Why the Dollar is Falling

[FaGal]

Why the Dollar is Falling
www.mises.org - By Antony P. Mueller - March 8, 2005



When confronted with complaints about the falling value of the dollar, the U.S. official is said to have responded to his European visitors: "The dollar is our currency, but it's your problem." That was in 1971. The politician to whom this statement is attributed was John Connally, who at that time served as the secretary of the U.S. Treasury. His boss was Richard Nixon, the same President who used a word for the Italian lira which politeness prohibits repeating. Nevertheless, Connally and Nixon made clear how matters were.

In the meantime, the Italian lira no longer exists. It has merged into the euro, when the single European currency was established in 1999. The endeavors to create a common currency had begun in the early 1970s, when the Europeans began to construct their own currency systems based on stable exchange rates and off the dollar standard.

The Bretton Woods System (named after the resort where the conference took place in New Hampshire in 1944) bestowed a singular privilege to the U.S. when the dollar became the point of reference for the new currency system. With the other member countries fixing their currencies to the U.S. dollar, and the U.S. dollar officially fixed to gold at 35 dollars per troy fine ounce, it seemed as if an ideal combination had been found to avoid international monetary disruptions.

The gold anchor was meant to curb an excessive production of U.S. dollars. When foreign countries had a trade surplus, they theoretically could have used the excess dollars and asked the U.S. to exchange them for gold. With a fixed parity between dollar and gold, this would have restricted dollar creation. However, France was one of the only countries that took the agreement literally and demanded that the U.S. exchange the earned dollars for gold instead of accumulating them as international reserves like other countries did which had persistent current account surpluses such as Japan and Germany.

The system as it evolved in the 1960s provided a free ride for the United States, and it did not take long for the U.S. to abuse this privilege. Pursuing the goal of expanding the welfare state along with ever more active foreign military involvements, the U.S. could no longer fulfill the agreement of making foreign currencies exchangeable into gold. The gold shortage of the late 1940s and of the 1950s had turned into a dollar glut. World inflation began its rise.

Under the transformed system, the need for adaptation was unilaterally transferred to foreign currencies. The system, which had once foreseen the change of currency parities as the exemption rather than the rule, entered into a phase of high instability when fixing and re-fixing of foreign currencies to the dollar became increasingly necessary.

In 1971, with the so-called "Smithsonian agreement," a final attempt was made to save the old system when the U.S. devalued its currency against gold and a series of other currencies, but soon it became clear that the Bretton Woods System was no longer viable. In 1973, with the adoption of the new rule that each country could choose its own currency arrangement, the Bretton Woods System had come to an end.

Since then, the international monetary system is more like a "non-system" than a "system," or, more precisely, the international monetary system consists of a multitude of different currency arrangements ranging from currency unions and currency blocs to freely floating exchange rates with many other schemes in between such as unilateral fixed parities, managed floating or currency boards, and currency baskets.

As early as 1970, the members of the European Economic Community, which later transformed into an expanded European Union decided to prepare for the establishment of a common currency. In 1999, the euro as a common currency was instituted, first for banking transactions and then, on January 1, 2002, as the sole legal tender in the member countries of the euro area. Currently, twelve European countries take part in the European Monetary Union.

In terms of absolute valuation, the euro is not very much of a better currency than the U.S. dollar. In economic decision-making, however, things happen on the margin and decisions are taken based on relative valuations. Given similar degrees of liquidity and financial market sophistication, the euro has become increasingly attractive for currency diversification, particularly due to the favorable foreign investment position of the euro area compared to that of the United States.

After some initial weakness—probably due to fears that the new arrangement might fail—the euro has gained markedly in value against the U.S. dollar over the past three years. The American currency is facing a rival. An increasing number of central banks announced plans to shift part of their international reserves into the European currency. The dollar is still the currency of the U.S., but a sinking dollar is no longer just a problem for foreigners, it is also a problem for the United States.

In the past, the United States could count on having the monopoly of issuing the currency with the highest degree of liquidity and financial market integration. Although there were stronger currencies than the U.S. dollar, such as the Swiss currency or the Japanese yen and the German mark, these currencies could not rival the U.S. dollar because of their limited market share.

The existence of the euro has changed this constellation. As to its market size, the euro area is up to the U.S. dollar with the tendency of further augmenting this position when new members of the European Union will adopt the single currency, some non-EU countries will peg their exchange rates to that of the European monetary union or when oil producers will change to euros when pricing their exports.

For a while in the 1990s, it appeared as if the U.S. dollar could regain its unique position. The 1990s saw Japan—the apparent commercial threat to the U.S. in the 1980s—sink into a prolonged stagnation. Germany, the other major player in the international trade arena, began to entangle itself in the morass of a costly and economically ill-conceived unification process.

After the fall of the Soviet Union and the dissolution of the Soviet Empire, the United States had emerged as the sole global military might, and, so it seemed, also as the undisputed economic and political power with global influence and far-reaching dominance. On this basis, the role of the dollar as the major reserve currency and the main currency for international transactions experienced a second spring.

In the 1990s, the new global constellation could be interpreted as the replay of the endings of World War I and World War II with the United States emerging for a third time on top of the world. In the 1990s, the triad of global dominance seemed well in place of the United States: an unrivalled military might, a booming and innovative economy and the only issuer of a global currency.

Since the turn to the 21stcentury, however, these factors of dominance have increasingly come under challenge. The mania of the New Economy has ended. The U.S. economy still registers high growth rates due to unrelenting consumption spending, but regarding its productive capacity, it is in a precarious state, as it is indicated by the persistence of high trade deficits. The military power of the United States in its present form is largely inefficient with respect to the relation between financial costs and political outcome. Finally, and probably most important, the dollar no longer holds the monopoly of being the only available international reserve currency.

While after 1919 and after 1945, the United States emerged as the largest international creditor, the U.S. became the world's largest debtor nation in the course of the 1990s. Also in contrast to the earlier world wars, the economies of Russia, Western Europe, and South East Asia were not devastated when the Cold War ended. As to their productive capacity and financial resources, these regions are on an even footing with the United States or even are superior—at least concerning their foreign investment position.

