Here's an extract of an article by John Mauldin
http://www.johnmauldin.com/
who explains much better than I can, the dangers facing the US Dollar and economy.
It's a bit long, but I think worth the read....
The Dollar - Oversold or Overwrought?
Is there anyone left who is bullish on the dollar? Even Greenspan and other Fed governors openly suggest the dollar and the trade deficit are too high. If the United States is borrowing to finance its trade deficit, then somebody must be lending, which means someone is saving. Everyone knows that the United States trade deficit, at 6% of GDP, takes around 83% of total world savings to finance (International Monetary Fund). The US government deficit soaks up a huge amount of our own national savings.
The reality is that the trade deficit cannot go much higher because the world is running out of the ability to lend more money. Someone somewhere must start to save more or the deficit must begin to come down. The classic ways are for the dollar to drop or for a recession to appear. What politician or Fed governor in his right mind would deliberately induce a recession? The answer that is left is for the dollar to drop, and that is clearly the way the Fed and the Treasury are leaning.
That also means the US must ultimately finance its own deficit. Thus we will be forced to save more and spend less. Given the boomer retirement coming all too rapidly down the road, it is hard to imagine a longer term scenario which yields growth in consumer spending, increased savings and a stable dollar, all at the same time.
So, the open short position on the dollar continues to climb. If everyone is on the same side of a trade, who is on the other side? Is the dollar extremely oversold? Maybe. I can paint a scenario either way.
Fundamentally, the dollar has not dropped all that much on a trade weighted real basis, and given the trade deficit, government debt and other factors, it still has a way to go, in my opinion. Further, the current short position of traders is a small percentage of the huge ($1 trillion a day) currency markets. There is still plenty of room for more short-selling.
On the other hand, the traders who move the market from day to day are all on one side of the trade. It is quite crowded. It feels a lot like this time last year when again everyone was short. The dollar stopped its slide and actually began to rise with a significant correction. Now we can see that correction was a buying opportunity. At the time, many said the dollar had reached its bottom. That scenario could, and likely will, play out again. Very few markets have ever gone down (or up) without significant corrections along the way.
The Sleeper Dollar Issue
Did you feel the ground shake? The epicenter of the economic quake happened in Laos last Tuesday. Southeast Asian nations and China signed an accord to create the world's biggest free trade area by removing tariffs for two billion people by the end of the decade. In macro-economic terms, that is tomorrow. Leaders in the 10-member Association of Southeast Asian Nations (ASEAN) also signed a pact to create an ASEAN Community along the lines of a unified Europe by 2020. It aims to create a common market with common security goals. ASEAN members are actively talking of creating their own "reserve currency" to compete with the dollar and the euro.
On an even larger note, Japan, South Korea, Australia and New Zealand have all agreed to start free-trade talks with the ASEAN countries. (Just for the record, the Association of Southeast Asian Nations consists of Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand and Vietnam.)
Now, let's couple that with another fact or two. The Wall Street Journal reports: "Total flows of Foreign Direct investment (FDI) have collapsed since 2000 - from a peak of $314 billion in 2000 to [a mere! - JM] $29.8 billion in 2003. That's down 90%. No doubt some of that decline is a cyclical response to the giant surge in the late 1990's. But some of that falloff might be structural. In 2003, for the first time, China attracted more FDI than the US ($53 billion). This comes as the US share of world FDI inflows fell to only 5.3% in 2003, from 22.6% in 2000."
Where is the US International Trade Commission? We are still putzing around with a Caribbean free trade agreement, which we cannot get done because of sugar subsidies to the Florida Fanful family, let alone a Central American agreement or a southern hemisphere agreement.
Right now, the world and especially Asia needs the US consumer. But we cannot always count on that. Asia is working hard on creating its own internal consumer demand. A free trade territory the size of the one developing is huge, and we should be driving the talks, not watching them.
The Balance of Financial Terror
Right now, the world and largely Asia, finances our deficits. It is a kind of vendor financing, where a company arranges the financing of its products so it can stay in business and grow. But there are limits.
"However, such a large deficit leaves the US effectively relying on what Larry Summers so aptly refers to as the 'balance of financial terror.' In fact, Summers' recent speeches are amongst the best arguments I have seen over the current account for ages. As Summers notes:
"'Inevitably, dependence on foreign governments for short-term financing has to raise questions and create vulnerabilities in both the economic and political realms. The question can fairly be asked: How long should the world's greatest debtor remain the world's largest borrower? I have previously used the term "balance of financial terror" to refer to a situation where we rely on the costs to others of not financing our current account deficit as assurance that financing will continue.'" (Global Equity Strategy, DKWR)
Free trade, whether in Europe or Asia is good for the world at large, and should be applauded and encouraged at every instance. But if the United States is to remain a major world power through this century, we must participate in that trade or be left behind.
Falling foreign direct investment, huge trade deficits, a world working actively to no longer be forced to rely on the American consumer for growth - these are all bearish on the dollar over the very long term. These are all events and facts which can change. Certainly the trade deficit is reaching its limit, but the longer we delay in creating balance, the worse the correction is likely to be.
One final thought. In 1971, the yen was at roughly 350. (Today it is at 102). In the 80's, Lee Iaccoco, the CEO of Chrysler, stated something to the effect that "Give me a 150 yen [to the dollar] and we can beat the Japanese." It fell soon after to 120. Japan and Toyota are still taking market share from Ford, GM and Chrsyler.
Those who take comfort that a falling dollar will make our companies more competitive, who yearn for a floating Chinese Renminbi, should be careful for what they wish...They just might get it.
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