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Source:
http://straitstimes.asia1.com.sg/sub...66853,00.html?
Jan 24, 2006
Whither the US dollar?
Analysts differ over whether the greenback's fortunes hinge on the US current account deficit, which will be a major topic at the World Economic Forum which begins tomorrow
By Simon Kennedy and John Fraher
'THE ol' dollar, it's gonna go down,' said Mr Bill Gates at last year's World Economic Forum in Davos, Switzerland. He, Mr George Soros and Mr Warren Buffett bet against the United States currency last year.
They lost.
Economists at Deutsche Bank say that is because forecasts for a lower dollar ignore China's emergence as an economic powerhouse. They and Harvard University economist Richard Cooper say the dollar's 2005 gain - 15 per cent against the yen and 14 per cent against the euro - vindicates a theory that a record US current account deficit will not necessarily push the currency down. The theory suggests that those predicting a dollar drop this year, including Merrill Lynch and UBS, may be at risk of further losses.
'The current account deficit is entirely sustainable and a natural consequence of globalisation,' says Mr Cooper, a former US undersecretary of state for economic affairs. 'In terms of fundamen- tals, there are no reasons why the dollar shouldn't be doing well.'
Globalisation's effect on the US$1.9 trillion-a-day (S$3.1 trillion-a-day) foreign exchange market will be a major topic this week as Microsoft chairman Gates, billionaire financier Soros, Mr Cooper and 2,500 executives, policymakers and investors attend this year's Davos conference.
The dollar's bounce last year from three years of decline counters the traditional theory that an economy cannot run a large current account deficit for too long.
Harvard's Mr Kenneth Rogoff, a former International Monetary Fund chief economist and another Davos delegate, said in a study last year that the dollar might need to fall 40 per cent to keep luring the US$2.1 billion of foreign cash the US needs every day to plug the gap, which last year reached a record 6.5 per cent of gross domestic product (GDP).
Betting on that, Berkshire Hathaway chairman Buffett, who says he has a 'very long-term' position against the dollar, started selling it in 2002. Mr Soros, echoing Mr Gates, called the dollar 'overvalued' in an interview last year at Davos.
But Mr Peter Garber, a global strategist at Deutsche Bank in New York whose research helped spark the debate, says otherwise. 'Soros and Gates were looking at textbooks which say deficits that huge can't last forever,' he says. 'But they've still got a long way to go because of the complex nature of the world economy.'
To Mr Garber and colleagues David Folkerts-Landau and Michael Dooley, the rise of China, which may have surpassed the United Kingdom as the world's fourth-biggest economy, helps explain why the billionaires got it wrong. They say there is a new economic system they call 'Bretton Woods II', recalling the global currency regime established after World War II that tied exchange rates to the dollar.
The modern version centres on China's strategy of delivering growth through exports, which it spurs by buying US government securities to keep its currency, the yuan, undervalued.
China's foreign exchange reserves rose US$209 billion to a record US$818.9 billion last year, triple their 2002 level. China accounted for purchases of a net US$2.2 billion of US Treasury securities last November, bringing its holdings to US$249.8 billion, according to latest reports from the People's Bank of China and the US Treasury Department.
Such purchases hold down US interest rates, stimulating consumer spending and the imports that widen the trade gap.
The relationship might last another decade, Mr Garber says, providing the dollar with a constant source of demand and reducing the economic threat posed by the US current account shortfall.
'Historical evidence suggests that when deficits stray above 4 per cent of GDP for long, then precipitous depreciations of the currency are the norm, but that is not happening to the dollar because excess savings in China are flowing into the US,' says Mr Folkerts-Landau, head of global markets research at Deutsche Bank.
But other analysts say the 'Bretton Woods II' argument is oversimplified and that the dollar faces a day of reckoning.
Former US Treasury economist Nouriel Roubini, who now runs his own investment consulting firm in New York and will be in Davos, says the relationship will break down as Asian nations embrace more flexible currencies. China last July ended its currency peg with the dollar, and Mr Roubini predicts it will soon allow the yuan to rise 10 per cent more, reducing its need for US government securities.
'It's going to unravel in 2006, and the current account will re-emerge as a bearish force on the dollar,' he says.
Mr Martin Feldstein, president of the National Bureau of Economic Research in Massachusetts, says the dollar rose last year because of higher US interest rates and a now-expired tax break that encouraged American companies to repatriate profits.
'None of these is a permanent solution for the current account, so when they unwind we'll see declines in the dollar,' he says. 'The magnitudes and growth of the imbalances are so great it's unsustainable.'
Some Davos-bound policymakers are concerned. 'Anybody looking at the size of the current account imbalance has to be troubled,' New York Fed president Timothy Geithner said last week. And European Central Bank president Jean-Claude Trichet calls the deficit a 'risk to global growth'.
For now, the majority of economists are sticking with their traditional textbooks. Since Jan 1, the dollar has declined 2 per cent against the euro and yen. Barclays Capital and Morgan Stanley, two of the biggest dollar bulls last year, say it is time to sell the currency as the Fed stops raising rates. UBS and Merrill Lynch are maintaining their predictions of last year for a dollar slide.
Not even all Deutsche Bank analysts agree the dollar can hold its own. Mr Bankim Chadha, the bank's head of macro currency research (New York), last month forecast a drop to US$1.27 per euro by the end of this year.
While Messrs Soros, Gates and Buffett declined to comment for this article, both Mr Soros and Mr Buffett issued dire outlooks for the US economy this month, suggesting they remain bearish towards its currency.
Mr Soros expects a US recession next year, and Mr Buffett says the trade deficit poses a 'big danger'. He predicts a 'big adjustment'.
'The question is whether some of the fears of last year will be realised this year,' says Nobel laureate Joseph Stiglitz, an economist at Columbia University and also Davos-bound. 'There is strong reason to worry.'
So far, the Fed has not raised red flags. Chairman Alan Greenspan, who leaves office at the end of this month, said on Nov 14 that the US is having little trouble attracting foreign capital.
Mr Ben Bernanke, slated to succeed Mr Greenspan, says a 'global savings glut' is flooding the US with international cash, offsetting the trade gap and capping interest rates. 'I don't expect this demand would drop precipitously,' he said on Nov 15.
HBOS, the most accurate forecaster in the nine months ended Sept 30, remains bullish. 'Dollars provided by the deficit are being soaked up by capital flows,' says Mr Steve Pearson, its chief currency strategist. 'It's important to consider both sides of the coin.' -- BLOOMBERG
NO WORRIES
'The current account deficit is entirely sustainable and a natural consequence of globalisation.'
-- MR RICHARD COOPER, a Harvard University economist
START WORRYING
'It's going to unravel in 2006, and the current account will re-emerge as a bearish force on the dollar.'
-- MR NOURIEL ROUBINI, a former US Treasury economist
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