The performance of the U.S. economy in the past century owes much to the role of the U.S. dollar in the international monetary system, and a large part of attaining this role was the result of the political and military supremacy that the United States had gained since 1919. In the 20th century, the position of the U.S. dollar in the world represented a major underpinning of the prosperity at home, which in turn fed back positively on the dollar's foreign role.

As long as fiat money rules, currencies, particularly the standing of the dollar and the euro, also reflect their value as a "political currency." They represent the degree of global political and financial power and in turn they provide the basis for attaining supremacy. They are tools in the hands of governments in the struggle for dominance.

With the dollar privilege passing, the U.S. confronts a radically different situation than in the past, and a tormenting process of changing the accustomed world-view is on the horizon. However, even as of now, the role of the euro as a rival to the U.S. dollar is rarely a subject of concern in the United States. It is the same with additional power shifts that are going on, all of them potentially reducing or even eliminating the dominant role of the U.S. currency in the world economy.

New alliances are emerging that neither politically nor militarily may be benign to the United States. Also, older powers have maintained their might. The Soviet Union has disappeared, but Russia remains a military power matching the nuclear overkill capacity of the United States. China is beyond any immediate control or persuasion by the United States.

The current U.S. President identified an "axis of evil", composed of countries with relatively modest economic, financial, and military clout—and situated far away from the shores of North America. But how about the other axis that is being formed, right at the U.S. border and stretching down the South American continent. The alliance between Fidel Castro of Cuba, Hugo Chavez of Venezuela, and Lula da Silva of Brazil? What about the constant rumors that Brazil strives to become a nuclear power? What about the deals that are being made between Latin American countries and China with the perspective of forming an economic symbiosis between China's need for food and oil, and this region's abundance of natural resources?

Then there is another axis that has come into existence in the past few years: the fraternization between the leaders of France, Germany and Russia. This entente covers the Euro-Asian continent, the geo-strategic heart of the world. It represents an alliance that is ready and capable of challenging U.S. influence in almost any aspect. What do these constellations imply for the role of the U.S. dollar?

Anytime soon one may expect that countries like Russia or Venezuela and other oil producers will turn to the euro as the currency for their oil exports. The move to the euro as a currency for international transactions and reserves during the past couple of years may represent only the initial stage of long-lasting process. Currency shifts of such proportions start slowly but over time they will gain more momentum. By now, the euro may have passed the threshold that had limited its global use. Once a means of payment is widely accepted, it becomes increasingly more attractive for a wider use.

There is a consensus currently among the major players in international finance, particularly among the relevant governments and central banks, that an abrupt fall of the dollar should be avoided. Japan, the largest foreign holder of U.S. assets, depends on U.S. protection in the face of the growing muscle of China in its region. China itself most likely would also like to avoid a dollar crash at least as long as it has not yet spent a considerable part of its dollar reserves in the effort to secure future supplies of food and oil around the world. The Europeans do not want a much weaker dollar because as of now it is mainly exports that are booming in the major economies of this region.

In contrast to the wishes, however, the fundamental geo-strategic trends call for a reduced global role of the dollar. While the temporary interests of the major global players are directed at maintaining dollar stability and thus avoiding a rapid demise of the dollar's role as a global currency, these desires are not congruent with the longer-term aspirations of the foreign players themselves.

The international monetary system has entered a stage when it becomes more difficult to manage a conflict that is getting out of control the longer it lasts. Inexorably, the constellation moves to a point where the potential loss will outweigh perceived benefits—not only for the holders of U.S. dollar reserves, but also for the United States itself.

Under such conditions, economic and financial decisions in the private sector are prone to be made under false premises. One must not forget that three of the most essential prices in the modern monetary economy are politically determined or manipulated prices: the oil price, interest rates, and the exchange rates. Taking away the interventions, the price that the U.S. pays for imported oil, and the price for money and credit should already be much higher than they currently are. At their present levels, they reflect a position of the U.S. dollar in the global system that can hardly be maintained.

Given the importance of these three prices for the economy and their potential direction, it is not difficult to assess the prospect for asset prices, particularly those of stocks, bonds, and real estate which all must come down when the fall of the dollar continues.

[FaGal]

Weak Dollar Getting Pummeled
www.reuters.com - March 10, 2005 - By Jamie McGeever


NEW YORK - The dollar weakened on Thursday against most currencies on concerns over global central bank reserve diversification, a widening U.S. trade deficit and tumbling bond prices.

"We're just in a general dollar downtrend right now," said Sophia Drossos, currency strategist at Morgan Stanley in New York.

Having slumped to multi-month lows against its major counterparts on Wednesday, the dollar suffered another blow on Thursday after Japanese Prime Minister Junichiro Koizumi told parliament that, generally speaking, diversity in foreign exchange reserves was a good thing.

The Ministry of Finance, which manages the world's largest foreign reserve holding of $840.6 billion, quickly clarified that it has no plans to shift funds out of the dollars.

But the specter of diversification was raised again, putting pressure on the dollar again, much like had happened after South Korea's central bank mentioned the subject in a report last month.

"Although MoF quickly suggested that they had no plans to change now, the suspicion lingers that more Asian central bank diversifiers are to appear," wrote Goldman Sachs analysts in a research note on Thursday.

Early morning in New York, the euro was up at $1.3414 and sterling was a touch stronger at $1.9253 .

The dollar was down 0.4 percent at 1.1542 Swiss francs and largely flat at 103.98 yen .

The yen came under some selling pressure after weak Japanese core machinery orders. The euro rose to 140.00 yen earlier in the session for the first time this year.

Sterling managed to take the Bank of England's decision to kept interest rates unchanged at 4.75 percent largely in its stride.

"The 'diversification' word really spooked the market ... but the bond market selloff is weighing on the dollar big time," said Samarjit Shankar, director of global strategy at Mellon Bank in Boston. "The bond market is really adding that extra piece of weight on the dollar right now."

The price of U.S. Treasuries have fallen steeply this week, pushing the yield on the 10-year note up to 4.57 percent, its highest level since July last year.

They're now down at around 4.487 percent on Thursday, but have convincingly broken up through key technical levels that were intact for several months.

TRADE DATA IN FOCUS

The rise in bond yields is sometimes seen as a supportive factor for a currency, as it offers investors a higher rate of return relative to other fixed income markets.

