Dollar fall adds to global turbulence

[smallprint]

By Nick Beams
30 September 2003

The sharp drop in the value of the dollar in money markets last week has pointed to the underlying instability of the international financial system and the ever-present possibility of a major crisis. The dollar’s decline followed a meeting of the Group of Seven (G7) finance ministers in Dubai which called for exchange rates to reflect “economic fundamentals.”

snip

This is an unprecedented situation in which the world’s leading economy is being financed by the accumulation of debt.

The “orthodox” method for unravelling this situation and ensuring global “rebalancing” is a reduction in the value of the US dollar, thereby cutting the balance of payments deficit and lessening the dependence on foreign capital inflows, coupled with increased growth in Europe and Japan in order to ensure alternative sources of world growth US.

That appears to have been the thinking behind the remarks on currency rates contained in the G7 statement. However, the rapidity of the dollar’s fall in the subsequent days ignited fears that too rapid a loss of value could spark an outflow of capital from the US, leading to a jump in interest rates and a fall in equity markets.

more: http://www.wsws.org/articles/2003/sep2003/doll-s30.shtml

my comment: hey everybody, i'm a newbie when it comes to global economics (and i've never posted in this forum before), so i'd like to hear people's opinions on this piece and the fall of the dollar generally, so that i can learn something. is this article accurate? are its conclusions supported by the evidence? any comments would be appreciated.

fire away!

:bounce:

[papau]

1. This is very standard econ - dollar drop however isn't going to start

an "outflow"

but it will slow the "inflow". And that is not all good!

But step one " reduction in the value of the US dollar, thereby cutting the balance of payments deficit and lessening the dependence on foreign capital inflows" is quite logical

The increased growth in Europe and Japan in order to ensure alternative sources of world growth is not a direct result in the drop in the value of the dollar - and to the extent the EU and Japan suffer a cut back in exports because of the currency change, their growth will be negatively affected. So this is a "wish".

A panic could happen of course - where folks do not care about the capital loss to date, and just want out of the US dollar before it goes down further - and that would drive the currency ever lower and indeed increase interest rates (but equity markets are really not in lockstep with interest rates - the theory that the multiple - the P/E ratio is a present value that gets larger with lower interest rates - workds in the long run - but I would not bet the farm on the short term effect of a change in interest rates)- but I do not see how that makes a lasting change - a panic ends and trade and other flows determine the equil. balance for the exchange rate.

So I do not follow why this fellow thinks there are real fears that too rapid a loss of value could spark an outflow of capital from the US, leading to a jump in interest rates and a fall in equity markets - there are some fears - but not that big a deal! Indeed we will know the definition of "too rapid a loss of value" only when we actually have a panic!

Econ is such fun!

[smallprint]

2. questions

1. EU and Japan are in growth slumps. They want to develop their own growth, instead of depending on the USA. So how exactly are they trying to do that? How will the "wish" of a weaker dollar help them?

2. How would a panic end? Or-- how would it stop itself from going too far?

3. About the multiple-- everything I've seen says it's still too high. What's keeping the market from crashing? The legendary Plunge Protection Team?

Don't feel you have to answer all of these... I'm just thinking out loud.

thanks

:hi:

[happyslug]

5. Some Scenarios to think about:

First the big question is the Chinese Yuan and the Japanese Yen, both have been kept pegged to the dollar all through the 1990s. To keep these pegs constant both countries have been the biggest buyers of US Treasury bonds. Both countries are in slumps and have concern about internal tensions caused by those slumps. Both may prefer to see their currency go down further (along with the Dollar) than see their currency goes up in relation to the Dollar and see their exports drop (and their slumps made worse which could lead to revolution in either country, more China than Japan, but I can no longer exclude Japan from a revolution given the long deflation of the 1990s).

The EU Slump is tied in with the introduction of the Euro. Before the Euro each country could leave their own currency fall or raise as per the Dollar and each other, but with the Euro each country have to make an effort to keep their Euros the same price as other country's Euros. This restrict what each country can do. Thus some of the deficient spending generally recommended to end a slump Europe can not agree to unless every member agrees. That takes a lot of conscience and the lack of such a conscience is the reason no such deficient spending has been done.

Thus the issues are first, when will Europe increase deficient spending to gets its own Economy going? Second, when will Japan and China permit their currency to raise against the Dollar? And which will occur first?

Thus Scenario Number 1, Japan and China permit the Yen and Yuan to increase in value as per the Dollar. US Goods become cheaper in the East, but Chinese and Japanese goods become more expensive. