Far-Reaching Impact of Dollar's Slide

Yahoo ^ | Tuesday November 16, | Rachel Beck

[demlosers]

ALL BUSINESS: Steep Fall of U.S. Dollar Could Put Financial Markets, Economy in Jeopardy

NEW YORK (AP) -- The recent bounce in the stock market and the weakening of oil prices may be grabbing attention from another story that could put U.S. financial markets and the economy in jeopardy: the steep fall of the dollar.

The dollar has been struggling for almost two years, but in recent weeks its slump has been exaggerated, dropping against most major currencies and tumbling to a record low against the euro.

Should it stay on such a course, the implication extends a lot further than just bumping up the costs of vacations in Europe. And while the weak dollar is already helping U.S. exporters and companies doing business abroad, it could mean higher borrowing and mortgage costs and make everything from imported cars to toys more expensive.

The dollar hit a new low against the euro last week when it cost about $1.30 to buy one euro, the common currency used by 12 European nations. The greenback has also lost 10 percent of its value against the currencies of the United States' major trading partners since mid-May.

There are many reasons for that decline. Most recently, pressures are coming from investors' nervousness that President Bush and his administration would do little to stem the dollar's slide. U.S. Treasury Secretary John Snow on Monday said the United States would like the dollar to strengthen, but he repeated his position that international currency markets should be left to set its value.

Also weighing on the dollar are the huge U.S. trade and budget deficits.

The recent sell-off comes despite some favorable news that at other times should have helped strengthen the dollar. For one, new data on the job market shows improving employment growth, which supports the view that the economy is gaining traction.

In addition, the Federal Reserve raised interest rates last Wednesday for the fourth time in five months. The federal funds rate, the interest that banks charge each other, now sits at 2 percent, double the 46-year low of 1 percent that it was at in June.

With this weakness in the dollar, there is concern over how foreign investors will react -- particularly Asian central banks, which in recent years purchased dollars to hold down the value of their currencies and then used those dollars to buy U.S. Treasurys.

There are indications that foreigners are starting to pull back their investments, which is worrisome given that they own about 48 percent of Treasurys and 24 percent of U.S. corporate debt, according to The Bond Market Association.

In August, the most recent data available, net foreign purchases of government bonds fell 34 percent to an 10-month low of $14.7 billion. Meanwhile, foreigners sold $2 billion in stocks, down sharply from the $9.8 billion gain the month before, according to the Treasury Department.

"Their portfolios are saturated with U.S. dollars, and they need to consider what is the risk to buying additional dollars," said Bernard Baumohl, who heads The Economic Outlook Group in Princeton, N.J., and is the author of a new book "The Secrets of Economic Indicators: Hidden Clues to Future Economic Trends and Investment Opportunities."

The problem with all this is that we need that foreign money to cover shortfalls in the U.S. trade and budget deficits. And it is hard to drum up that missing cash inflow from other sources.

Consider that foreign private investors would have to increase their accumulation of U.S. stocks and bonds by six times this year from what they spent last year should the foreign central banks curb their dollar-buying, according to a recent report issued by the Federal Reserve Bank of New York.

Thus, a continual dollar decline could set off a vicious cycle of events.

It could prompt the Fed to hike interest rates to attract foreign capital, which would likely lead to a drop in bond prices. That would trickle over into higher mortgage and borrowing costs, which then could pinch corporate earnings as well as consumer spending. A weak dollar could also lead to higher inflation, which historically has been bad for stock prices.

Former U.S. Treasury Secretary Robert Rubin suggested in a speech last week that unless politicians in Washington get serious about reducing the federal deficit, an acceleration of the dollar's decline could be far reaching.

"If markets begin to fear long-term fiscal disarray and if foreign providers of the capital inflows upon which we have now become so enormously dependent share this fear and also develop a concern about our currency, then the markets may begin to demand sharply higher interest rates on long-term debt and possibly even create conditions of serious disruptions in our financial markets, with all the problems that that can lead to for our economy," he said.

Even with all those negative factors potentially at work, there is no chance that foreigners would dump their dollar-backed holdings entirely. That would drive up the value of their currencies and cause big portfolio losses.

And there are plenty of economists who believe the sinking dollar is good news. One is Stephen Roach of Morgan Stanley, who thinks that the declining dollar will provide "long overdue restraint to interest-rate sensitive and asset-driven spending of American consumers and businesses."

That, in turn, will rebuild national savings, which will thereby reduce the large current account and trade deficits.

It sounds good. That is, if it works.

Rachel Beck is the national business columnist for The Associated Press. Write to her at rbeck(at)ap.org

[Nick Danger]

actually, i think the foreign money has nowhere else to go.

You got it, bro. Just listen to these journalism majors tell us that we gotta worry about that Euro taking over the role of the world's reserve currency.

The Euro is 15 economic basket cases headed over a demographic cliff as their populations age, because they aren't even reproducing themselves. Meanwhile, the geography is filling up with Muslims. The Euro a long-term store of value? It is to laugh. As a currency, the Euro is nothing but hype.

The Yen would make more sense, but the job is too big for Japan's britches. Besides, they got that nut in Korea to worry about, who might lob a few nukes at 'em just to cause trouble. Nobody's going to bet on a country that could be turned into glass in five minutes by North Korea.

Who's left? The communists in China? The Ruble? Oh, my sides!

