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Sunday, December 03, 2006

The Falling Dollar

Gerard Baker points out that In the last five-years, the US currency has fallen by about 18 per cent against those of its main trading partners. This seems to have been driven in large part by America’s indebtedness to the rest of the world. The US is running a current account deficit of roughly $800 billion, or about 7 per cent of its total national output. He does not think that this means the American economy is doomed. He is right in pointing out that the exchange rate merely reflects the changing premium that investors demand for investing in the US. Investors may have grown more concerned about placing their money in the US in the past year, especially as European and Japanese performance has improved and that this simply means they demand a lower price for investing there to protect them against further dollar depreciation. The dollar surely needs to keep on falling. What matters is that its drop is an orderly and stable one, not a sudden collapse – that may hurt China, the most important trading partner of the US with a trillion dollar in surplus most of which are invested in dollar/dollar denominated financial instruments!!
As I see it, the US was not so pushy when it came to enforcing Yuan float – its huring them and would hurt them more in future, if this continues. The budget and trade deficits of US running into trillion plus dollars is not a casual affair that can get self corrected or ignored – this needs a strong willed and concerted effort to correct this. The deflation of the dollar is further accentuated by the sagging interest in the housing market – with first and second mortgage leverage tied ot those assets. Gerard is right - Uniquely in the modern history of international financial markets, the world’s most important currency is underwritten by the economic policies of another country – if I may add only to a significant extent –I agree with Rich Karlgaard that the US economy shall definitely bounce back – courtesy the entrepreneurism, optimism and resilience of the Americans –the world’s economic engine won’t get spurted that easily and for long- it will humm back more strongly with some policy driven lubrication. I am optimistic about this happening.

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"All views expressed are my personal views are not related in any way to my employer"