But not in this instance. Dross at Morgan Stanley suggests the market is worried about incipient inflation pressures, and although the Federal Reserve will certainly act to keep them from building, it might not act quick enough.

"It's not a scare, but it's a concern. Inflation is never good for a currency," she said.

The massive U.S. current account deficit hasn't been particularly good for the dollar either in recent years, and a reminder of this may come on Friday morning when the Commerce Department releases January's data.

The figures are expected to show a deficit of $56.5 billion, slightly wider than the previous month and what would be the second widest on record.

Data released on Thursday from two of the U.S.'s biggest trading partners suggest its deficit won't be narrowing significantly any time soon.

Germany, the euro zone's largest economy, appears to be coping with a strong currency, as it posted a trade surplus of 12.9 billion euros in January on record exports.

And China posted a surplus of $11 billion in the first two months of the year.

Meanwhile, U.S. weekly jobless claims, which rose an unexpectedly high 17,00 last week, kept the dollar under pressure too, analysts said. Economists had expected no change on the week.

[FaGal]

Dollar catching Asian flu
www.atimes.com - By Alan Boyd - March 11, 2005



SYDNEY - They may be telling a different story to money markets, but Asian central banks have been quietly switching their dollar holdings to regional currencies for at least three years, confirm global banking data. In a further, and so far the biggest, setback for the greenback's status as the undisputed reserve currency, Japan on Thursday said it might diversify its holdings, though monetary chiefs later sought to play down the prospect. South Korea rattled currency traders with a similar announcement late last month, followed by a similar backtrack.

China, India, Thailand, Indonesia, Taiwan, the Philippines and Hong Kong have already started a sell-off, despite a diplomatic show of solidarity for the greenback that is prudently designed to prevent a crisis of confidence in exchange systems. The likelihood is that much of this outflow will never return to US dollars as economic interdependence within East Asia and the widening shadow cast by China's trading conglomerates are slowly transforming the traditional market structure.

The Bank of International Settlements (BIS), which acts as a bank for the world's central banks, has just released a study showing that the ratio of dollar deposits held in Asian offshore reserves declined to 67% in September, down from 81% in the third quarter of 2001. India was the biggest seller, reducing its dollar assets from 68% of total reserves to just 43%. China, which directly links the yuan to the dollar and is under US pressure to allow a freer movement of its currency, trimmed the dollar share from 83% to 68%.

This shift conforms with global trends as central banks seek a buffer from the burgeoning US trade and budget deficits. A separate survey by European-based Central Banking Publications found that 29 of 65 nations surveyed were cutting back on the dollar and 39 were buying more euros. America's annual budget deficit of US$500 billion is largely funded by Asian purchases of US government bonds, mostly from China and Japan. The US trade and current account deficits are in a similar plight: it took $530 billion of foreign capital to finance US imports in 2003 and $650 billion last year. Projections for 2005 range up to $800 billion.

Export-led Asian central banks have been accumulating dollars for two decades or more to keep their own currencies competitive. Japan alone has stockpiled $841 billion of reserves to stop the yen from over-valuing as it searches for an economic stimulus. If the central banks pull out, the US may find it hard to borrow the cash it needs to keep the wheels of government turning. The conventional wisdom is that Asia is in too deep to quit, as to do so would invite huge exchange losses.

But some monetary chiefs have already decided there are greater risks in staying in bond markets as rock-bottom US interest rates - still only moderately above the 45-year low reached last year - have dragged yields to unappealing levels. China became a net seller of US government bonds in 2002, shifting much of its reserves to euros, Australian and Canadian dollars. Taiwan left the securities market in the same year and Hong Kong sharply reduced its exposure.

Currency market trading has also had a shift of emphasis, with China's yuan emerging as a potential regional substitute, albeit in the distant future. While this reflects the changing structure of East Asian trade, it is also an indicator of the increasing maturity of Asian exchange activity. According to the BIS data, turnover of the yuan in Asia has surged by 530% since the third quarter of 2001, compared with more restrained growth of 48% by the dollar, 49% by the euro and 93% by the pound sterling.

Trading in India's rupee grew by 114% in the same period and the yen registered 35% growth. The big losers were the Hong Kong dollar (21%) and the Singapore dollar (32%), reflecting the declining economic fundamentals of the two trading hubs. It is a similar picture with foreign exchange derivatives. Trading in yuan derivatives has soared by a staggering 272,355% in the past three years; next best was the Thai baht, with a growth of 2,858%. Dollar trading in derivatives rose by a mere 94% in this time, with euro trading up by 95%, pound trading by 126% and the yen trading by 58%.

The yuan data were calculated from a very low base in previous years and the BIS cautioned that the Chinese currency still had a miniscule influence on trade, due to tight domestic curbs on portfolio funds: it comprises only about 1% of the overall ratio of forex turnover to gross trade flows.

Movements in the dollar/yen spot rate remain the prime influence on Asian currencies and more than 90% of all external trade is still conducted directly in dollars. Only about 12% of holdings are believed to be in euros. Nonetheless, the yuan is converging with the yen and the Korean won and already exerts a strong pull on spot rates for the Hong Kong and Taiwan currencies, possibly hinting at a significant unrecorded trade in the Chinese currency.

While Asian currencies were expected to align themselves with US currency after the 1997-98 regional financial crisis in a de facto dollar bloc, the BIS said there is little evidence that this has occurred, despite the dollar links adopted by China and Malaysia. Rather, it appears that Asian currencies have become more elastic and their central bankers increasingly determined to pursue an independent course as financial markets gain greater depth and begin to more accurately mirror the region's importance to world trade.

However, it remains to be seen how much leash they will be given before being reined in by the nervous US Federal Reserve. The Bank of Korea, which has $200 billion of reserves and $69 billion of US Treasury debt, tentatively announced last month that some might be switched to other currencies, then quickly backtracked when the won surged to a seven-year high in global currency markets. The bank said the proposal, first floated in a parliamentary debate, was not a statement of intent.