These guys will all buy some Euros just to wave their swords at us, but they won't buy very many before they start wondering how many is too many. You don't want to be holding Euro-denominated bonds when the Muslims take over; paying interest is forbidden by the Koran.

When all is said and done, you are absolutely right: these guys have nowhere else to go. If you want to be holding a currency where the country is still going to be here in 30 years, you buy ours.

[sibbel]

There you're right...
A stake's something else!
Otherwise every lame waiter would be a
"stakeholder"...

[sibbel]

Haha,
"Y quièn va comprar dolares, sí espanol es la lengua principal?"

[cherry]

well, what do we do now for our personal finances?...anything?

[Nick Danger]

In California, maybe. Not in the whole country. Might happen in a hundred years, though.

[aquila48]

A weak dollar leads to a tightening of the money supply because a higher interest rate must be paid to those who would buy treasuries. Why would anyone loan you money at a rate less than a treasury?? Answer: They won't. So less money will be sought after for loans because the cost of borrowing goes up.

OK, lets follow this logic a bit more... China and Japan have a huge amount of dollars because of our trade imbalance with them. What are they going to do with them? They are caught in as big a bind as we are. For sure they're not going buy Euros - they'll immediately lose 40% from a couple of years ago. What would you do in their shoes?

Would you just sit on them?

Would you keep buying treasuries and at leat get some minimal interest?

Would you buy stocks and bonds in american companies?

Would you start buying hard assets in the US, such as real estate?

[TChris]

...we are slowly and slowly progressing towards being a third world nation

Or, or NOT! The greatest pinch will be felt by those who depend heavily on debt for their lifestyle. Get out of debt, don't buy so much imported stuff and everything will be more or less OK.

[Centurion2000]

Would you start buying hard assets in the US, such as real estate?

That one.

[Ramcat]

Since the election there has been a daily barrage to talk down our economy.

[Pylot]

Its a good question with no simple answer.

The key to the answer is to figure out which currency will emerge in the next few years as more stable than the dollar. There will be a lot of global grief as that transition occurs. I don't see a clear or obvious answer.

Japan has a long ways to go to get out of its worker/retiree imbalance. The Chinese are too corrupt to be depended on. I had heard the idea floated a while back that the Asian countries might attempt a Euro. Who knows?

[Pylot]

I am wondering if China does not take the opportunity to clean up its act a bit. If it did, it would become formidable virtually overnight. The economy is going gangbusters over there and the masses are getting a taste of it. Enough to cause unrest in the country side.

I think China's real postion today is not that good simply because of the percentage of non performing loans their banks hold. But if their economy were allowed to grow without being stolen off by the power elites then that percentage of non performing loans could get very small in a few years (as compared to the total economy). They could grow themselves right out of their trouble just like the US has done for the past 25 years or so.

Japan is holding the lions share of the US treasuries. China only holds $180 billion in US treasuries. Japan will go to great lenghts not to get screwed (again) by making the Yen more valuable than the dollar. They have routinely gone into the market and purchased dollars in order to preserve their own hide.

Hard to say what a viable strategy is because as the inflation hits the US those same dollars held today will buy less and less here.

[arthurus]

A weak dollar IS inflation. This article covers all the aspects of inflatiion without mentioning the cause,i.e. the creation of money/liquidity in greater amounts than the market needs it to maintain an even price level. Inflation, weakening the unit of currency is done to stiff a nation's creditors. They get repaid in cheaper dollars, thus they do not get back the value that they are due.That is why the dollar level of this deficit is trivial. We are inflating the debt away, making the fools who lent Americans money eat it. Of, course it will come back to bite as the cost of borrowing money will go up more than the actual rate of inflation as lenders take the heightened risk inot account.

[arthurus]

A weakening dollar, i.e. inflation does NO good. Foreign prices rise in America and so do American prices in America but with a lag.Inflation trashes predictibility which discourages ivestment which causes the economy to slow which causes a loss of jobs and declining incomes.

[nanak]

DEBT = Opiat
Once somebody gets hooked on it, it's worse than crystal meth.

Look at our federal government. Can they get rid of it?

[demlosers]

Plus the Chinese Yuan is pegged to the US dollar, which makes the Yuan worth just as much as the dollar before and after the $ slide.

[demlosers]

DEBT = Opiat

Once somebody gets hooked on it, it's worse than crystal meth.

Look at our federal government. Can they get rid of it?

The last time was about 170 years ago. You'll probably have to wait another 170 years for them to kick the habit. LoL!

[aquila48]

A weak dollar IS inflation.

And where is this inflation?? We have lower inflation than the Euro block! Using the Euro, we have deflation!! (the europeans can come here and buy goods a lot cheaper (in euros) than they did anytime in the past 3 years plus.

The reason we haven't seen it is that our biggest exporter, China, pegs its currency against the dollar, and the others (including the Euro) are not raising the price of their products in dollars, thus squeezing their profits. By all measures a base Mercedes and BMW should both start at $50K plus, but you can get them today for the essentially the same as when the euro-dollar were at parity.

Obiously this unstable situation can't continue just getting worse. There'll be a point of reckoning, where the chinese will be forced to revalue at a huge cost to them and higher prices for us. The european companies are handling their shrinking profit by moving more and more factories here.

My real interest in not wringing my hands, but rather how can we personally profit from this scenario? What investment strategy can we employ today to come out of it ahead of the game.

Any ideas would be appreciated and would make a great discussion.