US current account deficit might be.
In a recent column (FT, December 15), Raghuram Rajan, the chief economist of the International Monetary Fund, argues that the US could sustain a current account deficit of 3 per cent of gross domestic product (half the current level) indefinitely.

Given US potential growth, net external liabilities would stabilise at 50 per cent of GDP, against roughly 30 per cent today.

Suppose, then, that the current account deficit were to be reduced from 6 per cent to 3 per cent of GDP over half a dozen years. With potential growth of supply at 3½ per cent a year, real domestic demand would then need to grow at around 3 per cent.

Now turn to the required changes in real exchange rates. To achieve a fall in the current account deficit, at full employment, of 3 per cent of GDP, the increased domestic supply - and reduced domestic demand - for tradeable goods and services in the US would amount to about an eighth of current output in this sector.

Some analysts suggest that the needed overall real exchange rate adjustment could be close to 30 per cent from the peak three years ago. This would imply a further depreciation nearly as large as the one so far.

Non-Japan Asia contains the world's fastest growing economies and biggest populations. These are the countries that would normally be expected to run current account deficits, financed by long-term capital inflows. Yet that has not happened, largely because exchange rate intervention and monetary sterilisation are thwarting the natural adjustment. The result has been an astonishing accumulation of foreign currency reserves

China, for example, holds reserves equal to a third of GDP, up from a sixth just four years ago. What is the point of exporting real goods in return for pieces of paper whose value will tumble when the Chinese seek to cash them in?

The world will only dispense with its dependence on the accumulation of mountainous US liabilities if non-Japan Asia - above all, China - play the role to be expected of the world's fastest growing and most populous countries.

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A floating threat
China - With floating exchange rates you do not need such a big currency reserve
Rolf Englund Financial Times 8/12 2004

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Trade Gap Widens to a Record $55.5 Bln
The U.S. trade deficit widened to an all-time high of $55.5 billion in October
Bloomberg 14/12 2004

The most acute risks are posed by the large and rapidly growing US current account deficits.
They exceed 6 per cent of gross domestic product and are on a trajectory to reach 10 per cent
- more than $1,000bn annually - within the next few years
Fred Bergsten Financial Times 14/12 2004

The writer is director of the Institute for International Economics and editor of its forthcoming publication
The United States and the World Economy: Foreign Economic Policy for the Next Decade, on which this article is based

The good news is that the current orderly decline of the dollar, if continued for another six months at its recent pace, could achieve the cumulative decline of 30 per cent from its early-2002 peak needed to restore a sustainable US external position by cutting the external deficits in half.

But the decline could just as easily turn into an overshooting freefall that would shatter confidence, drive US interest rates towards double digits and crash equities à la Black Monday in 1987. Or it could stall, thereby storing up bigger problems a year or so out if other countries block the counterpart rise in their own currencies.

The root cause of the problem is low US national saving, which requires the US to borrow massive sums abroad and thus run large current account deficits.
There is unfortunately no reliable policy instrument to enhance US private saving.

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Institute for International Economics

A weaker dollar and higher bond yields would be catastrophic for current global upturn
the more critical question for most of us is why the world's central banks need the $3,000bn in currency reserves they now possess
Kit Juckes, Head of Market Strategy, Royal Bank of Scotland Financial Markets 10/12 2004

Sir, Henry Kaufman assures us that there can be no alternative to the dollar as a reserve currency ("Why there can be no alternative to the US dollar", December 9).
That may well be true, but the more critical question for most of us is why the world's central banks need the $3,000bn in currency reserves they now possess, and whether an attempt at slowing the rate of reserve accumulation will result in a further, and significant, fall by the dollar.

The dollar was the world's principal reserve currency in the 1960s, 1970s, 1980s and 1990s. But in the 1960s, the US started running a significant budget deficit in part because it was fighting a war on the other side of the world, in Vietnam.A recession then prompted the Federal Reserve to cut interest rates and this, in turn, led to a deterioration in the balance of payments and an increase in reserve accumulation by central banks whose currencies were pegged to the dollar in the Bretton Woods system of fixed exchange rates.

This all seems eerily familiar. In 1970-71, central banks became increasingly concerned at the growth of their reserves, the difficulties they faced in trying to sterilise them in domestic money markets and the threat that excess liquidity would prove inflationary. The Bundesbank was the first to move, revaluing the D-Mark in August 1971.

The dollar halved in value between 1971 and the end of the decade against the D-Mark (from DM4 to just over DM1.50), and the dollar fell from Y350 to Y180. But, the dollar remained the world's only significant reserve currency (though even by 1986, global currency reserves totalled just $200bn).

At the moment, the unprecedented increase in global financial liquidity caused by attempts to peg currencies to the dollar is causing commodity and asset price inflation, rather than the kind of goods price inflation that most concerns central banks.

But inflation is in positive territory even in Japan and bubbles (in bonds and real estate) will not easily be deflated.

A much weaker dollar and higher bond yields would be catastrophic for the current global economic upturn. A more modest adjustment is still possible, but not for long.

A floating threat
China - With floating exchange rates you do not need such a big currency reserve
Rolf Englund Financial Times 8/12 2004

From Mr Rolf Englund.

Sir, The dollar optimists usually pin their hopes on the central bank of the People's Republic of China. They think China will continue to support the dollar by accumulating more dollar-denominated assets (ie, US bonds).

China has declared that it intends, in due course, to let its currency float. With floating exchange rates you do not need such a big currency reserve as when a fixed rate has to be defended.

China's currency reserves are now estimated to be about $500bn, which seems to be much more than will be needed later on. This does not bode well for the dollar or the bond market.

Rolf Englund, Director, IntCom, Stockholm, Sweden

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Kan man undvika recession i USA när man måste minska importen med 600 miljarder dollar?

A significant decline in both consumption and investment will mean a recession in the US.

This conclusion is so obvious that the only question is why the markets are not forecasting it already.
Barry Eichengreen Financial Times 20/12 2004

Rolf Englund på Nationalekonomiska Föreningen 30/11 2004

Interesting times ahead for all
Rolf Englund, Letters to the Editor, Financial Times, November 6, 2000

The growing external deficits of the world's "sole superpower" have put the global economy
on a path that is not merely unsustainable but also dangerously so.
US and Asian policymakers seem determined to take no decisive action in response.
This is understandable, but a big mistake.
Martin Wolf Financial Times December 8 2004

Up to the end of 2001, the US was accommodating the behaviour of private investors who pushed the dollar up in their misguided enthusiasm for US assets. Since then, markets have come to their senses. Left to themselves, they would bring adjustment through a sharper decline in the dollar and higher US interest rates.

There are big dangers in present trends, as Nouriel Roubini of the Stern School at New York University and Brad Setser of Oxford University have explained.*

US gross external liabilities are some 11 times export earnings, while net liabilities are about three times exports. The latter figure is similar to those of crisis-hit Latin American economies such as Argentina and Brazil.

As investors ought to realise, the dollar depreciation needs to be large enough to bring these about. Since the pass-through from the exchange rate to prices is itself low, the dollar will have to fall a long way.

Adjustment will come via a mixture of exchange rate depreciation and measures to reduce spending. The latter will probably come from higher interest rates, rising household bankruptcies and weak investment.

These threats are not just to the US but also to the world economy as a whole.

A 40 per cent devaluation of the US dollar against the renminbi would cost the Chinese government up to $200bn, as the domestic currency value of its dollar reserves fell. In a few years' time, that cost might double. Even China's government might be embarrassed by losses on that scale. What is certain is that its reserves already far exceed what is required by the dictates of reasonable prudence.

Nouriel Roubini and Brad Setser The US as Net Debtor: The Sustainability of the US External Imbalances pdf

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U.S. Twin Deficits No Problem, Nobel Laureate Edward Prescott Says in Stockholm
Reuters 7/12 2004

"The U.S. (current) account deficit, no problem.
People that say there is (a problem) are ignorant, they do not understand something called balance sheet, present value, something that a good undergraduate (economics student) learns," Prescott said.
Reuters 7/12 2004

Arizona State University Economics Professor Edward Prescott, who also works for the U.S. Federal Reserve Bank of Minneapolis, also said Asian central banks were unlikely to go on accumulating dollars forever.

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Trichet should not bemoan the rising euro
My advice to Europeans is simple: sit back, relax and enjoy the terms-of-trade gains from your currency's ascent.
Melvyn Krauss Financial Times December 7 2004

Jag tror att dollarn är kvar på nivån 1,20 mot euron om ett år
Handelsbankens chefsekonom Jan Häggström, Dagens Industri 6/12 2004
reporter Cecilia Aronsson

"Jag tror att dollarn är kvar på nivån 1,20 mot euron om ett år. Men man ska inte bli förvånad över stora slag i de här sammanhangen", säger Handelsbankens chefsekonom Jan Häggström.

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Don't Confuse Me With the Facts
By John Mauldin December 3, 2004
Highly recommended

America has habits that are inappropriate, to say the least, for the guardian of the world's main reserve currency: rampant government borrowing, furious consumer spending and a current-account deficit big enough to have bankrupted any other country some time ago. This makes a dollar devaluation inevitable
The Economist 2/12 2004

A second disturbing feature of the global financial system is that it has become a giant money press as America's easy-money policy has spilled beyond its borders.

This gush of global liquidity has not pushed up inflation. Instead it has flowed into share prices and houses around the world, inflating a series of asset-price bubbles.

America's current-account deficit is at the heart of these global concerns. The OECD's latest Economic Outlook predicts that the deficit will rise to $825 billion by 2006 (6.4% of America's GDP) assuming unchanged exchange rates.

Periods of dollar decline have often been unhappy for the world economy. The breakdown of Bretton Woods that led to a weaker dollar in the early 1970s was painful for all, contributing to rising inflation and recession. In the late 1980s, the falling dollar had few ill-effects on America's economy, but it played a big role in inflating a bubble in Japan by forcing Japanese authorities to slash interest rates.

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To bring about a substantial reduction in the external deficit without a deep recession, the US needs a huge change in internal relative prices.
About Maurice Obstfeld and Kenneth Rogoff The Unsustainable US Current Account Position Revealed
Martin Wolf Financial Times 1/12 2004

How far might the dollar fall? By as much as 50 per cent from its peak, in trade-weighted nominal terms, suggest two distinguished international economists, Maurice Obstfeld of the University of California, Berkeley and Kenneth Rogoff of Harvard.* Up to now, the fall has been just 17 per cent, on a broad trade-weighted basis (see chart). More, it seems, is on the way.

If there were no changes in relative prices, a reduction in US demand would not only improve the current account deficit, but also generate a recession. A reduction in demand equal to the current account deficit would end up reducing it only from 6 per cent to 4.2 per cent of GDP. But it would also lower demand for non-tradeables and so reduce GDP by 4.2 per cent. To eliminate the external deficit, GDP would need to fall by a sixth and output of non-tradeables by a fifth. This would be a depression.

The size of the required price changes is determined by “elasticities of substitution” a fancy name for the changes in relative prices needed to bring about given changes in demand. According to Prof Obstfeld and Prof Rogoff, the real exchange rate depreciation needed in the US could be as big as 34 per cent.
Finally, because the pass-through of changes in nominal exchange rates to prices is low, the nominal exchange rate change needed might be double the real one.

This is not an analysis of what will happen. It is an analysis of what could happen if the US had to eliminate its current account deficit. Provided the rest of the world is happy to finance a substantial (albeit somewhat smaller) deficit indefinitely or is relaxed about the speed of adjustment, the required changes in relative prices can be smaller, slower or both.

Yet the risks are also obvious. To bring about a substantial reduction in the external deficit without a deep recession, the US needs a huge change in internal relative prices. If the financing of the deficit is indeed in doubt, a weak dollar is a certainty.

Hard currency enthusiasts may want the US to choose a depression, instead, or hope the deficit can grow without limit. Neither position is sensible. Big adjustments in the dollar's real value are a certainty. The only questions are when, how and how much.

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Kan man undvika recession i USA när man måste minska importen med 600 miljarder dollar?
Rolf Englund på Nationalekonomiska Föreningen 30/11 2004

Interesting times ahead for all
It is not only the rate of growth that might be too high. With the large and unsustainable trade deficit it is also the level of demand and GNP that is too high. When that level has to be adjusted we will all living in interesting times.
Rolf Englund, Letters to the Editor, Financial Times, November 6, 2000

The Unsustainable US Current Account Position Revisited, Maurice Obstfeld and Kenneth Rogoff, NBER Working Paper 10869

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Unilateral action can stop the dollar's slide
Paul de Grauwe, professor of international economics at the University of Leuven Financial Times November 30 2004

There is no doubt that there is a problem with the dollar. The large US current account deficit is unsustainable and will have to be corrected. But will this correction be helped by a further depreciation of the dollar against the euro? Hardly, for at least two reasons.

First, the main cause of the US current account deficit is excessive consumption and insufficient saving in America. To reduce the deficit, US savings rates will have to be raised. This requires a drastic increase in US interest rates and a reduction in the budget deficit.

Second, although a dollar depreciation can help in reducing the deficit, it will have to be a broad-based depreciation, not just against the euro and a few other currencies.

There is increasing evidence that the foreign exchange markets are not efficient. Exchange rates are often driven by fads - psychological moods of pessimism and optimism. These push the exchange rate far from their underlying fundamentals.

After the euro was launched in 1999, the dollar first appreciated by close to 40 per cent, until 2001, since when it has dropped by 50 per cent.

During this period, US growth was generally more favourable than eurozone growth, inflation differentials were close to zero and the US current account deficit was invariably high.

RE: "invariably high" ?

If the US does not come forward, the ECB will have to go it alone. If the bank is able to create a perception that it is strongly determined to halt the decline and that it has the means to do so, such a strategy can succeed.

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Europe must help slow the dollar's decline
History suggests that sharp, sustained movements of the dollar are a sign of monetary disequilibrium. If money market rates in either the US or abroad are pegged for a long time at a level badly out of line with so-called neutral rates, large speculative waves of capital are likely eventually to rock the currency markets.
Brendan Brown Financial Times November 26 2004

It is probable that the main force behind the dollar's latest slide is indeed monetary. Competing explanations are implausible. The so-called US current account deficit problem, for example, has been around for a quarter of a century.

There is a danger that the Fed, under Alan Greenspan, is underestimating the neutral level of US rates due to complacency about the inflationary impact of a falling dollar and high commodity prices.

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How long will the euro survive? The author shows that the answer depends principally on Germany.
New Book: "Euro on Trial" by Brendan Brown

Does reduction of the US current account deficit require or
does it cause a fall in the dollar?
The two possible answers lead to opposite conclusions about the impact on economic policy both in the US and the rest of the world.
Wolfgang Munchau Financial Times November 29 2004

The adjustment occurs through the exchange rate. Most of the burden would fall on the eurozone. The European Central Bank could lower interest rates, but this probably would not affect the euro-dollar exchange rate significantly. The ECB could also try to intervene to slow the dollar's depreciation. But that would only delay an inevitable adjustment. In fact, this scenario has minimal policy implications. The US need not do much. The Europeans could not do much. But the international economy does not work according to this old-fashioned textbook scenario.

In many modern models, the terms of trade play a far less important role and it is not the dollar that causes the adjustment in the current account, but the reverse. Even a substantial shift in the exchange rate could not eradicate a US current account deficit now heading for 6 per cent of gross domestic product this year. It would take a real demand shock, such as a crash in house prices. This is the conclusion of Maurice Obstfeld and Kenneth Rogoff, who have revisited their investigation of the global impact of a rebalancing in the US current account (click). They calculated this could trigger a 20 to 40 per cent fall in the dollar's real exchange rate, depending on how fast it happened.

A large devaluation of the dollar need not be catastrophic, as Obstfeld and Rogoff point out, but it can be. In the late 1980s, the dollar devalued by 40 per cent on a trade-weighted basis in an economic environment that was benign for the US and most of the rest of the world. Product and financial markets are said to be more flexible today and better-able to absorb shocks. But...

But there are some disturbing parallels with the early 1970s, when dollar devaluation created significant economic instability. There are some uncanny parallels, too, between the Bretton Woods system of semi-fixed exchange rates, which collapsed at that time, and today's dollar pegs.

The correction of the US current account deficit is not certain, but probable.

(RE: Remember Stein's Law: "If something cannot go on for ever it will stop.") click

Yet the economic policies of the two largest economies in the world, are not prepared for it. When the adjustment happens, it will turn out to be unnecessarily harsh.

The day could come when foreign investors demand better terms for financing America's spending spree (and savings shortfall).
That is the day the dollar will collapse, interest rates will soar and the stock market will plunge.
Stephen S. Roach, The New York Times/IHT 27/11 2004

Americans fail to save enough - whereas the rest of the world saves too much. American consumers have borrowed against the future by squandering their savings. The personal savings rate was just 0.2 percent of disposable personal income in September - down from 7.7 percent as recently as 1992. Moreover, large federal budget deficits mean the government's savings rate is negative.

American consumers have borrowed against the future by squandering their savings. The personal savings rate was just 0.2 percent of disposable personal income in September - down from 7.7 percent as recently as 1992.

This is a dangerous arrangement. The day could come when foreign investors demand better terms for financing America's spending spree (and savings shortfall). That is the day the dollar will collapse, interest rates will soar and the stock market will plunge. In such a crisis, a U.S. recession would be a near certainty. And the rest of an America-centric world would be quick to follow.

The only way to avoid this unhappy future is for the world's major central banks to carefully manage a gradual but significant depreciation of the dollar over the next several years.

Rolf Englund:
It will not be easy to do that (if the market thinks the dollar will depreciate for many years, why not sell your dollars at once?)

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Persistent and widespread efforts to resist currency moves are doomed to fail, and if pursued long enough, can lead to serious resource misallocation.
The reluctance of America's trading partners to allow dollar depreciation, even as the U.S. current account deficit has grown to a point where nearly $2 billion a day must be purchased in order to keep the dollar stable, has created a massive global imbalance.
John H. Makin, American Enterprise Institute November 24, 2004

The pain tied to the unwinding of such misallocation produces further resistance to currency adjustment, but eventually maintaining an artificial set of exchange rates becomes impossible. We have probably reached that point.

Unwinding the strong U.S. consumption surge--the concomitant of restoring U.S. savings to something close to normal--at the same time that the currencies of export-oriented Asian and European economies appreciate, will result in slower global growth unless Asia and Europe pursue more stimulative policies.

China's peg to the dollar has meant that its currency has depreciated rapidly along with the dollar. Inflation pressures in China have increased while the cost of oil imports for China's heavily oil-dependent export industries has increased as well. The peg has destabilized China's domestic economy. Higher inflation and pegged interest rates leading to potential disintermediation in China's inflexible financial system have already forced the Chinese government to begin to allow interest rates to begin to rise. Chinese savers do not want to earn 2 percent on bank deposits while 6-percent inflation erodes the purchasing power of savings. China's recent move toward greater flexibility of interest rates seems to portend more overall flexibility in China's financial system. That will include currency appreciation in order to reduce its need to purchase dollars while simultaneously cushioning its oil-dependent economy from higher petroleum prices. Even a moderate 10 or 15 percent revaluation of China's currency, perhaps through a transition to a Singapore-style currency basket, would ease the pressure for dollar weakness against the other currencies like the euro, the yen, and the currencies of Korea and Taiwan.

Another year of dollar pegging will mean a U.S. current account deficit of more than $700 billion and a negative U.S. saving rate.

Only more policy stimulation in Europe and Japan can turn the scenario of global rebalancing with a weaker dollar into a global positive-sum game.

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If you combine a fiscal adjustment with a rise in Americans' private saving, a sizeable but controlled decline in the dollar and faster growth abroad, Mr Bush could reduce his country's imbalances with relatively little pain.
Unfortunately, there are a worrying number of things that could go wrong.
The Economist 25/11 2004

A dollar crash, if it occurred, could trigger a terrifying global slump.
Robert J. Samuelson Washington Post 17/11 2004

George Bush hasn't much discussed what could be his biggest economic problem. It's not budget deficits or jobs. It's the possible crash of the dollar on foreign exchange markets. Even if Bush understood it, he would be hard-pressed to explain it to the public. Worse, there are no obvious ways to prevent it. Nor is it certain how big the threat is. Little wonder Bush hasn't said much. If John Kerry had won, the situation would have been the same. But a dollar crash, if it occurred, could trigger a terrifying global slump.

In 1990 the U.S. current account deficit was $79 billion, or 1.4 percent of gross domestic product. In 2004, it's expected to hit an unprecedented $665 billion, or 5.6 percent of GDP, says economist Nariman Behravesh of Global Insight.

A sell-off could spill over into the stock and bond markets and cause a deep global recession. Here's how. Foreign traders and investors sell dollars on foreign exchange markets. The dollar declines in relation to the euro, the yen and other currencies. The dollar's decline means that the value of foreigners' investments in U.S. stocks and bonds -- measured in their own currencies -- is also dropping. So foreigners stop buying U.S. stocks and start selling what they have. The stock market drops sharply. Presto: the makings of a global recession. The stock market slide causes American consumer confidence and spending to weaken. If foreigners also flee the bond market, long-term interest rates on bonds and mortgages might rise. Higher currencies make Europe's and Japan's exports less competitive. Their industries stagnate. The United States, Europe and Japan constitute about half the global economy. Their recessions would hurt the Asian, Latin American and African countries that export to them. Markets interconnect; weakness spreads. It's grim.

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No end in sight for dollar slide
China had cut the size of its US Treasury bond holdings in its foreign exchange reserves to $180bn to avoid losses from a weakening US dollar.
BBC 26/11 2004

Bank of England chief economist Charles Bean said with the US budget deficit at a record $413 bn, overseas investors were unlikely to continue buying assets across the Atlantic.
This meant a potentially "substantial" decline in the dollar's value could go ahead as the Bush administration acts to cut the budget deficit, Mr Bean said.

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Harvard president warns on global imbalances
Financial Times 28/1 2006

Lawrence Summers, the president of Harvard University and former US Treasury secretary, has warned that there is a dangerous degree of complacency about global economic imbalances.

Commenting on the general lack of concern at the World Economic Forum about the soaring US trade deficit, Mr Summers recalled the sense of calm that existed before the Mexcian crisis in 1994 and the bursting of the technology bubble in 2000. “The time of greatest serenity was also the time of greatest risk”.

Lawrence Summers

Adjusting to the dollar's inevitable fall
Altering the path of the US external accounts, while sustaining global economic activity, is among the biggest challenges now confronting policymakers.
Martin Wolf Financial Times November 24 2004

The longer the adjustment is postponed, the more painful it is likely to be. What is needed is a co-operative solution, with changes made by all sides. If such a solution is to be found, it is necessary to recognise,
first, that a problem does exist,
second, that it reflects the behaviour of most of the significant players in the world economy and,
third, that a solution requires both changes in relative prices (that is, in real exchange rates) and changes in growth of supply and demand across the globe.

Reaching the needed enlightenment demands the elimination of the illusions that either the attractiveness of the US economy to foreign investors, or superior US rates of economic growth, or high US fiscal deficits are the cause of soaring external deficits.

Myth one - the deficit is driven by capital inflows attracted by high US real returns.

At the macroeconomic level, the counterpart of the growing deficits has not been rising investment but declining savings. As Larry Summers, former US treasury secretary, /RE: he is now President at Harvard University/ has noted, "at 1.5 per cent, the [net] national savings rate is about half what it was in the late 1980s and early 1990s . . . . In fact, net investment has declined over the last four or five years in the US, suggesting that all of the deterioration of the current account deficit can be attributed to reduced savings and increased consumption rather than to increased investment".*

Larry Summers: The US Current Account Deficit and the Global Economy, Per Jacobsson Lecture, IMF, October 3 2004

Myth two - the deficit is caused by high economic growth in the US.

Myth three - high US fiscal deficits are to blame.

What then is the bottom line?

It is, first, that the current account deficit's trajectory cannot be explained away by positive features of the US economy. It is, second, that a big real depreciation of the dollar is inescapable if the trend is to be changed. The world must stop pretending that what is inevitable can be wished away.

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Kommentar av Rolf Englund:Två uppfattningar står emot varandra:
Å ena sidan Martin Wolf och Larry Summers och
å andra sidan EMU-kramarna Klas Eklund (USA har världens starkaste ekonomi), Mats Johansson (det stora språnget i väster) och förre moderatledaren nuvarande generaldirektören för Riksgäldskontoret Bo Lundgren (Reagans marknadsliberala politik grunden för en uppgångsfas utan motsvarighet)

Och Mats Svegfors, som försvarade kronkursförsvaret och bytte sida om EMU

Den 19 januari 2005 ger Martin Wolf den årliga Sven Rydenfelt-föreläsningen i Lund. Wolf är chief economics commentator vid Financial Times.
Läs mer hos Timbro.

Mer av Martin Wolf

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The solution is a tax rise
Stephen Cecchetti Financial Times November 23 2004

Den kraftiga dollarförsvagningen kan få negativa konsekvenser på svensk export.
Electrolux, SCA och Sandvik bland de mer dollarkänsliga.
DN Ekonomi 23/11 2004

The stock market's pessimism about the dollar's decline is a little perplexing.
Stock traders have traditionally liked a weaker dollar because it helps multinational corporations.
But now the market is focusing on the negative aspects of a struggling greenback
CNBC's Bob Pisani 22/11 2004

Capital flight, with foreign investors shying away from dollar-denominated assets.
The possibility of higher inflation.
An eventual lower return on investments.
Interest rate hikes to make U.S. bonds more attractive.

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Dollar moving in one direction only: down
The risk of a rout, according to Raghuram Rajan, chief economist at the International Monetary Fund, "is not a high probability but it is not zero".
Financial Times November 18 2004

Derek Halpenny, currency analyst at Bank of Tokyo-Mitsubishi, points to a "very grim" outlook for the dollar in the near term. "With the foreign exchange market now focused entirely on the problem of the US budget and current account deficits, there is a real risk that dollar selling becomes a crisis of confidence," he says.

There is a fear in the currency markets that the dollar's decline, which has been gradual and orderly so far, will turn into a rout. In the event that net foreign investment into the US falls well short of the amount the US needs to finance its $600bn current account deficit, the US currency could fall sharply, leading to higher US interest rates and ultimately lower growth. The knock-on effect on less flexible European and Japanese economies could be great.

The risk of a rout, according to Raghuram Rajan, chief economist at the International Monetary Fund, "is not a high probability but it is not zero".

Capital flows can be volatile and the risk for the US and the world is that an uncontrolled fall in the dollar occurs before the US current account deficit has become more manageable. According to recent research by Nouriel Roubini and Brad Setser of New York and Oxford universities, "the tensions created by the current system are large, large enough to crack the system in the next three to four years".

The problem is that US imports are 16 per cent of gross domestic product while its exports constitute only 11 per cent of GDP, so balanced growth raises US exports faster than it does imports.

This is one of the rare times that the currency markets and most academic economists speak with one voice. The pressure on the dollar is downward. While most hope that any falls occur gradually, giving the world time to adjust, no one should be surprised if, at some point, the currency realignment becomes rapid and destabilising.

Alan Greenspan triggered fresh falls in the dollar on Friday after issuing a strong warning about the unsustainability of the US current account deficit.
Financial Times 19/11 2004

Speaking as finance ministers and central bank governors began gathering in Berlin for the G20 meeting of leading world economies, Mr Greenspan gave a broad hint he expected the dollar to bear much of the brunt of adjusting a current account deficit in excess of 5 per cent of gross domestic product. The Fed chairman also played down the effectiveness of financial intervention but made clear that US interest rates were on a clear upward trend. The dollar dropped to a four-and-a-half year low against the yen after Mr Greenspan's comments, while the euro surged close to its record earlier this week of over $1.30. Gold prices also rose, to the highest level for more than 16 years.

Remarks by Chairman Alan Greenspan
At the European Banking Congress 2004, Frankfurt, Germany
November 19, 2004

If the dollar is not allowed to fall against the yuan, it will probably continue to fall heavily against something else.
Europe’s finance ministers can do little about it. They have surrendered control of the currency to an independent central bank that targets inflation, not the exchange rate.
The Economist 19/11 2004

On Friday, the American currency fell to its weakest level against the yen since April 2000. It also remained around record lows against the euro. Earlier in the week, Nicolas Sarkozy, France’s finance minister, had declared that “the greenback has become unhinged”. The European Central Bank has not intervened directly on behalf of the euro for four years. It is unlikely to do so again without American backing. Japan’s monetary authorities have no such compunction. The finance ministry happily spent over ¥20 trillion ($170 billion) propping up the dollar last year and over ¥14 trillion in the first three months of this year. For Japan, unlike South Korea, buying dollars is profitable. And if it is also inflationary, so much the better for a country still gripped by deflation. Interest rates on American assets, such as Treasuries, may be low. But they are higher than the zero interest rates on offer in Japan. Moreover, printing yen to buy dollars is one way to inject liquidity into Japan’s moribund financial system.

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Euron

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Kina kommer att göra en revalvering. Men vågar inte sig på en flytande växelkurs.
Det kinesiska banksystemet anses alltför bräckligt.
Johan Schück DN 20/11 2004

Många bedömare tror visserligen att Kina kommer att göra en revalvering, alltså skriva upp den egna valutan, någon gång under nästa år. Men någon form av knytning till dollarn kommer att bevaras, eftersom man inte vågar sig på en flytande växelkurs där det kan uppstå stora marknadsrörelser. Det kinesiska banksystemet anses alltför bräckligt för att klara sådana påfrestningar.

Därför talar det mesta för att Kina och Japan kommer att fortsätta att med sina köp av amerikanska statspapper på obestämd tid framåt. Det betyder att dollarn även fortsättningsvis kommer att falla mer mot euron än mot japanska yenen och andra asiatiska valutor. Kinesiska yuanen hålls fortfarande stabil mot dollarn, fastän på en nivå än hittills.

Obalanserna i världsekonomin fortsätter att växa, vilket betyder ökade risker för en urladdning längre fram.

Något bekvämt sätt att förändra situationen finns dock inte.

Klas Eklunds slutsats är att dollarn kommer att försvagas gradvis men att det inte blir något ras – åtminstone inte under de närmaste åren som är hans prognoshorisont.
SvD Näringsliv 17/11 2004

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The world needs another Plaza Accord
There is a point at which one or other central bank will cry "Enough!" and the house of cards will fall.
Peter Bernstein Financial Times November 17 2004

The writer is a New York-based economic consultant and
author of Against the Gods: The Remarkable Story of Risk (John Wiley & Sons)

On September 22 1985, the ministers of finance and governors of the central banks of France, Germany, Japan, the UK and the US signed an accord at the Plaza Hotel in New York. It stated that signatories "were of the view that recent shifts in fundamental economic conditions among their countries, together with policy commitments for the future, have not been reflected fully in exchange markets . . . In view of the present and prospective changes in the fundamentals, some further orderly appreciation of the main non-dollar currencies against the dollar is desirable. They stand ready to co-operate more closely to encourage this when to do so would be helpful."

Over the next two years, the dollar dropped by 30 per cent and America's deficit on current account began shrinking. By 1991, the current account was just about in balance. A neat job, elegantly executed.

Kommentar RE: Jo, men efter 1991 kom 1992 and all that

On the economic side, the scale of the problem is daunting. The rapidly expanding US current account deficit is now more than 5 per cent of gross domestic product, as against only 2 per cent in 1985.

Furthermore, the small surplus of 1991 was also the consequence of a recession in the US that curtailed the flow of imports even as exports kept rising - but the US slipped right back into the red as soon as recovery got under way.

In many countries, economic growth is excessively dependent on exports, which depend on a strong dollar.

But, as Herb Stein, the late economist, put it: "If so

mething can't go on forever, it won't."

Kommentar RE:"If something cannot go on for ever it will stop", actually, I think.

There is a point at which one or other central bank will cry "Enough!" and the house of cards will fall in. Indeed, China has already begun diversifying its foreign exchange reserves into other currencies and investments.

Nevertheless, as Stein reminds us, the current situation cannot go on forever.

The optimal solution is a replay of the Plaza Accord - an orderly appreciation of the main non-dollar currencies against the dollar, which is a more benign method of curtailing America's appetite for imports

Without such an accord, the outlook for an orderly dollar devaluation is dim.

The Plaza Agreement and the Louvre Accord

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The Bush administration has apparently decided that letting the dollar slide is a good way to shrink America's trade deficit.
During the Bush years, 92 percent of the nearly $1 trillion increase in publicly held debt has been financed by foreign lenders.
New York Times/IHT 15/11 2004

This is dubious economic policy. It provides a modicum of relief to U.S. exporters, but it increases the nation's vulnerability to higher prices and higher interest rates, while ignoring fiscal measures that would more assuredly anchor the United States in the global economy.

If leadership is not forthcoming, the invisible hand of the global financial community is all too likely to provide the push.

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Dollarn måste falla med 30-40 procent
Det menar amerikanske ekonomen Barry Bosworth, som var bland de första att förutspå kronraset i början av 1990-talet.
Johan Schück DN Ekonomi 12/11 2004

Minus 35 procent på mindre än fyra år dollarn under 7 kr och lägsta nivån någonsin mot euron.
Varför har dollarn inte fallit mer - och snabbare?
Lars-Georg Bergkvist SvD Näringsliv 12/11 2004

The dollar is likely to fall further.
This is creating more dilemmas for Europe than for America
The real question is not whether the dollar needs to fall, but how drastic the economic effects of its fall will be.
From The Economist print edition Nov 11th 2004

Observera vad dollarn stod i 1992

The greenback has dropped by 15% against a broad basket of currencies since its peak in early 2002, but it is still not cheap. After adjusting for inflation, the dollar's trade-weighted value remains close to its 30-year average.

Because traded goods account for only around 25% of America's GDP, the current-account deficit of 5-6% of GDP amounts to an enormous 20-25% of traded-goods production. Thus closing the external deficit while maintaining domestic equilibrium requires a big change in the relative price of non-traded versus traded goods, and therefore in the exchange rate.

The real question is not whether the dollar needs to fall, but how drastic the economic effects of its fall will be. In the mid-1980s, the greenback's trade-weighted value declined by 40% with few ill-effects in America. The world economy absorbed the shock reasonably well. Unfortunately, the authors see more parallels today with the dollar's collapse in the 1970s, when the Bretton Woods system broke down.

Republicans risk disgrace if they raise taxes or if America suffers a financial and inflationary crisis because of its failure to bring the federal budget back under control
Anatole Kaletsky The Times 4/11 2004

If Neil Kinnock instead of John Major had won the 1992 election, the devaluation of Black Wednesday would have occurred even sooner. The monetary crisis which undermined the Tories’ long-established reputation for economic competence would have been blamed on Labour’s mismanagement. Black Wednesday (or Monday or Tuesday) would almost certainly have brought down the Kinnock Government and would unquestionably have ended Labour’s hopes of ever again becoming a serious party of government.

Will the Democrats one day thank John Kerry for losing, just as Labour is grateful to Mr Kinnock? This seems distinctly possible, given the challenges now facing America, especially in geopolitics and macroeconomics. Iraq is a mess which Mr Bush created and it is surely fitting that he should be the one forced to clean it up. The same is true of ballooning government deficits, escalating oil prices and the small but growing, threat of a crisis in the US balance of payments leading to an international run on the dollar.

Democrats must rebuild their party, unite around an impressive new leader and wait for Republican mythology to self-destruct in the face of events.

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Euron spricker när dollarn faller
Rolf Englund i EU-krönika i Nya Wermlands-Tidningen 2001-01-08

Dollar at record low against euro
The euro is now 57% above its all-time low
BBC 5/11 2004

The US currency dropped as low as $1.2962 against the euro on Friday.

French President Jacques Chirac said he was "a little bit worried about the weakness of the dollar". Speaking at a summit of European leaders in Brussels he hinted that the European Union should take action. "This should provoke certain reactions on our part," he said.

There are many reasons to be concerned about the dollar, but the number one reason is the trade deficit.
It is now at $600 billion and rising
I readily acknowledge there are those who say deficits do not matter. In the short term, you can make case for such an argument. But over the long term, I am at a loss to see how you can make such an argument.
John Mauldin, October 29, 2004

Yes, $600 billion is a fraction, and a very small one at that, of the annual international currency market, which trades $1.2 trillion every day. I understand that the US is a very desirable country to live in and in which to invest and do business. I understand that $600 billion is less than1% of our total national assets. I understand that our intellectual capital is a huge selling point. As many have pointed out, the dollar is holding its own this last year. Most of the above were true a few years ago, and the dollar still dropped since 2002. While the above reasons may make dollar bulls feel better, it seems to me like they are whistling past the graveyard. They really do not have much to do with currency valuations.

As Bill Gross of Pimco noted this week, the Fed is between a rock and a hard place. (www.pimco.com)...
"My/our most certain idea, as expressed in previous Outlooks, is that real interest rates in the United States will have to be kept low, that the old Taylor rule is out. Too much debt in a finance-based economy precludes raising interest rates like we have in the past and while that keeps the patient/economy breathing; it leads to asset bubbles, potential inflation, and a declining currency over time."

Our trade deficit is far higher than it was almost three years ago when the euro started to rise. Can the euro rise another 50%? I seriously doubt it. Such an imbalance in the world would reap a harvest of trouble. It could rise another 20% to above $1.50. While a long way from $0.82, in one sense, this would not be far from the value of $1.21 that the European Central Bank originally placed on the euro.

The longer the current competitive devaluation scenario continues, the greater the problems for Europe and countries which hold to a sound monetary practice. Not only do they see their American competitors get a currency advantage, they lose "share" to Asia as well.

If we do not see 4% inflation and 4-5% short term rates between now and the next recession, which I do not think will happen, the Fed will be forced to use what Ben Bernanke calls "Unconventional Weapons" to keep from having an "unwelcome drop in inflation" otherwise known as deflation or Japanese disease.

The normally upbeat (and always on target) Martin Barnes of Bank Credit Analyst recently released a report on the problem of a low US savings rate. Since I cannot come close to doing as good a job as he does, let's look at how he summarized the problem: "From a medium-term perspective, the problem of low U.S. savings and a large external deficit can play out in one of three ways. Let's call these scenarios the good, the bad and the ugly.

"The Ugly - This is where the markets riot in order to force a change in trend. A vicious plunge in the dollar triggers a crash in equity prices and risk spreads spike higher. A credit crunch takes hold as the credit markets seize up. The Fed eases aggressively, but that just feeds further dollar weakness. Central bank intervention is not able to stem the hemorrhaging of capital leaving the country. The economy grinds to a halt and a long-overdue consumer retrenchment occurs with a vengeance. With profits also imploding, employment falls sharply, encouraging further consumer cutbacks. The economy is at the edge of a deflationary precipice and policymakers are relatively powerless because there is not much fiscal or monetary ammunition to deal with the crisis.

The current account improves dramatically, but the adjustment is extremely painful. The global economy is severely impacted, not only by a U.S. economic downturn, but also by the deflationary effect of a sharp appreciation in overseas currencies. This encourages protectionism and attempted competitive devaluations in the major regions, but that just makes markets even more volatile.

So When Does All This Happen?

As I wrote three years ago, this is going to be a long process. And for that we should be grateful. The longer it takes for the world to re-balance from a US-centric world where we are the main economic consumer engine to one where consumption and growth are more evenly balanced, the better.

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The wolf at the door
A further steep decline in the dollar seems inevitable
The Economist print edition Oct 28th 2004

Most economists, and this newspaper, have been fretting about America's huge current-account deficit and predicting the dollar's sharp decline for years. The trouble with crying wolf too often is that people stop believing you.

After slipping 14% in broad trade-weighted terms since 2002, the dollar had stabilised this year, even as the current-account deficit continued to grow. This has encouraged some economists to offer theories explaining why America's current-account deficit does not matter and why the dollar need not fall further.

Policymakers' usual reply when asked about exchange rates is to say that they are set by the market. But if the dollar was truly being set by the market it would now be much weaker. The dollar has fallen by over 30% against the euro since 2001, but its trade-weighted index has fallen by much less because of heavy intervention by Asian central banks, aimed at holding down their currencies against the dollar.

Because Asian currencies have been held down against the dollar, America's current-account deficit has continued to swell, reaching almost 6% of GDP in the second quarter. The dollar is already below most estimates of its fair value against the euro, but it will need to undershoot if the deficit is to be reduced.

Economists at UBS estimate that the dollar's trade-weighted value might need to fall by another 20-30% to trim the deficit by enough to stabilise the ratio of America's external liabilities to GDP. Though it might seem unthinkable, that could imply a rate of around $1.70 against the euro.

Since 2001, Asia's official reserves have increased by $1.2 trillion, equivalent to two-thirds of America's cumulative deficit over that period. Currency intervention by Asian central banks helps to explain why America has so far been able to finance its deficit without higher American bond yields or a bigger fall in the dollar.

An excellent paper by George Magnus, an economist at UBS, argues that the parallels with Bretton Woods are superficial. One big difference is that in the 1960s the United States ran a current-account surplus and was a net creditor to the rest of the world. Today, America is the world's biggest debtor, which could undermine the dollar's role as an anchor currency.

Until recently, some argued that America's current-account deficit was sustainable because foreign investors were eager to buy American assets to take advantage of the economy's faster productivity growth and hence its higher returns. But private inward investment has slumped, leaving America dependent on foreign central banks. And foreign savings are no longer financing investment and hence future productivity gains as they were in the late 1990s. Foreigners are now financing consumption and government borrowing.

Stephen Roach, chief economist at Morgan Stanley, reckons that a weaker dollar would spark a rise in real bond yields, as foreign creditors demanded extra compensation for currency risk. That would slow consumer spending, boost saving and reduce the deficit.

In the three years from 1985, the dollar fell by 50% against the other main currencies. Inflation and bond yields rose and, in October 1987, the stockmarket crashed. America's current-account deficit is now almost twice as big as it was then, so the total fall in the dollar—and the fall-out in other financial markets—could well be larger. The wolf is licking his lips.

The dollar has to fall a long way from where it is now, if the current account deficit at full employment is to diminish
Martin Wolf, Financial Times 27/10 2004

On present trends, argues HSBC, the current account deficit could reach 8 per cent of gross domestic product by the end of the decade, up from just under 6 per cent today. This could also bring US net external liabilities to 90 per cent of GDP, against close to 40 per cent at the end of this year.

If such a vast increase in the external deficit were indeed to occur, it would be impossible to reduce the fiscal deficit, as both candidates promise, while enjoying the strong domestic demand that Americans expect.

On the contrary, unless the private sector were prepared to run a financial deficit far larger than at the peak of the bubble, in 2000, the fiscal deficit would explode. The dollar has to fall a long way from where it is now, if the current account deficit at full employment is to diminish. Only then could the fiscal deficit shrink. Neither side admits the extent of the economic vulnerability.

Dollarn rasar

Dollar Adjustment: How Far? Against What?
C. Fred Bergsten and John Williamson, editors
Institute for International Economics (pdf)

The dollar fell below $1.26 per euro for the first time since February
Bloomberg 20/10 2004

The Dollar Index, a basket of six currencies, dropped below 87 yesterday for the first time since February and weakened today. The dollar has dropped 1.3 percent this month against the euro as economic reports showed the trade gap widened and foreign investors slowed their purchases of U.S. financial assets.

``Speculators are loading up with boatloads of euros,'' said Grant Wilson, a currency trader in Pittsburgh at Mellon Financial Corp. ``The trade numbers have emboldened people to short the dollar.''

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”Det finns en bristande probleminsikt. Inom fem år kan /USA:s/ utlandsskuld nå 50 procent av BNP.
Det skapar en stor sårbarhet för räntehöjningar.
Jag förstår inte hur man kan se underskotten som ett långsiktigt problem”
Cecilia Hermansson, ekonom på Föreningssparbanken
Veckans Affärer nr 43, 18/10 2004, reporter Ragnar Roos

Some believe the world has entered a new era of managed exchange rates - Bretton Woods 2 - with Asia providing a limitless source of funding for the US current account shortfall for the foreseeable future.

George Magnus of UBS thinks this view is an illusion. There is no infrastructure to support a second Bretton Woods in a world of limited capital controls. The Asian currencies’ stability against the dollar is a temporary expedient that will break down in the next one to two years, leading to a 20-30 per cent fall in the dollar, a rise in real interest rates and the risks of a global economic slowdown.

Source: Philip Coggan,Financial Times October 18 2004

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The US dollar crashed on Friday
through its well-worn trading range against the euro, sliding to a seven-month low
Financial Times 15/10 2004

Dollarn/kronor står 18/10 i 7.2583 -0.0784

Dallas Fed president Robert McTeer warned that “Over time, there is only one way for the dollar to go - lower”. Just for good measure, he also talked about the theoretical possibility of a “crisis” precipitating “rapidly rising interest rates and a rapidly depreciating dollar” if and when the wider world stops funding the rapidly expanding US current account deficit.
Financial Times 9/10 2004

Dallas Fed

The Sustainability of the US External Imbalances (pdf)
Nouriel Roubini and Brad Setser Research Associate, Global Economic Governance Programme, University College, Oxford
First Draft: September 2004

Nouriel Roubini's Global Macroeconomic and Financial Policy Site (ranked as the #1 Web Site in Economics in the world by The Economist Magazine)

The risks ahead for the world economy
Fred Bergsten The Economist print edition Sep 9th 2004
Fred Bergsten is director of the Institute for International Economics in Washington. His book, “The United States and the World Economy: Foreign Economic Policy for the Next Administration” is forthcoming.
Very Important Article

America on the comfortable path to ruin
These two facts - the rest of the world's surplus output and the US goal of full employment - explain the global macro-economic picture
Martin Wolf, Financial Times, August 18 2004
Very Important Article

There are big medium-term risks ahead
Global macroeconomic imbalances, the impact of a rising Asia, protectionism and vulnerability to terrorist outrages
Martin Wolf 20/7 2004

If Asian central banks stopped financing the US current account deficit, the euro's exchange rate would shoot through the roof to the detriment of the eurozone economy.
Wolfgang Munchau Financial Times July 26 2004

If this view is correct, the eurozone can afford to look inward with impunity. But as Barry Eichengreen, professor of economics at the University of California, Berkeley, notes,Global Imbalances and the Lessons of Bretton Woods - NBER Working Paper No. w10497 this view may well be wrong.

Perhaps the biggest difference between the old and new monetary order is the availability of a liquid alternative currency - the euro. The French and Germans of the 1960s had no real reserve currency alternatives to the dollar, while today's Asian countries do. There is no indication that Asian central banks are even close to shifting out of dollars. But if one Asian central bank starts to dump dollars for whatever reason, the others may follow swiftly.

The real question is not whether the present monetary system is sustainable, but whether it is sustainable for another two, five or 20 years. In the latter case, it may well be justified to speak of a new Bretton Woods era. But there are compelling reasons against such a scenario.

China has about 200m underemployed workers. With net job creation of about 10m-12m a year, China has a clear interest in pursuing the same policies for at least one more decade, perhaps longer. In other words, the periphery's interest in pursuing present policies is consistent with continued US current account deficits. Nothing will last forever, of course. But nor did the Bretton Woods system.

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The /US/ economy is skipping along nicely and rates, after all, are still very low.
But the market is also starting to fret about inflationary pressures. Indeed, some—this newspaper included—think that the Fed has been too sluggish: with monetary policy still loose, inflation is likely to creep upwards. But the outlook for interest rates will be quite different if inflation is not America's biggest economic problem.
A fascinating paper, “Dicing with Debt”, by Stephen King, the head economist at HSBC, a big British bank, explains why it might not be.
The Economist 1/7 2004</p>

He argues that the Fed was wrong to cut interest rates so much

When economic growth is fuelled by asset prices and debt, pushing up interest rates is likely to have an effect only in so far as it affects expectations about the prices of those assets.
This creates huge problems for policymakers. Will a small rise in rates have a small effect (because, say, expectations about further rises in house prices are so entrenched)? Or a big one (because people expect more rate rises)? Whatever the answers to these questions in the short term, at some point, says Mr King, attitudes towards asset prices and debt will have to change.

Debt and the dollar, employment and interest rates, the US economy and world trade, money supply and inflation/deflation,taxes, deficits, commodity prices, politics, war, regulation plus a host of other variables.
They are all related in a very complex and dynamic fashion.
Changing one of them may change each of the others in often unpredictable ways, which in turn affect all the others.
Today, we start a series trying to understand how they fit together
The Supercycle of Debt -- Economic Commentary by John Mauldin
Free Republic

Are markets about to start panicking about the dollar again - with good reason?
The Economist 30/6 2004

The current account essentially comprises two things: the trade balance and overseas investment income. America’s trade deficit is bad and getting worse, even though the dollar has fallen by 23% from its recent high in February 2002. A $46.6 billion trade deficit in March had risen to $48.3 billion in April. In the absence of a net surplus from foreign investment, notes Jim O’Neill, the chief international economist at Goldman Sachs, this would mean a current-account deficit for the year of more than $600 billion, or getting on for 6% of GDP.

No problem, say the more sanguine: America has long been able to finance its large and growing deficit because it is such a wonderful place in which to invest.

There are, however, a couple of snags with this argument.

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BMW bets on dollar rebound
BMW, the German luxury carmaker, has stopped all long-term hedging of the dollar, calling an end to the US currency's two-year decline.
Financial Times, March 17 2004, 19:35

The carmaker is one of Europe's heaviest users of currency hedging to protect its revenues from volatile foreign exchange markets. But it now believes the US currency is "significantly" under-valued and must bounce back.

The dollar has fallen by 29 per cent against the euro in the past two years, pricing many European exporters out of US markets. As the US currency approached the $1.30 mark against the euro earlier this year, European politicians clamoured for a cut in interest rates to make the eurozone more competitive.

BMW said it believed the "correct" value for the dollar was $1.10 to the euro compared with $1.22 - the level it reached in late trading on Wednesday.

Volkswagen, Europe's biggest carmaker, increased its hedging at the end of last year after the falling dollar knocked E1.2bn from annual profits.

On Wednesday, the dollar was at $1.224 against the euro, off a three-month low at $1.208. In February, the single currency had made a series of lifetime highs, peaking just below $1.30.

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The dollar, said John Connolly, treasury secretary to Richard Nixon, "is our currency, but your problem".
Gerhard Schröder, Germany's chancellor, knows what he meant
A world in which macroeconomic health can be achieved only at the expense of ever greater private and public debt accumulation in its biggest and richest economy is unstable. It is also perverse.
Martin Wolf, Financial Times 1/3 2004

Unfortunately for him, US policy-makers have no desire - and little ability - to help him. So what do US policy-makers want? They wish to achieve full employment, or what economists call "internal balance". If this means a gigantic current account deficit or a tumbling currency, so be it.

Wynne Godley, of the Cambridge Endowment for Research in Finance, has illuminated the dilemma in several papers, most recently one co-authored with Alex Izuretia. (The US Current Account: Too Small Rather Than Too Large? January 15 2004, Report No. 207. He suggests thinking in terms of the financial balances - the gap between income and expenditure - of the foreign, public and private sectors, which must sum to zero.

During the stock-market bubble, the US private sector moved into an unprecedented deficit. Between the first quarter of 1992 and the third quarter of 2000, its financial balance deteriorated by 11.5 per cent of gross domestic product.

Something else happened over that period: an explosive increase in net foreign lending to the US - the inverse of the current account deficit. As a corollary, the fiscal position improved.

Then, when the bubble burst, the private deficit shrank, while the public sector's position moved in the opposite direction.

Achieving a given rate of growth has required still faster growth of domestic demand. This strongly suggests the real exchange rate has been at uncompetitive levels - or, more technically, at levels inconsistent with both internal and external balance over the longer run. In the second half of the 1990s, the explanation for the appreciation was private capital inflows. But this era has ended. In 2002 and the first three quarters of 2003, just over a quarter of the finance of the US current account deficit came from official, not private, sources.

To summarise, we can spy five dominating features of the global macroeconomic landscape. First, the eurozone and Japan, which generate a third of global GDP between them - much the same as the US - have very weak domestic demand.

Second, developing and newly industrialised Asia, containing the world's fastest growing economies, also has high domestic savings, strong debt aversion and a consequent determination to run current account surpluses and recycle capital inflows into foreign exchange reserves.

Third, Japan combines features of the eurozone and some of its Asian neighbours: slow demand growth; high savings; and a determination to slow exchange rate appreciation.

Fourth, a big divide has emerged between countries that allow their exchange rates to float relatively freely - which includes most of the OECD (except Japan) and the big Latin American countries - and those that do not, including much of Asia.

Finally, the US and a few other high-income countries, including the UK, are simply adjusting to surpluses generated elsewhere. The result has been massive accumulations of liabilities by the private or public sectors.

How then is all this going to end?

Part of the answer is that the weakness of the dollar is forcing the needed adjustment. In the US, it will raise output and, in time, reduce the need for huge financial deficits. This then is an optimistic view of global adjustment.

But there are also some noteworthy risks.

One is of a precipitate, rather than smooth, decline of the dollar. The dollar will probably need to fall further if the US is to combine internal balance with a manageable external deficit. Yet an abrupt fall could trigger sharp rises in US long-term interest rates and declines in US asset prices. This could cut household spending, thereby generating a renewed economic slowdown. It might, alternatively, drive the Fed towards debt-monetisation and so towards higher inflation.

Another risk is that neither Japan nor the eurozone is able to generate satisfactory growth in domestic demand. In that case, the external adjustment imposed upon them might also create a sharp domestic economic slowdown or even recession.

A final risk is that the external and internal adjustments do not happen: the US ends up with ever growing current account deficits, US protectionism explodes and the role of the dollar as a reserve currency comes into question.

A world in which macroeconomic health can be achieved only at the expense of ever greater private and public debt accumulation in its biggest and richest economy is unstable. It is also perverse.

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The dollar has hit a series of historic lows against just about every currency.
BBC News Online explains.
The dollar seems likely to fall: betting just how far is one of the best ways imaginable to lose even more money.
BBC 18/2 2004

Asia will not rethink currencies soon
Martin Wolf, Financial Times, 18/2 2004

The 7 stages of a dollar crisis
The inevitable crisis will inflict damage, but those who see where we are headed can protect themselves beforehand.
Bill Fleckenstein, CNBC 16/2 2004

Bill Fleckenstein is president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily Market Rap column on his Fleckensteincapital.com site.

Along the way to a full-blown crisis, the steps leading up to it may either pass unnoticed or prompt insufficient concern. That is the story of the dollar. Its decline continues to strike many folks as good news. It is only a matter of time before that perception changes. The inevitable crisis will inflict damage, but those who see where we are headed can protect themselves beforehand.

Here, then, is my outline of a 7-step process of creating a full-blown crisis.

Step 1. Nobody notices or pays attention that the dollar is falling.
Step 2. Folks wake up, but they either don't care or rationalize dollar weakness as a good thing.
Step 3. The central banks now know they have a problem, but the bankers think the market will obey them. It will, for a while. (This is the step we have now reached and what emerged at the G7 meeting.)
Step 4. The dollar now tests everyone's resolve by resuming its decline. The currency markets will not respond to jawboning by finance ministers.
Step 5. In this step, the finance ministers are forced to take action. (Think about it. Even if they'd stated that they wanted the dollar to go up, nothing either explicit or implied indicates they'll do anything about what's happening. That will come next.) When they do take action, the market will do what they want -- but only for a while.
Step 6. The ministers take some additional action, but it won't be enough, and the currency markets won't do what the ministers want.
Step 7. Finally, we'll have a full-blown crisis, and that will be the end game.

The recent performance of inflation has been especially notable in view of the substantial depreciation of the dollar in 2003. Against a broad basket of currencies of our trading partners, the foreign exchange value of the U.S. dollar has declined about 13 percent from its peak in early 2002. Ordinarily, currency depreciation is accompanied by a rise in dollar prices of imported goods and services, because foreign exporters endeavor to avoid experiencing price declines in their own currencies, which would otherwise result from the fall in the foreign exchange value of the dollar. Reflecting the swing from dollar appreciation to dollar depreciation, the dollar prices of goods and services imported into the United States have begun to rise after declining on balance for several years, but the turnaround to date has been mild. Apparently, foreign exporters have been willing to absorb some of the price decline measured in their own currencies and the consequent squeeze on profit margins it entails. Part of exporters' losses, however, have apparently been offset by short forward positions against the dollar in foreign exchange markets. A marked increase in foreign exchange derivative trading, especially in dollar-euro, is consistent with significant hedging of exports to the United States and to other markets that use currencies tied to the U.S. dollar. However, most contracts are short-term because long-term hedging is expensive. Thus, although hedging may delay the adjustment, it cannot eliminate the consequences of exchange rate change. Accordingly, the currency depreciation that we have experienced of late should eventually help to contain our current account deficit as foreign producers export less to the United States.

Full text

Top

The current-account deficit basically reflects America's lack of saving, by both households and the government
Not only is the government's budget deficit set to soar to a record $520 billion (almost 5% of GDP) this year, but the personal saving rate fell to only 1.3% of income in December, thanks to rampant consumer borrowing.
The Economist 5/2 2004

As John Connally, a former treasury secretary, told the rest of the world in 1971: “The dollar is our currency, but it is your problem.”

Not only do artificially low bond yields appear to offer false signals that America's budget deficit is no cause for concern, but by holding down mortgage rates (which are linked to bond yields) they are also prolonging an unsustainable boom in consumer spending and borrowing.

This benefits America in the short term, but allows even bigger imbalances (in the shape of domestic debt and foreign liabilities) to build up in the long term.

To contain these debts will eventually require a far sharper collapse in the dollar, a steeper rise in bond yields, and a harder economic landing. Anyone for tennis?

The US current account deficit, currently at 5 per cent of gross domestic product, is now widely regarded as unsustainable in the long run.
It would take either a recession or, preferably, a substantial devaluation of the dollar to reduce it to more manageable levels.
Financial Times editorial 5/2 2004

While the steep rise in the euro against the dollar is undeniably bad news for the eurozone, Europe's fundamental problem is its failure to generate sustained growth in domestic demand
Ed Crooks, Financial Times Analysis, 4/2 2004

Dollar's threat to eurozone
One question came up again and again at the recent meeting of the World Economic Forum at Davos: why are the Europeans not more worried about the dollar?
A sharp depreciation of the dollar would be the kind of shock that could mercilessly expose the weaknesses of the eurozone's system of economic governance.
Wolfgang Munchau, Financial Times 1/2 2004

Sakta men säkert stärks kronan och närmar sig åter nio kronor mot euron och sju kronor mot dollarn.
Det våras för kronan. Det är en uppfattning som delas av såväl Trading Strategy inom SEB Merchant Banking som merparten av ett femtiotal stora aktörer på valutamarknaden.
SEB 20/1 2004

På ett år har euron stärkts med 20 procent mot den amerikanska dollarn. På två år är motsvarande siffra hela 30 procent. Är detta ett problem för Europa?
Många finansministrar, centralbankschefer och ekonomer svarar ja på den frågan.
Peter Wolodarski, DN 2004-01-17

U.S. Fiscal Policies and Priorities for Long-Run Sustainability
International Monetary Fund January 7, 2004

"USA har ryckt åt sig ett stort försprång och har världens mest framgångsrika ekonomi"
Klas Eklund på SvD:s ledarsida 2000-08-11

Svagare dollar är nyttig medicin för EU
Thomas Norén, Inblick, SvD ledarsida10/1 2004

The euro hit another new high against the dollar this week, above $1.28.
That is over 50% above its low in 2001.
The Economist 8/1 2004

The dollar's recent slide should have been easy to predict
House prices are still rising, but the record suggests that property is now a screaming sell.
The Economist print edition Dec 30th 2003

IN AUGUST we disclosed the incredible forecasting record of America's top economists who attend the annual symposium of the Federal Reserve Bank of Kansas City in Jackson Hole, Wyoming. Each year our economics editor conducts an informal poll of a select group who meet for drinks after dinner.

At the peak of the stockmarket boom they were asked: “Is this a bubble?”“No,” they confidently voted.
In 2001 they ruled out an American recession and last year they predicted that interest rates would not fall to 1%.
In short, they provide an excellent contrarian indicator.

So it has proved once again. In August they were asked: “Will the dollar fall to $1.25 against the euro at any time in the next 12 months?” They gave a resounding “No”, with one exception. (One euro then bought $1.10.)

We asked our Jackson Hole gang a second question in August: “Will American house prices fall in the year to mid-2004?” All but one answered “No”. House prices are still rising (see article), but the record suggests that property is now a screaming sell.

Början på sidan

The next Bubble - House Prices

The US current account deficit was $135bn - in the third quarter
Financial Times 16/12 2003

The dangers of the dollar's decline
Current account deficits and deflationary pressure are being shifted from the US towards other high-income countries. Among the most endangered is an already feeble eurozone
Martin Wolf, Financial Times December 17 2003
Very Important Article

Since the end of January 2002, the dollar has lost 31 per cent of its value against the Australian dollar, 30 per cent against the euro, 19 per cent against the yen and sterling and 18 per cent against the Canadian dollar. Yet against the most important of emerging market currencies, China's renminbi, the dollar has moved not at all. The Hong Kong dollar and Malaysian ringgit are also fixed. But even the Indian rupee, Korean won, Taiwanese and Singaporean dollars and Russian rouble have barely moved.

What is going on? "Intervention" is the answer. The world has returned to the Bretton Woods era, which ended in 1971, with the move to generalised floating. But it has done so only partially. Peter Garber of Deutsche Bank has put forward an elegant account of the new global monetary system at a forum organised by the International Monetary Fund.

In the old Bretton Woods era, there were just two groups of countries: the US and the rest. The US, as the core country, adjusted to the policies of everybody else until, in 1971, it ceased abruptly to do so. Today, however, the world economy is divided into three parts: the US is the first; in Mr Garber's terminology, the "capital-account zone" is the second; and "the trade account zone" is the third.

Countries in the capital-account zone target domestic monetary stability, while letting private capital flows set exchange rates. Countries in the trade-account zone fix exchange rates, while trying to sterilise the domestic monetary consequences.

The objective of countries in the trade-account zone is growth. In Mr Garber's words: "The fundamental global imbalance is not in the exchange rate. The fundamental global imbalance is the enormous excess supply of labour in Asia now waiting to enter the modern global economy. The exchange rate is only the valve that controls that rate of entry." In order to maximise growth, Asian mercantilists lend the US the money with which to purchase their surging exports. When they demand repayment, the US will devalue and so partially default.

The growing external deficit appears to be structural: since 1990, US exports of goods and services have been growing at 5.7 per cent a year, in constant prices, while imports have been growing at 8.8 per cent.

Mark Cliffe of ING argues that it would need an 11 per cent fall in US GDP, relative to trend, to reduce the current account deficit to 2 per cent of GDP. It should go without saying that the US would not tolerate such a slump.

There are two possible escapes from the recessionary trap: depreciation of the real exchange rate and faster growth in the rest of the world. But, according to Mr Cliffe, it would take a 36 per cent increase in the rest of the world's GDP, a 34 per cent decline in the trade-weighted dollar, or some mixture of the two, to reduce the current account deficit to 2 per cent of GDP.

Full text

Början på sidan

The dollar has hit a series of historic lows against just about every currency.
BBC News Online explains, 9/12 2003

Rubin säger att "tvillingunderskotten" sammantaget utgör ett "mycket allvarligt hot mot USA:s framtida ekonomiska välstånd".
DN Ekonomi 21/11 2003

Robert Rubin diskuterar sin nya bok om Clintonadministrationens ekonomiska politik, "In an uncertain world"

Prognoserna indikerar nu att USA:s federala budget kan ackumulera ett underskott på 5.000 miljarder dollar under det kommande decenniet. Underskottet i bytesbalansen har passerat 5 procent, långt över de rekord som slogs under president Ronald Reagan på 80-talet. Rubin säger att "tvillingunderskotten" sammantaget utgör ett "mycket allvarligt hot mot USA:s framtida ekonomiska välstånd".

Han ser då framför sig ett scenario med ett ekonomiskt moras som på 70-talet. Dollarn kan rasa kraftigt och dra ned USA-tillväxten ordentligt eftersom en svagare valuta driver upp räntorna vilket i sin tur kan underminera investeringar och hämma produktivitetstillväxten. Särskilt illa blir det om ett dollarras sammanfaller med ett ökat offentligt upplåningsbehov för att finansiera budgetunderskottet. Aktiemarknaden kommer då sannolikt att reagera "negativt", säger Rubin med en typisk underdrift.

Net inflows of investment into American bonds and shares plunged from $50 billion in August to only $4 billion in September, the lowest level since the crisis caused by the collapse of Long-Term Capital Management in October 1998.
The Economist 20/11 2003

The very suggestion that foreigners might not continue to buy dollar assets in future was enough to make some investors sell this week. A cheaper dollar will help to reduce America's external deficit, while at the same time supporting growth. The risk is that if the greenback falls too fast, bond yields could rise, choking off recovery.

1986 the US twin deficits reached about 9 per cent of gross domestic product.
Currently, the twin deficits are about 10 per cent of US GDP - and on a rising trend.
The subsequent narrowing of the imbalance was accompanied by a 50 per cent decline in the dollar's trade-weighted value between 1985 and 1987.
Lex, Financial Times 20/11 2003

Focus is shifting towards the impact of strong US growth on the country's current account deficit. Forecasts point to the deficit's reaching 6, or even 7, per cent of gross domestic product next year. The deficit could narrow if the US grew more slowly than its trading partners. But, ahead of the 2004 US presidential election, this seems highly unlikely.

While foreigners have been prepared to finance the deficit the position has been sustainable. But the deteriorating trend in net US portfolio inflows suggests a growing reluctance by foreign private investors to shoulder this burden.

Faced with a widening deficit and a declining ability to fund the gap, further dollar weakness appears almost inevitable. Historical precedent suggests the scale of adjustment required could be substantial. HSBC notes that in 1986 the US twin deficits reached about 9 per cent of gross domestic product. The subsequent narrowing of the imbalance was accompanied by a 50 per cent decline in the dollar's trade-weighted value between 1985 and 1987.

Currently, the twin deficits are about 10 per cent of US GDP - and on a rising trend. Meanwhile, the Federal Reserve's broad trade-weighted index has fallen by only 11 per cent since its February 2002 peak. Even without consideration of damaging trade conflicts, the dollar is destined to move substantially lower in 2004.

Charts/Diagrams

The dollar's recent rally is unlikely to last
The Economist 28/8 2003

After travelling one way for most of the past 18 months, the dollar has changed direction. Since late May it has risen by 9% against the euro, brushing a four-month high of $1.08. A few economists are even musing that it might once again reach parity. So were all those predictions of a plunge in the dollar wrong?

The main reason to believe that the dollar will soon resume its downward path is America's huge current-account deficit. A dollar rally driven by stronger American growth is not sustainable in the medium term. America's imports are currently 50% larger than its exports, so the current-account deficit will increase even if imports grow at the same pace as exports.

But if, as widely expected, the United States continues to be the locomotive for the world economy over the coming years, then its imports are likely to grow faster than its exports. If the current-account deficit is to be reduced, then either America's growth must slow or the dollar must fall to improve American firms' competitiveness.

Europe's single currency, the euro, has surged against the US dollar and
on Monday regained the value at which it was launched four years ago - $1.17.
BBC 19/5 2003

Dollarns försvagning fortsätter. I går förmiddag kostade en dollar 7:83 kronor.
Det innebär att den amerikanska valutan fallit i värde med 10 procent på bara två månader.

DN nyhetsplats 20/5 2003

Dollarn försvagas till lägsta nivån på fyra år

Den amerikanska dollarn har fortsatt falla i värde under måndagen och en dollar kostade på eftermiddagen 7 kronor och 86 öre om man betalar med svenska pengar och en euro ger 1,17 dollar. Det var på kvällen den 6 maj som dollarn gick ner under 8-kronorsnivån, för första gången sedan i februari 1999. Men fallet tycks än så länge inte bekymra amerikanerna.
Ekot 2003-05-19

US backs off from 'strong dollar'

US Treasury Secretary John Snow has broken with the long tradition of backing a strong dollar, hinting that the boost to exports from a weaker greenback is a welcome change.
BBC Monday, 12 May, 2003

Living with a lower dollar
The threat is that the cold wind of recession and rapidly falling inflation could envelop the
continent unless domestic demand rises strongly.
Finamcial Times, editorial, May 10 2003

When major currencies fall from a precarious perch, they have a habit of dropping a long way. The US dollar, the darling of investors until 15 months ago, has already fallen by 17 per cent on a trade-weighted basis and by 25 per cent against the euro. That could be just the start. The US dollar's fall in the mid 1970s and its dizzying drop from an even loftier peak in early 1985 dwarf the current decline.

Only fools or knaves attempt to forecast currency movements with any precision, but it would be unwise to expect the greenback to regain its former value quickly. The forces depressing the dollar remain large: the US still needs to attract net capital inflows greater than $1bn every day to prevent the dollar falling further. So at the very least we had better get used to living with a lower dollar.

For the US the consequences are largely benign. Its economy has significant spare capacity and the pricing power of companies is weak. The likelihood of a damaging rise in inflation driven by higher import prices is small. Indeed, a boost to the average price level would be welcomed in the Federal Reserve, which this week warned about the possibility of "an unwelcome substantial fall in inflation".

In addition, greater competitiveness should ease the difficulties faced by the tradable goods sector, increasing its share of the US market and improving prospects abroad. Though trade flows move slowly, the current account deficit, which reached 5 per cent of gross domestic product in 2002, would gradually move closer to balance.

The more worrying aspects of a lower dollar will be felt elsewhere. East Asian governments are intervening to limit the relative rise in their currency values, leaving Europe to bear most of the immediate costs of adjustment. In the eurozone, net exports have driven economic growth in many countries while domestic demand grew by a miserly 0.2 per cent in 2002. Net exports can no longer be relied on to raise economic growth.

The threat is that the cold wind of recession and rapidly falling inflation could envelop the continent unless domestic demand rises strongly.

Full text

Euron spricker när dollarn faller
Rolf Englund i EU-krönika i Nya Wermlands-Tidningen 2001-01-08

Few have realised the most dangerous feature of Emu:
it has locked Germany into a seriously uncompetitive real exchange rate
Martin Wolf, Financial Times, March 31, 1999

Den europeiska mardrömmen Tyskland är inte Sverige i kvadrat. Tysklands problem är långt värre än så.
Arbetslösheten överstiger 10 procent, tillväxten är närmast obefintlig, budgeten går med underskott,
banksystemet skakar, risken för deflation är överhängande och landets industri befinner sig i en svår kostnadskris.
Den tyska utvecklingen är en europeisk mardröm, vars slut vi ännu inte sett skymten av.
Peter Wolodarski DN 27/4 2003

Into a new era
Last week was a watershed in the history of monetary policy.
Thirty years of overriding attention to inflation are at an end.
The world's most important central banks - the Federal Reserve and the European Central Bank -
admitted that inflation might fall too low.
By Martin Wolf
Financial Times May 13 2003 19:54

The probability of an unwelcome substantial fall in inflation, though minor, exceeds that of a pick-up in inflation from its already low level. - Federal Reserve, May 6 2003

If we accept that deflation can be dangerous, is it likely? The answer is that it may already be here.

The world economy and the OECD countries in particular are also well into their third year of sub-trend growth. As a result, the most recent OECD Economic Outlook sets the output gap - a measure of capacity utilisation - at minus 0.4 per cent in 2001, minus 1.2 per cent last year and a forecast minus 1.8 per cent for 2003.

Governor Ben Bernanke of the Fed pointed out last year, the monetary authorities can drive all interest rates down to zero, push down the exchange rate and, most effective of all, finance a fiscal deficit of any imaginable size.

f we agree that deflation is not inconceivable, the question becomes whether anything can be done about it. Persistent deflation is a symptom of chronic excess supply. The solution is to create demand.

Accept, then, that deflation is a genuine possibility but that it can be dealt with. This brings us to a final question, which is how the movements in exchange rates under way will affect the distribution of deflationary pressure and the locus of the needed response. The answer is that a huge part of the world's deflationary pressure is being exported to the eurozone.

This is good news for the US, as John Snow, secretary of the Treasury, noted last weekend in his comment that a weaker currency would help US exporters. But it poses a challenge to the eurozone authorities.

The euro reached its trough against the dollar on October 25 2000. Since then it has appreciated by 24 per cent against the pound, by 39 per cent against the dollar and the Chinese yuan and by 51 per cent against the Japanese yen.

On a trade-weighted effective basis, the euro is up 22 per cent. It is also back where it was at the launch of the currency in January 1999.

But the effective rate would need to rise another 11 per cent to match its peak in 1995 (measured by a synthetic euro, with the original currencies weighted by the conversion rates), while the rate against the dollar would need to rise another 21 per cent.

The decline in the dollar is part of a desirable global adjustment, given the ultimate unsustainability of the US current account deficit.

Yet the ECB is remarkably relaxed. In his press conference last week, Wim Duisenberg, the ECB president, remarked that "the euro, at the moment, is . . . roughly at average historical levels. So, there is not yet anything excessive about the level."

Fiull text - Top of page - Germany, EMU and all that

Rarely can a central bank's decision to leave interest rates unchanged, accompanied by a statement of less than 200 words, have had such an impact.
The US Federal Reserve's warning about too-low inflation on Tuesday can be taken as a fundamental reorientation of policy to cope with a world where, for the first time in decades, deflation has become a real threat to the world's largest economy.
By Alan Beattie FT.com site; May 09, 2003

"In contrast, over the same period, the probability of an unwelcome substantial fall in inflation,
though minor, exceeds that of a pickup in inflation from its already low level."
http://www.federalreserve.gov/boarddocs/press/monetary/2003/20030506/default.htm

The dangers of letting a deflationary spiral take hold at a time of weak economic growth are well known from the Great Depression, with Japan providing a contemporary example. Central banks' inability to cut short-term interest rates below zero means that real (inflation-adjusted) interest rates rise as prices generally fall, weakening the real economy further. The Fed has long been aware of the dangers. Though continuing always to insist that the likelihood of deflation is remote - Tuesday's statement did not even use the word - its policymakers have been rattling an array of reflationary sabres in public for several months.

In March, the Fed sent out Vincent Reinhart, a senior staffer who acts as secretary to its open market committee, to argue that times had changed. "For the first time in 40 years, the Federal Open Market Committee is not in a position where it should obviously desire inflation to be lower than its current rate," Mr Reinhart told the National Association of Business Economists. He then elaborated on a list of measures that the bank could take to arrest deflation.

Top of page

A European investor, for example, would have lost 43 per cent over the past year with an investment in the S&P 500 index, compared with a 28 per cent drop in US dollar terms.
Financial Times Editorial 8/3 2003

As the dollar rose in the late 1990s, it became fashionable, but wrong, to dismiss the growing US current account deficit as unimportant.

Returns in the US were high and foreign investors were keen to buy US assets, so the dollar marched higher even though the gap between imports and exports grew year by year. It could not last. US investment returns were disappointing, net private foreign purchases of US assets declined by almost a half between 2000 and 2002; foreign direct investment collapsed. Yet the US still needed to attract $500bn a year net capital inflows, so the dollar began its slide. But with a falling dollar, foreign returns on US investments decline further so attracting foreign capital becomes harder still.

A European investor, for example, would have lost 43 per cent over the past year with an investment in the S&P 500 index, compared with a 28 per cent drop in US dollar terms.

Full text

Asia is footing the bill
Martin Wolf
Financial Times, February 18 2003 21:07

The US is both the world's greatest power and its biggest debtor. This has allowed it to deploy guns and consume butter. As I noted in a previous column ("The rake's progress of the dollar comes under threat", January 8 2003), the US current account deficit is nearly 50 per cent bigger than its defence spending.

The question is whether this combination should worry US strategic planners. The answer is that it should: a large and sustained fall in the dollar, along with a reduction in the US ability to run a huge external deficit, would make its role, though affordable, palpably more costly.

In 2002, according to the information collected by Consensus Forecasts, the US ran a current account deficit of $498bn. Meanwhile, the Asia Pacific region ran a surplus of $204bn, contributed largely by Japan, with a surplus of $113bn, Taiwan and mainland China, both with $21bn, Singapore, with $20bn, and Hong Kong, with $17bn (see chart). Western Europe ran a surplus of $115bn, of which the eurozone's share was $45bn, while eastern Europe ran one of $8bn. Latin America ran a small deficit of $15bn, while the rest of the countries covered by Consensus Forecasts ran a small surplus of $1bn.

These figures do not, it should be noted, add up. This is not so much because of countries excluded from the calculations as because of the well known black hole in the global balance of payments.

Sven Grassman påpekade The Black Hole i den svenska statistiken

“Självförvållad eftersläpning”
Torsten Sverenius i Gästkrönika i DN/Ekonomi 98-06-22

Se upp för falska profeter! Klas Eklund, Tiden 7-8/1987
dito som word-document

Klas Eklund

Mer om Sven Grassman

How far can it fall?
Is the party finally over? For years, currency experts have been confidently
—and largely mistakenly—forecasting the decline of the dollar
The Economist Jan 10th 2003

As the late Herbert Stein, former chairman of the US council of economic advisers,
once said: "If something cannot go on forever, it will stop." - (The Dollar)
Financial Times editorial 2/1 2003

Global economic engines misfire
Financial Times editorial, November 16 2002

The problem is that the four largest trading zones could each benefit from a depreciation: the US to stem its 5 per cent of gross domestic product current account deficit; the eurozone to provide a boost to demand; likewise in Japan; and the UK to provide greater balance between industry and consumer spending.

Simultaneous depreciations are, of course, impossible. But with the US dollar still perched so precariously over such a large current account deficit, the greenback is most likely to fall.. full text

US trade gap widens to record $38.5bn in August
Financial Times October 18 2002

Don't ignore the current account
Financial Times editorial, September 19 2002

Let the dollar fall
By Fred Bergsten
Financial Times Published: July 17 2002 19:48

BBC: IMF warns over dollar collapse
Friday, 5 July, 2002

The price of a falling dollar
By Martin Wolf
FT, June 25 2002 20:11

Recovering from the dollar
By David Hale
FT, June 24 2002 20:47

The eagle (the dollar) is landing
Financial Times, editorial, June 24 2002

What's in Store for the Dollar?
By John H. Makin
American Enterprise Institute (Timbros storasyster)
June 2002

Den starka dollarns stora svaghet
Joseph Stiglitz
DN 17 juni 2002

Ur Carl Bildts veckobrev v23/2002

Att det nu finns tendenser till en försvagning av den starka dollarna, och ty följande relativ förstärkning av euron, gör inte nödvändigtvis den utvecklingen lättare att hantera. En starkare euro gör det visserligen möjligt att hålla räntorna lägre längre än vad som annars skulle ha blivit fallet, men innebär samtidigt att amerikansk export blir mer konkurrenskraftig och europeisk mindre å.

Med en tillväxt- och sysselsättningsutveckling som inte är idealisk är det ett scenario inte utan problem.

RE: Carl Bildt är vare sig arrogant eller hurmoristisk. Han är helt enkelt oprecis.

Mer om Carl Bildt

``There is a fundamental shift out of U.S. dollar investments going on,'' said Laurie Cameron, head of global foreign exchange in New York at J.P. Morgan Chase & Co.'s private bank, which invests $300 billion. The U.S. is ``not going to be able to attract huge new chunks of foreign capital'' needed to support the dollar, she said.(Bloomberg 1/6)
More than $1 billion a day flows from the U.S. to foreign hands as a result of the U.S. current-account deficit, which swelled to a record $417.4 billion in 2001. That leaves the currency vulnerable when international investors shift to other countries.

A dollar short
By Peronet Despeignes and Christopher Swann,
"The risk is that the virtuous circle of feedback between the economy, equity markets and the dollar that brought good things to the US in the late 1990s could turn into a vicious circle of feedback in the period ahead."
FT, May 30 2002 21:10

Fasten your seatbelts (Dollar slide)
May 23rd 2002 From The Economist

Beware seismic shifts in sentiment (dollar)
Philip Coggan, FT, May 3 2002 15:35

Pressure on dollar forces - O'Neill to speak in riddles
By Christopher Swann, FT, May 2 2002 20:14

Fred Bergsten, head of the well-respected Institute for International Economics,
said that he believed the dollar was worth 20-25% too much.
BBC, 2 May, 2002

Dollar slides after O'Neill testimony
BBC, 2 May, 2002

A rapidly falling dollar represents perhaps the most significant threat to a smooth global recovery.
The greenback's value, in turn, relies upon the willingness of others to continue to fund the yawning US trade gap. Neither can be counted on.
Financial Times editorial April 26 2002 19:23

In the history of the Big Mac index, the dollar has never been more overvalued
Apr 25th 2002 From The Economist print edition

Mismanaged, misaligned or misunderstood?
Apr 2nd 2002 From The Economist Global Agenda

An unsustainable black hole
(The US current account deficit)
Martin Wolf
Financial Times, February 27 2002
RE: A difficult, but a state of the art article - highly recommended

THE EURO VERSUS THE DOLLAR:
WILL THERE BE A STRUGGLE FOR DOMINANCE?
C. Fred Bergsten, (highly respected) Director, Institute for International Economics, January 4, 2002

THE COMING RISE OF THE EURO
Institute for International Economics

How far can it fall?
Is the party finally over? For years, currency experts have been confidently
—and largely mistakenly—forecasting the decline of the dollar
The Economist Jan 10th 2003

Is the party finally over? For years, currency experts have been confidently—and largely mistakenly—forecasting the decline of the dollar. They were able to marshal an impressive array of evidence in support of their arguments. It was, they said, overvalued on any historical measure. America could not continue to absorb the large capital inflows which had propped up the greenback for so long. The euro, after its creation in January 1999, would soon challenge the dollar’s reserve-currency status. More recently, America’s burgeoning current-account deficit alarmed economists, who saw no alternative to a precipitous collapse of the dollar.

Neither the American recession in 2001 nor the huge and growing current-account deficit (about 5% of GDP) seemed to discourage people from holding dollars. And then, in the closing months of last year, the dollar finally started to weaken. By the end of the year, the dollar had lost 10% of its value as measured against a trade-weighted basket of currencies. The first few days of 2003 have seen it slip further against the euro and the yen.

The source of the great dollar surge in the late 1990s was easy to spot. The booming American economy offered enormously attractive rates of return on investment: as a consequence, large amounts of investment capital flooded into the country. Even when boom turned to bust, America still looked to be a better home for capital than many other, even more lacklustre economies.

The rise in the value of the euro might boost morale at the European Central Bank in Frankfurt, but it will not bring much comfort to Germany’s export-driven corporate sector.

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Charts/Diagrams

Top of page

As the late Herbert Stein, former chairman of the US council of economic advisers,
once said: "If something cannot go on forever, it will stop." - (The Dollar)
Financial Times editorial 2/1 2003

As the late Herbert Stein, former chairman of the US council of economic advisers, once said: "If something cannot go on forever, it will stop." The combination of an ever-rising US current account deficit with a strong dollar must cease. Indeed, it already is doing so. The currency weakened in 2002. It is rather likely to weaken further in 2003.