Japanese Prime Minister Junichiro Koizumi triggered a similar frenzy after suggesting on Thursday that his country "in general" might need to make an "overall judgment" on diversifying its foreign reserves. The dollar had fallen to a nine-week low against the euro by the time a Finance Ministry official came out with a "clarification". It was merely a topic for discussion, not policy intent, he said. "We are taking a very cautious stance on how to manage foreign reserves, because the impact would be big," Finance Minister Sadakazu Tanigaki told reporters.

Big, indeed, as Japan has the largest dollar reserves in the world. Almost all Asian currencies surged vis-a-vis the dollar following Koizumi's unexpected statement. The Indian rupee rose to 43.56 in late morning deals, sharply higher than Wednesday's close of 43.64. The dollar went down against the Indonesian rupiah by 17 points at 12 noon on Thursday from Wednesday's closing value of 9,375.00, while the South Korean won went up by 0.1% against the dollar, provoking the Ministry of Finance and Economy to say that it was contemplating to intervene in the foreign exchange market.

[FaGal]

Talk in Japan Shakes Dollar and Treasuries
By JONATHAN FUERBRINGER
New York times

The dollar fell and Treasury yields rose yesterday after the Japanese prime minister made remarks that suggested the country's central bank could be shifting some of its huge reserves out of dollars and Treasury securities.

Japan's Ministry of Finance quickly denied there was any change, a statement that limited the fall of the dollar and bolstered Treasury prices. But the volatile reactions in the markets underscore that the dollar, already under pressure from the drag of the United States' record current-account deficit, has another issue that could weigh on it in the future.

"There is a heightened sensitivity to anything that smacks of reserve reallocation," said Robert Sinche, global head of currency strategy at Bank of America.

Indeed, the comments from the prime minister, Junichiro Koizumi, came less than a month after reports, later denied, that the central bank of South Korea was planning to move some of its reserve holdings out of dollars and into other currencies. Even after the denial, those reports roiled the currency markets, and the dollar fell 1.5 percent against the euro and 1.4 percent against the yen on Feb. 22.

Yesterday, the dollar slipped as much as 0.4 percent against the euro and 0.1 percent against the yen. Late in trading, the euro was valued at $1.3424, with the dollar down 0.1 percent, and the dollar was up 0.2 percent against the yen, at 104.02 yen. The yield on the 10-year Treasury note, which jumped to 4.56 percent, finished the day at 4.50 percent, down from 4.52 percent on Wednesday.

The suggestion of diversification from dollars has put the focus on the role of Asian central banks in the performance of the dollar and Treasury securities.

China, Japan, Hong Kong, South Korea and Taiwan together hold 56 percent of the Treasury securities owned by foreigners. Many of those securities are held by their central banks. So any significant shift of their reserves out of dollars could spell trouble for both the American currency and the bond market.

Steven Englander, chief foreign exchange strategist for the Americas at Barclays Capital, said he did not expect such a shift "in a dramatic way" by these Asian central banks. But, he said, "everyone is thinking about it and that will weigh on the foreign exchange and bond markets."

Alan Greenspan, the chairman of the Federal Reserve, has said a shift out of dollars by foreign central banks and foreign private investors should be expected at some time, although he has not said it would necessarily be disruptive.

In a speech to the Council on Foreign Relations yesterday, Mr. Greenspan said that official and private foreign investors "will at some point choose greater balance in their asset accumulation."

Another emerging issue is what happens when China, which is being pressured by the United States and other countries to allow its currency to trade freely, moves away from pegging the yuan to the dollar.

To maintain the present peg, China has to sell yuan for dollars as the American currency weakens, building up huge dollar reserves, most of which are invested in Treasuries. Other Asian countries, including Japan and South Korea, have done the same so that their currencies stay competitive with the yuan.

Many analysts expect a small move toward delinking in the next 12 months that would allow for an increase of 3 percent to 5 percent in the value of the yuan. This could mean that China and other Asian countries would have less need to build up dollar reserves and, therefore, less need to invest in United States Treasury securities.

If this led to lower dollar reserves and a decline in central bank investments in the Treasury market, some analysts argue that the impact on the American market would depend on how attractive it would be at that time to invest in the United States.

If inflation was contained, economic growth was steady and the current-account and federal budget deficits were improving, attracting private money to replace a slowdown in investment by central banks would not be difficult. That would reduce any downward pressure on the dollar and upward pressure on Treasury yields.

Mr. Englander said that "a lot depends on how China delinks."

"The odds are it's going to be a mini-delink, rather than a maxi-delink," he said, which would minimize the impact on the dollar and the Treasury market.

Others argue that central banks would not want to do anything precipitous because that would be bad for global financial markets and could hurt the competitiveness of their own currencies.

"They don't want to disrupt the markets," said William Davison, head of the Hartford's fixed-income mutual funds.

Mr. Sinche at Bank of America said it was in China's interest to move slowly in ending the yuan's link to the dollar, and that would mean that any other central banks in Asia that want to shift reserves out of the dollar would have to move slowly.

Mr. Sinche also played down Mr. Koizumi's remarks as an indication of a new plan for reserves.

He said the comments, which were made before a parliamentary committee, were not an answer to a question on whether central bank reserves should be shifted, but regarded what should be done about the unrealized loss Japan's central bank has on its reserves. Since the loss is a result of a decline in the value of the dollar, an obvious political answer is to mention moving reserves out of dollars.

Mr. Koizumi told Japanese lawmakers that as a general rule "it's necessary to diversify the investment destinations," according to Bloomberg News. He added that he also believed it was important to consider "what's profitable and what's stable" when deciding where to hold foreign reserves.

Finance Ministry officials responded quickly to counter Mr. Koizumi's remarks, saying they had no plans to shift the reserves into other currencies. "At present, we have no plans to change the currency makeup" of Japan's foreign exchange reserves, Koichi Hosokawa, a vice minister of finance, told reporters.

Kamal Sharma, senior currency strategist at Dresdner Kleinwort Wasserstein in London, said, "I personally don't believe we'll ever get to a point where Asian central banks will not hold the dollar as the major international reserve currency."

Todd Zaun contributed reporting from Tokyo for this article.

[FaGal]

China, Greenspan rub salt in dollar wound
www.atimes.com - March 12, 2005



The US dollar was struggling near a two-month low against the euro on Friday as the market braced for fresh trade data that were likely to show a further widening of the trade gap. As if this weren't trouble enough for the besieged greenback, US Federal Reserve chairman Alan Greenspan stirred up the market Thursday night saying foreign investors would reduce their US asset holdings at some point, while new findings came to light that China is indeed doing so.

Saying he is not "overly" concerned about the record US trade gap or heavy consumer debt, Greenspan said the budget deficit gives him the shivers. The US current account deficit widened to a record US$164.7 billion from July through September, the most recent figures available, equivalent to 5.6% of gross domestic product (GDP). "Our current account deficit and household debt burdens do not strike me as overly worrisome, but that is certainly not the case for our fiscal deficit," Greenspan told the Council on Foreign Relations in New York. "Our fiscal prospects are, in my judgment, a significant obstacle to long-term stability, because the budget deficit is not readily subject to correction by market forces that stabilize other imbalances."

According to the high priest of finance, international investors have only modestly shifted their portfolios away from dollar assets so far. But he warned that they might at some point decide their portfolios are too dollar-centric, ominously adding that if the dollar keeps dropping, foreign exporters may start looking elsewhere.

Greenspan's comments came close on the heels of Japanese Prime Minister Junichiro Koizumi's startling remark on Thursday that Japan needs to diversify its foreign-exchange reserves, reviving fears of Asian central banks cutting their giant dollar reserves. Any move by Japan, which has the largest foreign-exchange reserve in the world ($840 billion), to reduce its dollar holdings could be disastrous for the greenback. The dollar has already been dropping against the yen for four straight weeks now. Koizumi's statement, though later qualified by his finance minister, will only prolong the agony.

US dollars accounted for 63.8% of the world's currency reserves at the end of 2003, down from 66.9% two years earlier, according to International Monetary Fund (IMF) figures released last April. A survey this January commissioned by the Royal Bank of Scotland Plc and conducted by London-based Central Banking Publications Ltd showed that central banks across the world were boosting euro holdings. Almost 70% of the 56 central banks surveyed said they had increased exposure to the euro.

Citing a more recent finding, Asia Times Online reported on Thursday (Dollar catching Asian flu) that Asian central banks have been quietly switching their dollar holdings to regional currencies for at least three years now. A study by the Bank of International Settlements (BIS), which acts as a bank for the world's central banks, shows that the ratio of dollar deposits held in Asian offshore reserves declined to 67% in September, down from 81% in the third quarter of 2001. India was the biggest seller, reducing its dollar assets from 68% of total reserves to just 43%. China, which directly links the yuan to the dollar and is under US pressure to allow a freer movement of its currency, trimmed the dollar share from 83% to 68% over the same period.

Bloomberg reported on Friday that according to an estimate by Lehman Brothers Holdings Inc, China's central bank has been cutting the share of its currency reserves held in dollars and replenishing them with euros. Some 76% of China's reserves were in dollars last year, down from 82% in 2003, said Lehman, the fifth-largest US securities firm.

There has been debate in China on whether it at all needs such a huge foreign-exchange reserve. China's forex chief, Guo Shuqing, a member of the National Committee of the China Political Consultative Conference (CPCC) and director general of the State Administration for Foreign Exchange Management (SAFEM), said that as an item of international payments, the growth of the foreign-exchange reserve is the result of the macroeconomic operation, but not the objective China is particularly pursuing. An adequate foreign-exchange reserve is favorable for payment abilities, comprehensive national power and creditworthiness, reducing risks of reform and safeguarding financial security, he said.

Guo pointed out, however, that excessive growth could be detrimental. In a rare and stern warning against the inflow of speculative funds, or "hot money", in the name of investment, he told local governments not to lure foreign investment "haphazardly". Regulators have been playing down the amount and impact of hot money over the past year, but Guo said China might see "no end of trouble in the future" unless local governments are acutely aware of risk mitigation in soaking in foreign funds.

"China pays great attention to speculative funds," Guo said in an interview with Xinhua on the sidelines of the annual session of the National Committee of the Chinese People's Political Consultative Conference, China's top advisory body. "Foreign-exchange administration departments and other macroeconomic departments are investigating the issue and will punish illegal activities severely."

China's foreign-exchange reserve added as much as $206.7 billion last year alone. Guo said the overall inflow of capital is "normal and legal" and reflects the "market scenario", but there are also some "worrisome" problems. "Fake foreign investment" is actually being used to purchase yuan-denominated assets and commercial housing on speculative purpose, he noted. Hot money has pushed housing prices to a very high level, making cities look "prosperous" but doing no good to the investment climate, as it leads to higher living and business costs. Typically, this means great risks for local financial institutions, enterprises and even individuals. When the real-estate bubble bursts, they will suffer from huge losses, Guo said. Hot money has also sneaked into China under capital accounts or based on no real trade, he claimed.

Guo said China's foreign-exchange reserve, second only to Japan's, is quite enough to pay the country's debts. But its debts in foreign currency may snowball to an amount that engenders "systematic risks". He revealed that newly added foreign-exchange reserves last year include $60.6 billion in foreign direct investment, $32 billion in trade surplus, $30 billion from foreign-exchange clearing under the account of imports and exports by enterprises, $35 billion in foreign debts, more than $10 billion in service trade surplus, $30 billion in individual asset transfer and earnings being brought about, and more than $10 billion in securities investment, among others.

Mountains of foreign-exchange reserves have long been an excuse used by some countries, especially the United States, to demand appreciation of the yuan, which now floats against the US dollar within a narrow band. But Premier Wen Jiabao reiterated in his government work report last week that China would keep the yuan "basically stable".

[FaGal]

March 12, 2005
Trade Gap Widens on Record Imports
By ELIZABETH BECKER

WASHINGTON, March 11 - America's appetite for foreign imports broke all records in January, reaching $159.1 billion and contributing to a monthly trade deficit that is the second highest on record. The $58.3 billion trade deficit defied predictions that a weakened dollar and lower oil prices would narrow the United States' trade gap.

Instead, the Commerce Department said on Friday that American consumers continued to buy foreign-made goods at an avid pace, raising the trade deficit 4.5 percent from $55.7 billion in December. January's trade figures included a 75 percent surge in Chinese textile and apparel shipments, reflecting the end to global quotas and the beginning of what some experts see as a future of China supplying as much as 70 percent of the United States textile and apparel market.

The Bush administration said on Friday that the latest trade figures should be seen as testimony to the strength of the American economy and its role as an engine of global growth.

"We view these figures as an affirmation that we're growing faster than our trading partners by as much as 2 percent, and we need them to take steps so they can grow and buy our products," Rob Nichols, the spokesman for Treasury Secretary John W. Snow, said in an interview.

But Representative Benjamin L. Cardin of Maryland, the ranking Democrat on the trade subcommittee of the House Ways and Means Committee, was far less sanguine. He said he would push for immediate action in Congress, beginning with safeguards to limit imports of textile goods from China. The limits, which had been approved by the administration, were blocked by a court injunction.

"We are obviously in a free fall here, with deficit after deficit, and it just cries out for action," Mr. Cardin said in an interview.

China, however, is also pushing along the global economy, spurring growth especially in Asia.

Yet while most other industrialized countries enjoy a trade surplus with China, the United States had a deficit of $15.3 billion in January, the largest with a single country on record. China accounted for a fourth of the trade shortfall in January. Among other major trading partners, the United States had a $6.2 billion deficit with Japan and $6.1 billion with Canada.

The imbalance with China has led to increasingly loud accusations that Beijing engages in unfair trading practices, from hidden subsidies to undervaluing its currency.

Representative Clay Shaw, the Republican from Florida who heads the trade subcommittee of the House Ways and Means Committee, said he planned to hold hearings on the trading practices of China.

As bad as the trade figures were for January, some analysts say the imbalance will grow.

"Most ominously, matters should get worse because of the jump in oil prices in February," said Ashraf Laidi, the chief currency analyst at the M. G. Financial Group in New York, who predicted that next month's deficit could hit $62 billion.

Analysts had hoped that a drop in the price of imported oil in January would help diminish the trade imbalance. The Commerce Department said the average price of imported oil was $35.35 a barrel in January, the lowest since July.

The weakened dollar was also expected to spur export growth, which it did by 0.4 percent, but not enough to offset the import growth of 1.9 percent.

The dollar continued to weaken on Friday, initially falling against the euro and the yen after the January trade figures were announced. It later recovered, and the dollar closed down 0.2 percent with the euro valued at $1.3453, compared with $1.3424 Thursday. Against the yen, the dollar was off 0.1 percent for the day, at 103.88 yen.

News of the deficit also weighed on the bond markets, where investors are worried that a weaker dollar might discourage foreign investment in Treasury securities. The yield on the Treasury's 10-year note rose to 4.54 percent, from 4.47 percent Thursday. That is the highest yield since July. The price of the 10-year note, which moves in the opposite direction, fell 19/32, to 95 22/32.

Joel L. Naroff, president of Naroff Economic Advisers, said there were several reasons the export figures were disappointing. Like the administration, he cited the fact that Europe and Japan were buying fewer goods because of slow economic growth. But Mr. Naroff said American companies seemed to be raising the prices of their goods for exports rather than taking advantage of the weaker dollar to make their products more attractive to foreign buyers.

With no relief in sight, some analysts are suggesting there are deeper problems behind the trade deficit.

Thea M. Lea, the senior trade adviser for the A.F.L.-C.I.O., said that the administration should develop policies that encourage and reward companies for producing in the United States, as does China, Japan, and European nations.

"To be a cutting-edge nation in this global economy," Ms. Lea said, "we need to take steps to shape taxes, improve research, examine trade policy and improve education to make it possible for our companies and our workers to succeed in the global marketplace."

[FaGal]

The world turns the US dollar down to the benefit of the euro
english.pravda.ru - March 12, 2005



Central banks in several Asian states considerably reduced the dollar constituent of their reserves


The US currency has been balancing on the verge of disaster these days. Several countries have announced their intention to diversify their dollar reserves this week. Central banks have decided to add some euro cash to their financial sources.

Another stage of the American currency decline touched upon Russia as well. The dollar value has been declining against the Russian ruble since February 9th, 2005. The US dollar costs 27.46 rubles at the moment in Russia in comparison with 28.18 rubles per dollar just a month ago.

This is the result of another wave of the anti-dollar hysteria. The story started with a message from the Basel-based Bank for International Settlements. It was said that central banks in several Asian states considerably reduced the dollar constituent of their reserves over the recent several years. Banks of China and India, for example, were rather emphatic about such a decision of theirs. The dollar funds of those banks, BIS said, made up 81 percent of their total reserves in 2001. The dollar index dropped to 67 percent by September of 2004. The most considerable reduction of dollar reserves was registered in India: they dropped from 68 to 43 percent from 2001 to 2004.

Market specialists realized that the dollar dependence of the dynamic Asian region was exaggerated. The new concept later resulted in a very active promotion of the European currency. The European Central Bank said that it was going to raise its basic rate (2.25 percent currently) to create "the image of the euro" as a more attractive and reliable world currency. The statement from the bank gave an additional incentive to the growth of the euro.

The dollar started plummeting. The slide was intensified even further after the statement from the Japanese Prime Minister Koizumi. The minister told the national parliament that it was necessary to consider the issue regarding the diversification of Japanese currency reserves. Spokespeople for the Finance Ministry of Japan assured the troubled market a bit later that Japan would not be enlarging its euro-assets: the dollar demise was suspended. Nevertheless, the dollar rate has already stepped over the psychologically important level of 1.34 dollars per euro.

The future of the American currency can hardly be viewed as promising, though. The USA is to publish the balance of trade data in the near future. Specialists believe that they can hardly be better than the previous ones. "The liquidation of the dual American deficit - of the balance of trade and payment - is a matter of distant future. Oil prices are growing, and they have nothing to cut deficit on," FIBO analyst, Rushan Zeinetdinov said.

Europe and Japan taught a good lesson to the States. The US Federal Reserve System is taking measures to stabilize the national currency. European and Asian specialists, however, believe that those measures are not sufficient. Raising the FRS rate by only 0.25 percent cannot stop the ongoing decline of the US dollar. Europe is apparently tired of the never-ending financial fight with the USA and decided to play the game of the strong euro, although it is definitely not good for European exporters. The strong euro might eventually undermine the global reputation of the dollar as the major world currency.