The present course of the US economy is unsustainable. Net US liabilities to the rest of the world are some 25 per cent of gross domestic product - in the neighbourhood of $2,500bn (£1,562bn). In the first three quarters of 2002, the current account deficit ran at close to five per cent of GDP. As recently as 1997, however, the deficit was only 1.5 per cent of GDP. It is bigger this year than two years ago, despite last year's economic slowdown.

Since the beginning of 1997, trend growth of exports of goods and services, at constant prices, has been 2.2 per cent a year, of GDP 3 per cent and of imports 7.4 per cent.

Even under quite conservative assumptions, the current account deficit could, on current trends, be over 7 per cent of GDP by 2007. By that year, US net external liabilities would, at current exchange rates, be close to 65 per cent of GDP.

If the dollar is to remain strong, despite these deficits, the rest of the world must accumulate net claims on the US economy at $500bn a year, and rising, for the indefinite future. This is hard to imagine.

Already, there has been a steep decline in net private foreign purchases of US assets, from $978bn in 2000 to an annual rate of just $560bn in the first three quarters of 2002. Net foreign direct investment has collapsed, from $308bn in 2000 to an annualised $14bn in 2002.

This decline in private foreign purchases of US assets has been offset by a big increase in foreign government net purchases of US assets, from $38bn in 2000 to an annualised rate of $136bn in 2002. There has also been a steep fall in US private purchases of foreign assets, from $605bn in 2000 to an annual rate of just $380bn in 2002. If foreign governments stopped propping up the dollar and US investors invested abroad, as before, the dollar would tumble.

Other currencies must rise if the dollar is to fall. But the two biggest economies after the US - the eurozone and Japan - are highly dependent on export demand, at least for the moment, while no big economy offers obviously superior returns to those available in the US. Moreover, other governments, particularly in Asia, are desperately unwilling to see their currencies rise against the dollar.

The most potent of all large-scale purchaser of dollars is Japan. Its vast foreign reserves, already $395bn at the end of 2001, rose to $461bn by October 2002. With the finance minister talking of a yen exchange rate below Y150 to the dollar and pressure on the Bank of Japan to expand the money supply, further purchases are probable.

If the dollar is to fall, the important currency against which this is likely to happen is the euro, since it belongs to the one large entity whose authorities will refuse to buy dollar assets in large quantities. The dollar has already fallen 16 per cent against the euro since the end of January 2002. This slide could easily continue in 2003.

This is a tale of irresistible force meeting immovable objects. The force is the growing pile of US liabilities. The objects are the low real returns in other big economies and the unwillingness of many governments to tolerate currency appreciation. In the short term, the objects may win. In the long run, the force will be stronger. The dollar must fall. The longer it remains high, the bigger its fall will be.

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US trade gap widens to record $38.5bn in August
Financial Times October 18 2002

The Commerce Department said the US trade deficit grew to $38.5bn in August from a revised $35.1bn in July.

Exports fell while imports rose. Deficits rose with China, oil exporters, Mexico and Taiwan, but fell with Western Europe and Japan.

The widening deficit has been a perennial area of concern for some economists. Some fear it raises risks of future turmoil in currency and financial markets.

It means the US attracts a net $1bn a day in foreign capital to help keep the dollar and equity markets from falling and interest rates from rising.

Investors' perception that the US enjoys relatively greater stability, stronger productivity growth and long-term economic prospects has helped attract that needed capital, but some economists fear it is increasingly financing short-term consumption rather than long-term investment.

Don't ignore the current account
Financial Times editorial, September 19 2002

Ask most serious economists and they will admit to feeling pretty queasy about growing trade imbalances in rich countries. Paul O'Neill, the US Treasury secretary, disagrees. He cannot comprehend the concern about the gaping US current account deficit. "I just think it is a meaningless concept," he has said.

On one level Mr O'Neill cannot be faulted. The current account deficit is just an accounting concept, which, by definition, must equal the value of foreign net capital flows to the US. According to Mr O'Neill, these flows explain everything. For him, that the current account deficit is well over 4 per cent of US gross domestic product, that it absorbs 6 per cent of global gross saving and more than 70 per cent of the world's non-domestic saving flows, simply shows how attractive investment in the US is to foreigners.

But this mantra represents the triumph of blinkered assertion over evidence. It fails to explain why the deficit grew in the 1990s, whether it is sustainable and how it might unwind.

Fortunately, the International Monetary Fund published a valuable contributed to the debate yesterday. It concludes that global current account imbalances matter, that their present levels are unlikely to be sustained and that the world should worry about a rapid correction.

The unwinding of the US current account deficit could be slow and benign. If domestic demand were to grow fast, particularly in Europe and Japan, world output would expand as the imbalances shrank. The trouble is that an alternative unpleasant correction looks more likely. In this scenario, revised expectations of US growth prospects would cause lower US consumption, imports and growth; and a sharply lower dollar would export some of the pain to Europe and Japan.

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IMF World Economic Outlook
Trade and Finance September 2002

IMF: Chapter II.Essays on Trade and Finance
How Worrisome Are External Imbalances?
230k pdf file

Rolf Englund 2001-05-21
U.S. Trade Deficit: Causes, Magnitude and Consequenses

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Let the dollar fall
By Fred Bergsten
Financial Times Published: July 17 2002 19:48

The exchange rate of the dollar has declined steadily and gradually for the past six months. It has fallen by a trade-weighted average of about 10 per cent and by about 20 per cent against the euro. This represents a reversal of about a quarter of the dollar's rise from 1995 to the beginning of this year.

A substantial correction of the overvalued dollar was as inevitable as a substantial correction of the overvalued US stock market. America's current account deficit is approaching $500bn, or 5 per cent of gross domestic product, far higher than before the sharp dollar falls of the early 1970s, late 1970s, mid-1980s and mid-1990s. The only issues were by how much and when the dollar would correct.

The US can probably sustain current account deficits of 2 to 2.5 per cent of GDP, about half their present magnitude. Since every 1 per cent fall in the dollar produces an improvement of about $10bn in the current account, with a lag of about two years, an ultimate depreciation of perhaps 25 per cent was to be expected.

The decline to date has achieved about a third of this.

To be sure, all non-dollar countries will experience some erosion of their price competitiveness as the dollar falls. This is the inevitable flip side of the reduction in America's unsustainable trade deficit. But all main currencies are rising together against the dollar so none of their trade-weighted averages is appreciating very much. In any event, exports to the US account for less than 3 per cent of the eurozone and Japanese economies, so even large changes in those sales will have minimal impact on them.

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Recovering from the dollar
By David Hale
FT, June 24 2002 20:47

There are increasing signs in the market that the US dollar has embarked on a correction that could be prolonged and sustained. If so, that is likely to provide an important boost for the global economy.

There is no precise way to predict how far the dollar will fall but the risk of a prolonged decline is high for three reasons. First, the US will have an unprecedented current account deficit of $450bn-$500bn (£310bn-£340bn) during the next 12 months - equivalent to about 5 per cent of gross domestic product. It is very unusual for mature industrial countries to run such large external deficits for several years in a row.

Second, global investors already have significant exposure to US financial assets. They own about 40 per cent of the US Treasury market, 24 per cent of the corporate bond market and 13 per cent of the equity market. The total value of these holdings is about $8,400bn, or a sum equal to 80 per cent of GDP. If investors simply decide to reallocate a small share of these assets to other currencies, the US may find it difficult to finance the current account deficit without a large dollar decline.

Last, the US Federal Reserve Board intends to hold US interest rates steady because of concern about the resilience of domestic spending and the risk that a war with Iraq could produce an oil-price shock this autumn.

Alan Greenspan, chairman of the Federal Reserve, restrained interest rates on three occasions during the 1990s for reasons independent of the US economy.

Because Japan and Europe have become heavily dependent on export-led growth, there is a strong chance that they will attempt to limit the dollar's depreciation. They will start with intervention but will then probably resort to easing monetary policy. The Bank of Japan will begin to sell yen; the European Central Bank, meanwhile, will defer the interest-rate increases that might otherwise have occurred because of the persistence of inflation rates above 2 per cent.

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Euron spricker när dollarn faller
Rolf Englund i EU-krönika i Nya Wermlands-Tidningen 2001-01-08

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The eagle (the dollar) is landing
Financial Times, editorial, June 24 2002

From 1995 to 2000, the combination of strong demand with a soaring dollar made the US the locomotive of world demand. That era is now over. It is essential for policymakers everywhere to adjust to this uncomfortable new reality.

Astonishingly, the US emerged from a significant economic slowdown with a current account deficit of 4.3 per cent of gross domestic product in the first quarter of this year. This was close to the peak in the fourth quarter of 2000.

To sustain the dollar, net capital inflows must now rise from well over $400bn a year. Yet in the second half of 2001, net direct investment plus purchases of corporate stocks were minus $16bn. Demand for bonds remained strong. But the willingness of foreigners to buy bonds is vulnerable to currency risk.

That risk is now real.

The dollar is at a two-year low against the euro. It has depreciated by 11 per cent against it since the end of January 2002. Yet the dollar remains very strong. On a trade-weighted basis, it is more than 30 per cent above where it was in 1995.

The real exchange rate is higher than at any time in the past three decades, except for 1984 and 1985.

The US currency seems to have a long way to fall.

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Euron spricker när dollarn faller
Rolf Englund i EU-krönika i Nya Wermlands-Tidningen 2001-01-08

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What's in Store for the Dollar?
By John H. Makin
American Enterprise Institute (Timbros storasyster)
June 2002

It will be very interesting to observe the response in the global economy should the recent drop in the dollar accelerate. American manufacturers and labor unions are screaming for a weaker dollar while the U.S. Treasury speaks uneasily about a strong dollar being in the nation's best interests. It may be in America's best interests when the world economy is strong, but it may not be in the best interests of the United States when domestic demand growth is insufficient to propel a sustainable recovery that includes a rise in capital formation.

Take a look at the fundamentals. The U.S. current account deficit means that about 1.3 billion dollars are on offer in the foreign exchange markets every day. As the desire of international investors to acquire more assets in the United States begins to cool, the capital inflows that snap up those available dollars has started to slip and so has the dollar.

A weaker dollar could present the Federal Reserve with a conflict between the needs of the domestic economy for continued monetary accommodation and the need for tighter money to achieve external balance and slow the dollar's decline. After all, with an eye on the domestic economy, the Fed has cut interest rates by 475 basis points since January 2001, only to see the U.S. stock market subsequently drop last year for a second year in a row and to watch stocks weaken again this year as concerns about sustainable growth and profits keep stock prices under pressure.

The other part of the Fed's dilemma is tied to the extraordinarily low current level of short-term interest rates. Such low short-term interest rates have encouraged households to continue to purchase consumer durables, housing, and related items at a vigorous pace, especially viewed in the context of the weak employment picture. Meanwhile, corporations have increased issuance of long-term debt but have converted their borrowing into short-term debt because of the extraordinarily low rates on offer, thanks to the Fed's very accommodative stance on the Federal funds rate.

Meanwhile, the Bush administration would do well to abandon the idea of a "dollar policy." The exchange rate is a price determined in global currency markets. Having a dollar policy that includes strong-dollar rhetoric suggests a willingness to intervene in currency markets should the dollar become "weak." That is not the stated policy of the Bush administration, so probably the less said about the "dollar policy" the better.

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Klas Eklund på SvD:s ledarsida 2000-08-11
För 20 år sedan inledde Ronald Reagan en våg av skattesänkningar i västvärlden. När USA sänkte sina skatter skärptes trycket på andra att följa efter.
Under en period blundade många i Europa och en rad ekonomer (däribland jag själv) hävdade att Reaganomics var ett oansvarigt tänkande.
Men vi hade fel. USA har ryckt åt sig ett stort försprång och har världens mest framgångsrika ekonomi.

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Den starka dollarns stora svaghet
Joseph Stiglitz
DN 17 juni 2002

Frågan handlar i dag är inte bara om att dollarn faller, utan främst vad de amerikanska myndigheterna avser att göra åt det. USA:s frispråkige finansminister Paul O´Neill anser att det inte är så mycket USA kan eller bör göra för att hålla kursen uppe.

Hans uttalande har kritiserats av vissa som anser att han ger upp den tro på en stark dollar som var Clintonadministrationens signum.

Ett ansvar för det ekonomiska ledarskapet är att avslöja ekonomiska myter - framför allt att inte skapa dem.

Clintons "starka dollar" är ett särskilt flagrant exempel på en ekonomisk myt: hans politik tycks utgå ifrån att finansdepartementet kan och bör upprätthålla den starka dollarn, och att en stark dollar är bra för USA.

När jag var ordförande i presidentens ekonomiska råd (President´s Council of Economic Advisers) blev jag ofta tillfrågad om jag trodde på Clintons starka dollar. Jag svarade att jag trodde på "jämviktsdollarn". Med andra ord, växelkurser är inte olika andra priser. Precis som när det gäller äpplen och apelsiner är det marknaden som ska sköta prissättningen.

Den som sade sig stödja en politik för "den starka apelsinen" skulle omedelbart förlöjligas. Ändå är det många av dem som normalt tror på marknadskrafterna som tycks tro att just växelkurserna styrs av andra mekanismer, de tycks tro att ett ord eller en blick från en finansminister kan få valutor att stiga eller sjunka. På en valutamarknad är syftet också ofta att gissa vad andra ska tycka. Men även om regeringsinterventioner kan påverka valutakurser på kort sikt, är det marknadens fundamenta som räknas på längre sikt.

Vid ett tillfälle tillfrågades finansdepartementet om den starka dollarns effekter för exporten. Svaret var att en stark dollar betyder en stark ekonomi och att en stark ekonomi förbättrar möjligheterna till export.

Men, hur mäktigt finansdepartementet än må vara, kan det inte ändra ekonomins lagar. Efterfrågekurvorna pekar nedåt: med högre priser kommer efterfrågan på amerikanska varor att minska, och en stark dollar betyder att amerikanska varor blir dyrare. Den kanske främsta invändningen mot denna tro på en stark dollar är just att den uppmuntrar en sammanblandning när det gäller en stark valuta och en stark ekonomi. Vi bör inte vara mer känslomässigt bundna vid dollarns kurs än vid något annat pris.

En stark valuta försvårar export, och när en ekonomi hotas av stigande arbetslöshet kan kursen göra en svår situation än svårare. Å andra sidan kan en stark valuta leda till minskad inflation, eftersom importpriserna sjunker. Om inflationen är den prioriterade frågan, kan en stark valutakurs vara bra för ekonomin.

Tron på en stark dollar tyder också på en ekonomisk nationalism som inte passar in i dagens globaliserade värld. Om dollarn är stark, är euron eller yenen svag. Men hur ska de politiska ledarna i andra länder reagera på det? Bör de acceptera en stark dollar, även om det innebär en svag euro eller en svag yen?

Vad som krävs är en intern amerikansk debatt om den starka dollarn.

Världens rikaste land måste låna miljarder dollar från omvärlden för att täcka gigantiska underskott. Det är den starka dollarn, inte japansk protektionism, som är den främsta anledningen till underskottet i handeln med Japan.

Den starka dollarn har också lett till protektionism på hemmaplan, senast illustrerat av ståltullarna. Det är hög tid att överge tron på den starka dollarn.

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Since the dollar began its ascent against other currencies in the mid-1990s, pundits have been predicting that it would soon fall back to earth. Instead the US currency continued to rally.

Yet now, just as the US is recovering from recession, the dollar looks vulnerable. Yesterday, the greenback fell to a 15-month low against the euro, taking its losses against the European currency to 9 per cent since the start of March. "There is growing confidence among analysts that the era of the invincible dollar is finally drawing to a close," says Michael Lewis, senior currency strategist at Deutsche Bank.

Many economists believe that something more profound is also occurring: that markets are starting to signal long-term concerns about the comparative strength of the US economy. "There's a real, emerging problem with perception," says Greg Valliere, managing director of the Washington policy research arm of Charles Schwab. "Whether the reality is as bad is debatable, but perceptions of the US investment climate have clearly changed."

The Achilles heel of the US dollar has been the bulging current account deficit, which is expected to reach $465bn this year. This means that the US needs to attract $1.3bn in overseas funds every day in order to prevent the dollar from falling.

The financial inflows that allowed the dollar to fund its bulging current account deficit appear to be waning. Last year, the average monthly net inflow into the US was $44bn. In the first two months of this year it averaged just $14.6bn. "There are signs that the US primacy as an investment location, offering unbeatable returns, is now under threat," says George Magnus, chief economist at UBS Warburg.