Specialists believe that the information of the Bank for International Settlements can be considered as another proof of the general trend to turn the dollar down as the key currency for saving deposits in.

[FaGal]

New York Times
March 12, 2005
Trade Gap Widens on Record Imports
By ELIZABETH BECKER

WASHINGTON, March 11 - America's appetite for foreign imports broke all records in January, reaching $159.1 billion and contributing to a monthly trade deficit that is the second highest on record. The $58.3 billion trade deficit defied predictions that a weakened dollar and lower oil prices would narrow the United States' trade gap.

Instead, the Commerce Department said on Friday that American consumers continued to buy foreign-made goods at an avid pace, raising the trade deficit 4.5 percent from $55.7 billion in December. January's trade figures included a 75 percent surge in Chinese textile and apparel shipments, reflecting the end to global quotas and the beginning of what some experts see as a future of China supplying as much as 70 percent of the United States textile and apparel market.

The Bush administration said on Friday that the latest trade figures should be seen as testimony to the strength of the American economy and its role as an engine of global growth.

"We view these figures as an affirmation that we're growing faster than our trading partners by as much as 2 percent, and we need them to take steps so they can grow and buy our products," Rob Nichols, the spokesman for Treasury Secretary John W. Snow, said in an interview.

But Representative Benjamin L. Cardin of Maryland, the ranking Democrat on the trade subcommittee of the House Ways and Means Committee, was far less sanguine. He said he would push for immediate action in Congress, beginning with safeguards to limit imports of textile goods from China. The limits, which had been approved by the administration, were blocked by a court injunction.

"We are obviously in a free fall here, with deficit after deficit, and it just cries out for action," Mr. Cardin said in an interview.

China, however, is also pushing along the global economy, spurring growth especially in Asia.

Yet while most other industrialized countries enjoy a trade surplus with China, the United States had a deficit of $15.3 billion in January, the largest with a single country on record. China accounted for a fourth of the trade shortfall in January. Among other major trading partners, the United States had a $6.2 billion deficit with Japan and $6.1 billion with Canada.

The imbalance with China has led to increasingly loud accusations that Beijing engages in unfair trading practices, from hidden subsidies to undervaluing its currency.

Representative Clay Shaw, the Republican from Florida who heads the trade subcommittee of the House Ways and Means Committee, said he planned to hold hearings on the trading practices of China.

As bad as the trade figures were for January, some analysts say the imbalance will grow.

"Most ominously, matters should get worse because of the jump in oil prices in February," said Ashraf Laidi, the chief currency analyst at the M. G. Financial Group in New York, who predicted that next month's deficit could hit $62 billion.

Analysts had hoped that a drop in the price of imported oil in January would help diminish the trade imbalance. The Commerce Department said the average price of imported oil was $35.35 a barrel in January, the lowest since July.

The weakened dollar was also expected to spur export growth, which it did by 0.4 percent, but not enough to offset the import growth of 1.9 percent.

The dollar continued to weaken on Friday, initially falling against the euro and the yen after the January trade figures were announced. It later recovered, and the dollar closed down 0.2 percent with the euro valued at $1.3453, compared with $1.3424 Thursday. Against the yen, the dollar was off 0.1 percent for the day, at 103.88 yen.

News of the deficit also weighed on the bond markets, where investors are worried that a weaker dollar might discourage foreign investment in Treasury securities. The yield on the Treasury's 10-year note rose to 4.54 percent, from 4.47 percent Thursday. That is the highest yield since July. The price of the 10-year note, which moves in the opposite direction, fell 19/32, to 95 22/32.

Joel L. Naroff, president of Naroff Economic Advisers, said there were several reasons the export figures were disappointing. Like the administration, he cited the fact that Europe and Japan were buying fewer goods because of slow economic growth. But Mr. Naroff said American companies seemed to be raising the prices of their goods for exports rather than taking advantage of the weaker dollar to make their products more attractive to foreign buyers.

With no relief in sight, some analysts are suggesting there are deeper problems behind the trade deficit.

Thea M. Lea, the senior trade adviser for the A.F.L.-C.I.O., said that the administration should develop policies that encourage and reward companies for producing in the United States, as does China, Japan, and European nations.

"To be a cutting-edge nation in this global economy," Ms. Lea said, "we need to take steps to shape taxes, improve research, examine trade policy and improve education to make it possible for our companies and our workers to succeed in the global marketplace."

[FaGal]

New York Times
March 12, 2005
EDITORIAL
Harbingers of Harder Times

At $58.3 billion, the United States' trade deficit for January exceeded everyone's worst expectations. The huge mismatch reported yesterday between imports and exports just missed breaking the monthly record, set last November, and is all the more remarkable for occurring in a month when the price of oil actually declined.

The trade deficit is the single most important factor in measuring the extent to which the nation lives beyond its means. As such, it should force us to own up to the dangers of rampant deficit spending. But the White House is showing no sign of action, as if doing nothing might make the problem smaller.

In response to yesterday's trade deficit figure, the dollar weakened against the euro and the yen, and traders predicted further declines in the weeks and months ahead. That, in turn, contributed to a drop in stock and bond prices. Such gyrations are certainly not unprecedented. The dollar has been on a downward trajectory for three straight years and was going into a fresh skid even before the latest trade deficit figure was released.

That slump was largely in response to recent reports, some later denied, that Asian central bankers may begin moving their huge dollar holdings into other currencies. That would mean higher interest rates in the United States because the government would need to sweeten Treasury yields, and higher interest rates imply further declines in stock and bond prices. A declining dollar also risks higher inflation; more expensive imports give domestic producers an excuse to raise prices.

There may be more trouble to come. Next week, the government will release figures showing how much capital flowed into the United States from abroad in January. Those numbers were down by nearly one-third in December. If next week's report is disappointing, the logical response from the currency markets would be to sell dollars - again raising the threat of all the possible side effects.

Since the trade deficit is intimately connected to the federal budget deficit, the best way to reduce the trade imbalance is to reduce the budget gap. But President Bush is calling for more tax cuts, politically implausible spending cuts and costly Social Security privatization. Both parties in Congress must address the twin trade and budget deficits - or risk being forced to do so by events beyond their control.