Investors have a number of concerns about the US economy and corporations. First, there is the issue of standards of corporate governance and accounting. "Investors used to shun Asia because of its crony capitalism. Now, many see this as a problem for the US," says Mr Magnus.

National accounts show corporate profits have been declining as a proportion of gross domestic product since 1997, while S&P 500 companies have been reporting earnings growth in excess of GDP growth. This indicates that reported profits have been flattered by favourable accounting.

Second, investors are increasingly aware that productivity gains have not translated into higher profitability. Consumers and employees, rather than investors, seem to be enjoying most of the gains of rising productivity. For the first time since the 1960s, real US incomes have risen for both rich and poor.

Third, there are fears that the vigour of the US economy is under threat from shifts in government policy. Brian Wesbury, chief economist of the investment firm Griffin, Kubik, Stephens & Thompson, says that the surge in government spending during the Bush presidency - the biggest since the Vietnam era - is diverting resources from the private sector.

Even those who believe that the US will remain the dominant force in the global economy concede that the dollar could fall further over the next few months. "It is not that we are expecting the US to come off its perch but it should come a little closer to earth," says Stephen Roach, chief economist at Morgan Stanley.

The ultimate fear is that such a fall in the dollar could become self-reinforcing. The US has grown accustomed to a steady inflow of overseas cash, helping to keep share prices higher, investment more robust, interest rates lower and inflation more subdued than they would otherwise have been.

If international investors become convinced that the dollar is on its way down, capital outflows could accelerate, says Rory Robertson, market strategist for the Macquarie Bank of Australia.
"The risk is that the virtuous circle of feedback between the economy, equity markets and the dollar that brought good things to the US in the late 1990s could turn into a vicious circle of feedback in the period ahead."

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Fasten your seatbelts (Dollar slide)
May 23rd 2002 From The Economist

The world’s currency markets have started to panic about what’s going on the world: they don’t like what they see, but they’re not quite sure how to react to it. The short-term consequences are clear—the big currencies have started to fluctuate in value as traders and investors change their minds, almost from minute to minute, about where to put their money. The longer-term implications could be more serious if this temporary volatility leads to a realignment of currencies, which in turn affects the economic outlook in the world’s biggest countries.

As America continues what has so far been a modest but remarkably steady recovery this year, after the mildest recession on record, its huge current-account deficit has become the focus of attention. Few economists are forecasting that the world’s biggest economy will surge ahead and match the pace of expansion it enjoyed in the late 1990s. With recovery taking place in Europe, some economists have started to question whether the rest of the world will remain content to lend America the billions of dollars it needs each year to deliver the capital-account surplus it needs to offset its current-account deficit. (Others have harboured these doubts for a long time.)

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Beware seismic shifts in sentiment (dollar)
Philip Coggan, FT, May 3 2002 15:35

The most noticeable change is the enthusiasm for real assets. Suddenly, equity investing is so 1990s; it is not much fun being a momentum player if your chosen asset is stationary or going backwards.

The second big shift in financial fundamentals is a change in attitude towards the dollar. So far, the dollar's decline has been relatively small-scale, with the euro edging back above 90 cents, its highest level of the year.

But the change in sentiment may be more important than the scale of the movement. It has come in spite of a robust US growth rate of 5.8 per cent (annualised) in the first quarter, although that was boosted by a slowdown in the rate at which companies were running down their inventories.

Investors are now focusing on the problems they ignored during the late 1990s, notably the US's large current account deficit. This did not narrow significantly during last year's economic slowdown and could thus widen alarmingly during the recovery.

The US's ability to finance that deficit has depended on the willingness of overseas investors to buy US assets. This proved no problem in the late 1990s when the US had a much more vibrant economy and stock market than either Europe or Japan. But if overseas investors suddenly lose their enthusiasm, a whole new set of problems will emerge.

A strong dollar has suited most of the world in recent years. Europe and Japan have, in effect, been able to export their deflationary pressures to the US; and the US economy has been strong enough to take the strain.

If the US dollar were to decline sharply, that would put severe pressure on European and Asian exporters and thereby on global growth. As Ashraf Laidi of the MG Financial Group points out, the US buys nearly a fifth of the world's exports.

It would also cause a dilemma for the US Federal Reserve. A falling dollar would add to inflationary pressures on the US economy. But increasing interest rates to choke off inflation would not necessarily support the dollar; these days, currency movements seem to be driven more by economic growth expectations than by yield support. And higher US interest rates would only increase the strain on the rest of the world economy.

Investors are in the mood for questioning old certainties - and that means accepting the possibility that inflation might return and that the dollar might cease to be the world's strongest currency.

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Pressure on dollar forces - O'Neill to speak in riddles
By Christopher Swann, FT, May 2 2002 20:14

The US may be the most powerful nation in the world, but on the subject of one of the biggest threats to its economy its has almost no voice. The critical issue of the value of the dollar has forced Paul O'Neill, US treasury secretary, to speak in riddles.

On the one hand an over-zealous support for the currency risks further enraging a manufacturing and industrial lobby, which claims that the exchange rate is taking a heavy toll on jobs and production.

On the other, currency traders have become accustomed to periodic reassurances that the long-standing "strong dollar policy" remains in place.

Many see this lack of clarity as evidence that the strong dollar policy never really meant much anyway. The phrase was adopted by Robert Rubin, treasury secretary between 1995 and 1999, partly to dispel fears that the US would seek to boost exports by coaxing its currency lower. There has never been any evidence, however, that an appreciation of the dollar has ever been an explicit goal.

"It is perhaps better to talk about a strong dollar rhetoric than a strong dollar policy," says Catherine Mann, a senior fellow at the Institute for International Economics. In short, the policy has meant acquiescing to the rise in the dollar since 1996 without actually promoting it.

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Klas Eklund: USA har ryckt åt sig ett stort försprång
och har världens mest framgångsrika ekonomi.

Rolf Englund: U.S. Trade Deficit:
Causes, Magnitude and Consequenses

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Dollar slides after O'Neill testimony
BBC, 2 May, 2002

Pessimism about the strength of the US recovery sent the dollar to its weakest level for six months against the euro and for two months against the yen on Thursday. Its slide followed Congressional testimony by US Treasury Secretary Paul O'Neill in which he said intervention to protect currencies seldom works.

"There is a real doubt about the effectiveness of interventions or words about intervention," Mr O'Neill told the Senate Banking Committee. "It is not possible any more to actually fool markets for very long."

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Fred Bergsten, head of the well-respected Institute for International Economics, said that he believed the dollar was worth 20-25% too much.
BBC, 2 May, 2002

For every percentage point the dollar rises, he said, the trade deficit expanded by $10bn, and unless policy changed gradually the result would be a sharp, and very painful, correction in the future.

The Dollar and the US Economy by C. Fred Bergsten, Director Institute for International Economics
Testimony before the Committee on Banking, Housing and Urban Affairs United States Senate 1 May 2002

In his own testimony, Mr O'Neill sympathised with the plight of US workers at the sharp end of the strong dollar. "I know these are issues where your heart breaks for the people that are directly affected by these things," he said. "I suppose it's no solace at all to the individuals who are directly affected but I think it's demonstrably clear that in fact... US citizens as a body, and the world as a body, are better off if we let competition and best-value products lead the world."

The current account deficit - the broadest measure of whether imports outweigh exports and by how much - was $417.4bn last year, not far off an all-time high. At 4% of total national output, the deficit has more than doubled from the 1.5% or so which was usual in the mid-1990s.

Despite the size of the deficit, Mr O'Neill said concerns like those of Mr Bergsten "ignore forces that are working in the market". "All the interventions that have been modelled would do damage to the U.S. economy if we decided to reduce the size of the current account deficit," he said. "So I don't find it very appealing to say we're going to cut off our arm because someday we might get a disease in it."

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Analysts sense day of reckoning for dollar:
A fall in capital inflows to the US has alarm bells ringing
Christopher Swann Financial Times; Apr 27, 2002

The key problem for the US currency is that investors do not need to sell US assets for the dollar to fall. All that is necessary is that they fail to buy. The bloated US current account deficit, running at about 4 per cent of gross domestic product, means that the US needs to attract a net inflow of around Dollars 1.5bn (Pounds 1.04bn) every day in order to stop the dollar falling. The latest figures from the US Treasury provide strong indications that capital inflows are finally drying up. In January the net inflow into US equities and fixed income was just Dollars 9.5bn. This is weak even compared with the Dollars 17.8bn the US attracted in September.

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A rapidly falling dollar represents perhaps the most significant threat to a smooth global recovery. The greenback's value, in turn, relies upon the willingness of others to continue to fund the yawning US trade gap. Neither can be counted on.
Financial Times editorial April 26 2002 19:23

So long predicted yet so elusive, the prospect of a significant fall in the US dollar is exciting currency markets again. Since it began to rise in 1995 the greenback has looked vulnerable to speculative attack but year after year it has proved immune.

Triggers for a dollar decline - the enduring Japanese trade surplus, the launch of the euro, the US recession - have come and gone. None has impeded its steady rise against the currencies of the US's trading partners.

That should not come as a great surprise: forecasting short-term currency movements has always been a mug's game. That the dollar has defied gravity for so long does not invalidate the view that it is overvalued. It simply means we cannot predict when it will fall. But fall it almost certainly will, for the US has spent more than it has earned for the past six years.

The faster growth of imports relative to exports has led to a huge US current account deficit, requiring net capital inflows (at the prevailing exchange rate) of at least $400bn every year. So far this has not presented a problem but the deficit continues to rise. The Organisation for Economic Co-operation and Development forecast the US current account deficit rising from 4.1 per cent of gross domestic product last year to almost 5 per cent in 2003.

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In the history of the Big Mac index, the dollar has never been more overvalued
Apr 25th 2002 From The Economist print edition

Every time we update our Big Mac index, readers complain that burgernomics does not cut the mustard. The Big Mac is an imperfect basket. Hamburgers cannot be traded across borders; prices may be distorted by taxes, different profit margins or differences in the cost of non-tradable goods and services, such as rents. Yet it seems to pay to follow burgernomics.

In 1999, for instance, the Big Mac index suggested that the euro was already overvalued at its launch, when nearly every economist predicted it would rise. Several studies confirm that, over the long run, purchasing-power parity—including the Big Mac PPP—is a fairly good guide to exchange-rate movements. Still, currencies can deviate from PPP for long periods.

In the early 1990s the Big Mac index repeatedly signalled that the dollar was undervalued, yet it continued to slide for several years until it flipped around. Our latest figures suggest that, sooner or later, the mighty dollar will tumble: relish for fans of burgernomics.

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Mismanaged, misaligned or misunderstood?
Apr 2nd 2002 From The Economist Global Agenda

The strength of the American dollar is once more causing tension in the world economy. But are the world’s major currencies misaligned? And can governments do anything about it if they are?

What goes up must come down. Besides being a reliable law of physics, this maxim seemed, at one time, to hold true for most currency movements. One moment policymakers would be worrying about, say, the strength of the British pound, the Japanese yen or even the now-deceased German mark; and their next headache would be about the same currency’s weakness. And those policymakers need not be British, Japanese or German, of course: dozens of small economies find their own, much less important currencies buffeted by the rollercoaster behaviour of the world’s most important ones.

But in recent years, currency crises have taken on a somewhat different character: they have become dominated by the unexpectedly persistent strength of the American dollar. Over a long period now, the greenback has been appreciating against the euro, the yen and sterling, with temporary fluctuations in the opposite direction failing to reverse the underlying trend. This surge in the dollar’s value has started to cause strains in international economic relations, with rows about trade souring the atmosphere of high-level diplomacy.

To begin with, the rising dollar was easy enough to explain. In the 1990s, when the American economy was enjoying its longest peacetime expansion on record, money flooded into the United States. With American stockmarkets booming, foreign investors wanted a slice of the action. The surge in American productivity in the latter half of the decade made foreign corporations even more eager to acquire American companies, or to set up operations there. No wonder the dollar gained at the expense of less attractive currencies.

But the sudden, sharp slowdown in the world’s largest economy, which started towards the end of 2000, demonstrated how difficult economic forecasting in general, and currency forecasting in particular, can be. Instead of falling back, as America’s edge over the other large economies started to fade, the dollar remained strong. Hopes that the euro, in particular, would appreciate significantly against the American currency were short-lived. Again, it is not difficult to find a rational explanation for this: soon after the American economy started to head towards recession, the experts (or, at least, some of them) were once again confounded when the euro-area economy stalled as well. Germany’s recession could turn out to be as bad as that seen in America last year, and it comes after a shorter period of weaker growth. Japan, stuck in its third recession in a decade, remains a basket-case.

Even the events of September 11^th, which some economists thought might finally dent the dollar’s reputation as a safe haven in the event of global political uncertainty, failed to weaken the greenback significantly. And the so far surprisingly strong economic recovery in America has only consolidated the dollar’s position as the strongest and the pre-eminent reserve currency.

But such pre-eminence comes at a price. George Bush has caused international outrage by his decision to impose tariffs of up to 30% on foreign imports of steel. One reason he took the step was as a response to bitter complaints from the American steel industry about unfair competition from abroad, and these have been exacerbated by America’s strong exchange rate. A high dollar means American goods are more expensive abroad while foreign-made goods are cheaper in dollar terms. American steelmakers are thus squeezed at both ends.

Mr Bush may have felt compelled to act for political reasons—steelmakers tend to be concentrated in areas of importance to his Republican Party, and important mid-term Congressional elections are due in November. But he has sparked off a potentially dangerous round of tit-for-tat retaliation. Besides the European Union, which is about to introduce steel import curbs of its own, in an effort to prevent the European market from being swamped by cheap exports previously destined for America, countries as far apart as China and Brazil are considering formal complaints to the World Trade Organisation. This forms a bleak backdrop for the newly-launched Doha round of global trade negotiations.

The strong dollar is proving a constant irritation. An stronger dollar—ie, a weaker yen—might suit the Japanese government by boosting demand for exports. But Tokyo was forced to deny that it was acting in any way to weaken the yen during the visit by Paul O’Neill, America’s treasury secretary, in January because that is the last thing the Americans want.

In Europe, by contrast, pride is hurt by the euro’s chronic weakness. The talk is—and has been ever since the currency came into being three years ago—of the euro being “undervalued”—it does not reflect the “fundamentals”, some economists argue. This debate goes right to the heart of exchange-rate policy. Who, after all, decides that a currency is undervalued, or overvalued, or just right? And what can governments do if they are unhappy with the value of their currency?

In a world of floating rates, the answer to the first question must ultimately be the foreign exchange markets. To some extent, currency values reflect the price that forex traders place on them and that, in turn, might partly result from an assessment of what politicians and economists like to call the fundamentals nowadays: by this they really mean the relative economic performance of different economies—whether inflation is low, for instance, and productivity is growing. But forex traders have a different perspective from government policymakers—their job is to make money, or at least not to lose it. Whatever their view of the economic fundamentals, they cannot ignore market trends.

With hundreds of billions of dollars crossing the foreign exchanges every day, another important determinant of currency values often gets overlooked. Much currency trading is not done by speculators, trying to make a fast buck, but takes place in response to normal trading needs. As business activity is increasingly global, companies and individuals need to change money to meet their day-to-day commercial obligations. The value of a currency is, in this sense, no different than any other commodity—its price will rise or fall in response to the laws of supply and demand. (Hence the dollar’s strength.)

And governments? Well, history is littered with discarded currency agreements and discredited finance ministers who thought they could beat the markets. For a time currency agreements can be effective, so long as the governments involved (and the governments of all the major currencies must be involved from the outset) abide by their promises. The Plaza Agreement of September 1985, and the Louvre Accord of February 1987 had some impact—but not for long.

This is not to say that governments are completely powerless. They can set policy objectives which will, if adhered to, deliver a sound economy—low inflation, sustainable growth, an attractive business environment. In the long run, these should make an economy appealing to foreign investors, both those who wish to hold assets and those who wish to conduct business there. But while the world economy is dominated by the size and vigour of America, other governments will often, if not always, have to cope with the strength of the world’s most important reserve currency.

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Svenska Dagbladet skriver 2001-07-26 på ledarsidan en hyllningsartikel till Gunnar Hökmarks odödliga tankar:

- Moderaternas ekonomisk-politiske talesman Gunnar Hökmark varnade nyligen för att Sverige kan komma att behöva "ett chockpaket för tillväxt" i höst. Ett sådant utspel skulle lätt kunna avfärdas som ett stycke uppskruvad retorik i sommarvärmen.

- Om det inte vore för att många tecken tyder på att konjunkturnedgången har kommit för att stanna ytterligare en tid.

- Tiderna är dåliga, det är alla överens om. En oförskämt stark dollar nämns i många kommentarer och analyser som en av orsakerna till problemen. Men det verkliga problemet är snarare att kronan är för svag - eller rättare sagt att den svenska regeringens politik är för svag, vilket avspeglar sig i ett lågt förtroende för kronan.