[FaGal]

New York Times
March 13, 2005
Savings: Lots of Talk, but Few Dollars
By EDMUND L. ANDREWS

WASHINGTON

THERE are moments when a particular word acquires such a compelling grip on the political imagination that it can be used as cover for all kinds of agendas.

The big word is not "bust" or "bankrupt," even though President Bush utters them often as he barnstorms the country to whip up a sense of crisis about Social Security. The word that is really catching on in Washington is "savings." Democrats say that Mr. Bush has greatly depleted national savings with his tax cuts and soaring fiscal deficits. Mr. Bush invokes the need for savings to justify more tax incentives as well as his plan to overhaul Social Security.

Without a doubt, the dearth of savings poses serious concerns. Economic growth requires investment, and investment requires savings. Because Americans consume far more than they produce, the country is now borrowing more than $600 billion a year from foreigners - almost 6 percent of the gross domestic product. Put another way, the United States is tapping the savings of almost every other part of the world - including relatively poor countries. At some point, those bills will come due and constrain growth for many years.

Another big concern is that millions of aging baby boomers may not have stashed away enough for their retirements. Only about half of all workers participate in a pension plan with their current employer, according to the Center for Retirement Research at Boston College. Less than one-quarter of workers are covered by a traditional defined-benefit retirement plan. And savings through individual retirement accounts and 401(k) plans have been meager: in 2001, the average worker in the 55-to-64 age group had a balance of only $42,000.

But if the problem is clear, the proposed solutions are not.

Start with President Bush's plan to overhaul Social Security by letting workers divert some of their payroll taxes to personal retirement accounts. Treasury Secretary John W. Snow says in his stump speech that the accounts would not only enable younger workers to "build a nest egg," but would also help the nation "create a larger pool of savings."

But at least for the next few decades, that last assertion would not be true. For every dollar a person contributed to his nest egg, the government would reduce at least a dollar in traditional Social Security benefits. At best, savings would simply be transferred from government to individual accounts.

More likely, the government would have to borrow trillions of dollars over the next several decades to pay full benefits to retirees who earned them under today's system.

"Moving to a forced savings account technically does not materially affect net national savings," Alan Greenspan, chairman of the Federal Reserve, said last month. "It merely moves savings from the government account to a private account." Mr. Greenspan is a supporter of personal accounts.

Savings are also at the heart of the battle over tax cuts.

For the third year in a row, Mr. Bush is proposing a big expansion of tax incentives for savings accounts. The most controversial idea is to create "lifetime savings accounts," into which individuals could contribute up to $5,000 a year and earn tax-free investment income.

The twist of these accounts is that people would not have to wait until retirement to withdraw money. They could do so at any time and for any reason. But economists are divided over whether tax-advantaged savings accounts - even traditional retirement accounts - actually increase national savings.

Personal savings have declined fairly steadily for more than two decades, even as tax incentives for savings have proliferated. According to a recent analysis by Elizabeth Bell, Adam Carasso and C. Eugene Steuerle at the Urban Institute, the federal government now spends more on tax breaks for retirement savings than Americans actually save.

Tax breaks for retirement programs cost $112 billion in 2004, according to the Office of Management and Budget. Personal savings - for any purpose - totaled only $100.8 billion, according to estimates by the Federal Reserve.

The issue isn't whether tax incentives prompt people to put money into 401(k) plans - the answer is clearly yes. The question is whether people actually save more, or whether they simply shelter income they were going to save anyway.

"The government does not really subsidize saving," wrote Mr. Steuerle and his colleagues in a paper published in the journal Tax Notes. "It subsidizes deposits, which can then be borrowed for consumption."

By contrast, one of the hottest ideas in Washington grows out of new research on the behavior of savers. Recent studies by researchers at the Wharton School of Business and Harvard showed that employee contributions to 401(k) plans soared at companies that automatically enrolled employees and gave them a chance to opt out.

Representative Rob Portman, Republican of Ohio and a senior member of the House Ways and Means Committee, is expected to introduce a bill next week with Representative Benjamin L. Cardin, Democrat of Maryland, that would call for automatic enrollment of workers in 401(k) plans.

But there is an even more curious turn to the politics of savings. A growing number of thoughtful analysts, Democrat and Republican alike, contend that today's tax incentives are misdirected at those who already have a strong propensity to save: people with high incomes who can spare the money.

Yet the tax incentive for savings that the Bush administration would scrap happens to be the one aimed precisely at low-income families.

Peter Orszag and William G. Gale of the Brookings Institution note that tax deductions for contributions to a retirement account provide a 35 percent deduction for people in the top tax brackets but only a 10 percent deduction for those in the lowest bracket. For tens of millions of low-income families, who owe no federal income tax at all, the tax benefit is zero.

To address that issue, Mr. Bush's 2001 tax cuts included a "saver's credit" aimed at low-income families. A family with an adjusted gross income below $30,000 is entitled to a 50 percent tax credit for retirement contributions of up to $2,000 a year.

A $1,000 credit would reduce a family's tax bill by $1,000. By contrast, a $1,000 deduction against income would save a person in the 10 percent bracket $100 at most.

Mr. Portman is so enthusiastic about the saver's credit that he wants to make it refundable, so families who don't owe any federal taxes could still get a check from the Internal Revenue Service.

But for reasons that are unclear, the Bush administration apparently wants to scrap the saver's credit entirely. Even as it pushes Congress to make almost all its other tax cuts permanent, the administration is not proposing to renew the credit when it expires in 2006. Treasury Department officials gave little explanation of why they did not propose a continuation of the credit, saying only that they had "pared down" their list of tax proposals while waiting for recommendations from President Bush's advisory panel on tax reform.

"The core of the president's priorities are in there, but a lot of other things aren't," said Taylor Griffin, a spokesman for the department. "We wanted to give the tax panel as much flexibility as possible."

The credit's fate can't be a matter of cost: it costs $1.2 billion a year. That isn't even a rounding error in Mr. Bush's agenda to permanently extend all his tax cuts for a total of $1.5 trillion over 10 years.

Maybe it's time to increase savings without spending so much money.