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Tung investmentbank spår svagare dollar
Dagens Industri 2001-07-25

De senaste månadernas nedgång i amerikanska aktier kommer att leda till en svagare dollar. Det budskapet kommer från den internationella investmentbanken Dresdner Kleinwort Wasserstein (DKW). Dollarn har under våren stärkts mot de flesta andra valutor trots den tydliga konjunkturnedgången i USA. Men nu är det dags för euron att stärkas, anser DKWs chefsstrateg för valutor, Jesper Dannesboe. Han ger flera skäl. "Europeiska investerare har dragit ned på sina företagsförvärv i USA. Amerikanska aktier går dåligt. Det talar för att euron ska stärkas."

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Dollar puzzle
Editorial, Financial Times, Mar 22, 2001

The recent performance of the dollar against the euro is, to put it mildly, puzzling. The US economy is flirting with recession and US interest rates are down 1.5 percentage points. So why has the dollar been so strong? Since the start of the year, the euro’s value has fallen back below Dollars 0.90 from Dollars 0.95: the dollar is at a 15-year high on a trade-weighted basis.

Well-rehearsed reasons for past dollar strength against the euro no longer apply. First, relatively poor economic growth in Europe can no longer be blamed. Published growth rates and economic forecasts have fallen by more in the US than in the euro-zone. Second, US interest rates have declined relative to those in the euro-zone, both at the short and long end.

Foreign exchange markets find daily excuses to push the euro lower against the dollar. Yesterday, a weak German IFO index was the culprit: the business climate index for western Germany fell to its lowest level for 18 months. But these explanations do not stand up to inspection.

For example, German business confidence may be falling but that does not imply a German, let alone a European recession. Germany represents only a third of euro-zone output and the IFO index is a poor indicator. Since 1961 it has fallen by a similar or greater amount 11 times, more than twice as often as output has fallen.

Various other explanations for the dollar’s strength have been doing the rounds. Perhaps the currency markets expect a short US downturn, and are already looking towards the green fields beyond. Maybe US and Japanese investors have been selling their European equities first. Perhaps investors still see the US as a safe haven in turbulent times. Theoretically, the currency markets might expect large US tax cuts to push up real interest rates as they did in the early Reagan years. None of these explanations holds water, particularly as they are not consistent with moves in other financial markets.

For Europe, a weak currency is not much of a concern. It helps exports and should not seriously affect thinking at the European Central Bank. For America, a strong dollar is more problematic. It means the US will find it harder to mitigate its downturn through higher exports. But policymakers cannot call for a gradual dollar decline for fear that things might get out of hand.

So the strength of the dollar seems to defy explanation. But so - until recently - did the enduring strength of equity markets. There must be a chance that soon, with some trigger, the dollar will fall from grace.

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First World fundamentalism
Financial Times, leader, February 17 2001
On currency intervention, the record is hardly impressive. After the Plaza accord, which addressed dollar overvaluation in the mid-1980s, official intervention came only when the market had already changed direction. Some argue that currency intervention in the late 1980s served to exacerbate the problems that subsequently overtook Japan.

The Asian crisis did not, at least in the early stages, show the US Treasury and the Inter-national Monetary Fund at their best. And while Mr O'Neill does not like the phrase "moral hazard", he is right to argue that capitalism cannot work well if the state removes risk from markets.

http://news.ft.com/ft/gx.cgi/ftc?pagename=View&c=Article&cid=FT3LUTSAAJC&live=true

The correct way to support the euroDaniel Gros, Financial Times, November2, 2000

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For more than a year, economists have been predicting that the
currency would soon succumb to the bloated US current account deficit
from Financial Times; Oct 24, 2000

Like the proverbial cat the dollar has had many lives. For more than a year, economists have been predicting that the currency would soon succumb to the bloated US current account deficit, which looks set to reach Dollars 440bn (Pounds 305bn) this year.

Until now the appeal of its assets has enabled the US to suck in 70 per cent of the world's capital account surpluses. "Each time international appetite for one class of US asset has started to wane, another has taken its place," says Paul Lambert, director of currencies and bonds at Deutsche Asset Management.

But once again analysts are beginning to ask whether the dollar is running out of lives.

"It is increasingly difficult to see what will come to the rescue of the dollar this time," says Jim O'Neill, head of currency research at Goldman Sachs.

Last year Dollars 73.6bn - or nearly one-third of cross-border M&A inflows to the US - came from the telecommunications sector. Now it looks as though this particular source of dollar support is likely to dry up.

Morgan Stanley Dean Witter argues that global M&A activity - which funded around 40 per cent of the US current account deficit last year - has finally peaked.

This is not the only cloud on the dollar's horizon.

Corporate bonds - an even more important source of dollar support than foreign direct investment - have also been losing their shine. Many investors have been selling corporate bonds. Pimco, the world's largest bond fund manager, has urged investors to avoid corporate bonds at all costs.

"Even a slowdown in the inflow into the US corporate bond market would leave a gaping hole in the funding of the current account deficit," says Mr Lambert, pointing out that flows in 1999 represented around 60 per cent of the deficit.

Nor can the dollar any longer rely on the outperformance of US shares. After several years of this, US stocks have actually lagged behind those in Europé.’

Even so, the dollar's recent habit of pulling rabbits out of hats has left economists reluctant to rule out the possibility that it will manage to attract new flows.

"Crisis in the Middle East and rising oil prices - if sustained - would generate continued demand for US Treasuries as a safe-haven asset," says Avinash Persaud, head of global research at State Street, the Boston-based investment bank.

One further possibility, argues Joseph Quinlan, an analyst, is that Japanese companies - which have recently stood back from the cross-border merger boom - will swoop down on US companies.

"This could be the dollar's 10th life," quips Mr Quinlan. But most think these are wild card options.

"It looks like the dollar bull run may have entered the final straight," says Mr Lambert.

With negative factors for the currency continuing to accumulate, the dollar can not be expected to defy gravity for much longer.

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Samuel Brittan: Watch the dollar, not the euro
Financial Times, October 12
The biggest flaw in the world economy is the US current account deficit, which could place a strain on the currency

Dollar in danger
David Hale, FT, September 5 2000
The writer is chief global economist at Zurich Financial Services Group

The US dollar has been so resilient for so long that most commentators cannot conceive of circumstances in which it would experience a sharp correction. Foreign demand for US assets remains so strong that there is little reason for investors to lose faith in the short term. But once the US presidential election is over confidence could be tested by a variety of policy surprises.

The second great risk posed by the presidential election is that it could set the stage for a clash between monetary and fiscal policy next year. The US currently enjoys such a large federal budget surplus that it will be impossible to prevent fiscal policy becoming more expansionary. The total surplus is projected to be $4,500bn over the next 10 years, or $2,500bn excluding Social Security.

In addition to the risk of inflationary overheating, Mr Greenspan is also concerned at the size of the US current account deficit and the danger that fiscal stimulus could increase it further. During the late 1990s, the US private savings rate fell sharply as the government built up large surpluses. If the government now reduces its surplus without any offsetting change in private savings, the current account deficit would easily expand to 6-7 per cent of GDP.

In the 1980s, fiscal stimulus initially helped to bolster the value of the dollar by increasing real interest rates. But it is unclear if tax cuts and higher spending would be as positive in 2001-2002 because of the changes which have occurred in the US’s external financial position since the early Reagan years.

The US will soon have a deficit on its international investment account of 20 per cent of GDP, compared with a previous peak of 24 per cent in 1894. The expansion of the current account deficit to 6-7 per cent of GDP when there is already a deficit on investment income could at some point frighten the foreign exchange market and set the stage for a dollar correction.

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Gunnar Örn: USA kraschlandar inom ett år

DI 1999-11-15

Varför ska världens rikaste land behöva låna pengar av omvärlden? För att hålla köptrycket uppe på New York-börsen?

Eller för att stötta dollarkursen? Även om det inte varit den ursprungliga avsikten har effekten blivit just den, och alla bävar för vad som ska hända när valutaströmmarna vänder.

USAs utlandsupplåning, alltså underskottet i den amerikanska bytesbalansen, är snart uppe i 4 procent av BNP. Så stort har det inte varit sedan 1987, strax före den beryktade börskraschen i oktober samma år.

Världens finansmarknader väntar nervöst. Om underskottet ska sluta växa måste USA antingen börja exportera mer eller importera mindre. Men det är svårt att se hur den omställningen ska ske utan att både börsen och dollarn rasar på kuppen.

Minskad importefterfrågan kräver att de amerikanska hushållen börjar öka sitt sparande och drar ned på sin konsumtion. Det skulle emellertid dämpa den ekonomiska tillväxten i USA.

Ökad export kräver att de amerikanska företagen blir mer konkurrenskraftiga. Om amerikanska produkter ska göras billigare i omvärlden - och utländska varor dyrare på den amerikanska hemmamarknaden - förutsätter det en svagare dollar än i dag.

Nu finns det en del experter som invänder att USAs underskott inte behöver vara något problem, så länge det lånade utländska kapitalet används till produktiva investeringar. Här har de en klar poäng. Det slitna uttrycket "leva över sina tillgångar" behöver inte vara tilllämpligt här.

Ekonomiprofessorn Gustav Cassel definierade det så här i början av seklet: "Ett land lever inte över sina tillgångar så länge underskottet i bytesbalansen är mindre än de samlade nettoinvesteringarna i landet."

Tesen upprepades i mitten av 1970-talet när Sverige åter fick stora underskott i bytesbalansen. Bland annat av SNS Konjunkturråd, som då bestod av Villy Bergström, Sven Grassman, Erik Lundberg och Göran Ohlin: "Så länge vi inte kommit i närheten av gränsen för vår kreditvärdighet ökar kapitalimporten våra möjligheter att sänka inflationstakten och öka den inhemska produktionen och sysselsättningen", hette det i 1977 års rapport.

Men allt beror på hur pengarna används. Sverige lyckades inte hoppa över 1970-talets kriser med hjälp av lånade pengar. Tvärtom, nyinvesteringarna krympte i takt med att bytesbalansunderskotten ökade. Utvecklingen tvingade fram två kraftiga devalveringar under 1981 och 1982.

Tio år senare rasade investeringarna så kraftigt att de inte ens räckte till att ersätta utslitet kapital, samtidigt som bytesbalansunderskottet rakade i höjden. Även detta tvingade fram en kraftig försvagning av den svenska kronan.

I slutändan beror allt på vilka investeringar som görs. Grovt uttryckt kan man säga att Sverige för 100 år sedan lånade till järnvägsbyggen och vattenkraft. 100 år senare gick pengarna till lyxsanering av betongförorter à la Brandbergen.

För att modifiera Cassels tes, kan man säga att ett land lever över sina tillgångar när det lånar till konsumtion eller improduktiva investeringar.

Dessutom, om alla länder finansierade sina nyinvesteringar med lån, skulle det till slut inte finnas några sparare kvar att låna av.

Under vissa omständigheter är det förmånligt för ett land att låna (importera kapital), ibland att spara (exportera kapital). Tumregeln är att mogna industriländer tjänar på att exportera kapital till snabbväxande "emerging markets", eller tillväxtmarknader.

Dagens amerikanska underskott är ungefär lika stort, mätt som andel av BNP, som det svenska var 1982 respektive 1992.

Skillnaden är att de amerikanska nyinvesteringarna är betydligt högre.

Men utvecklingen i USA de senaste åren påminner ändå en hel del om 1987: med krympande inhemskt sparande, stark dollar, växande underskott i utlandsaffärerna, stigande räntor men ändå rekordhöga P/e-tal på börsen.

Betyder det att historien måste upprepa sig? För att få svar på den frågan räcker det inte att bara titta på makrostatistik över nettoinvesteringar och valutaströmmar. Man måste gå på djupet och titta på hur investeringskapitalet används på mikronivå. Kan amerikanska bjässar som Intel, Microsoft och Cisco använda sina fordringsägares pengar mer effektivt år 2000 än de kunde 1987? Gör amerikanarna överlag intressantare och mer produktiva investeringar än européer och japaner? Har

USA, som världsledande nation inom IT och Internet, rentav blivit en "emerging market" som drar till sig investeringskapital från hela världen?

Om så är fallet kan amerikanerna fortsätta låna av omvärlden med gott samvete. Om inte, är den nuvarande utvecklingen helt ohållbar. Då har vi en kombinerad börskrasch och dollarkollaps att vänta inom en inte alltför avlägsen framtid.

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A miraculous error
Martin Wolf, FT, September 29 1999
The Federal Reserve inadvertently allowed unsustainable growth in the US, but this helped to offset the collapse of demand elsewhere and avoid deep world recession

Yen lessons from a hotel suite
FT, September 18, 1999
Picture the scene. A darkened room, minders huddled by the trouser-press, two men talking in hushed tones - perhaps over a drink from the minibar. It is neutral ground. But it is not a rendezvous between Moscow mobsters. The location is Tokyo.

A time for wizardry
John Plender, FT, August 21 1999

The great American public still has the spending bit between its teeth. That much is clear from the surge in imports that made such a signal contribution to this week's awful US trade figures.

Dollars And Downers
Robert J. Samuelson
Washington Post, August 12, 1999
The latest threat to America's economic boom is a weaker dollar.

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On June 17, 1998, the Bank of Japan and the Federal Reserve entered the foreign exchange markets selling billions of dollars to avoid a weaker yen.
Almost exactly a year later, on June 14, 1999, the Bank of Japan entered the foreign exchange markets buying billions of dollars to avoid a stronger yen. This reversal of an action deemed essential just twelve months earlier marked the end of a year that saw the transition from deflationary currency defenses to efforts at global reflation.
By John H. Makin

IMF Concludes Article IV Consultation with the United States On July 30, 1999
Although the performance of the U.S. economy had been remarkable, Directors noted the contribution of possibly transitory factors and cautioned that there were significant risks. Principal among these is the danger of a substantial and abrupt decline in U.S. equity prices.

Directors noted that the strength of demand, including corporate investment as well as household consumption, had been underpinned by the high level of stock prices-a level that was difficult to explain-and they were concerned that a sharp market decline could have significant effects on both domestic and foreign economies.

Some Directors were particularly concerned that a decline in equity prices could lead to an abrupt adjustment in the household savings rate, which was now at a historic low. Others were less concerned because they considered that national savings, which had been increasing, was the more relevant concept.

Directors also noted that the sharp widening of the external current account deficit and the appreciation of the dollar had been important-but could not be permanent-factors in allowing rapid domestic demand growth without rekindling inflation.

Further, Directors suggested that some other factors that had contributed to favorable wage and inflation performance in recent years, such as lower commodity prices, may also have transitory effects. Any abrupt reversal of these conditions could cause problems for macroeconomic management.

Directors considered that more than the usual uncertainty surrounded current estimates of potential output and the natural rate of unemployment, reducing the usefulness of these indicators as guides for macroeconomic policy. They recognized that strong investment and continued productivity gains had probably raised potential output more rapidly than in preceding periods, but agreed that it was difficult to gauge the respective contributions of underlying productivity performance and transitory factors.

Regardless of these uncertainties, however, Directors cautioned that the economy still faced resource constraints, and the recent very strong growth in domestic demand could not be sustained for much longer without having inflationary consequences.

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FT-leader 99-07-17
But the exceptional performance of the US economy masks economic imbalances elsewhere. The private-sector deficit (the gap between savings and investment) reached 4.2 per cent of gross domestic product last year, as booming stock markets have encouraged households to save less.

This deficit has been financed in part by the budget surplus and in part by capital inflows.

These inflows have resulted in a current account deficit (the inverse of a capital account surplus), and a strong dollar. With the US economy set to slow, and the rest of the world recovering, sooner or later either capital flows will become less forthcoming or the private sector will readjust its savings.

The closest parallel is probably the period between 1982 and 1985, the main difference being that the deficit was in the public rather than the private sector.

Then as now, huge capital inflows financed the deficit and kept the dollar strong.

But after 1985, the dollar slid into a decline which lasted 10 years.

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Fear of a dollar crisis as banks secretly step in
Sunday Times 98-10-18, David Smith, Economics Editor

EUROPEAN central banks have been secretly intervening in the currency markets to prop up the dollar and prevent a fall in the greenback's value from disrupting the start of the single currency. But there are worries that Alan Greenspan's cheap-money policy and fears that an American credit crunch will lead to recession will send the dollar tumbling, causing havoc in Europe.

Last week Greenspan cut the Fed Funds rate from 5.25% to 5%. Analysts believe there will be two more quarter-point cuts before the end of the year, and more reductions, to 4% or below, early next year. The dollar has dropped sharply against the yen after the cut in American rates on September 29 and America's hedge-fund crisis. But the fall against European currencies would have been sharper, analysts say, if not for central-bank intervention.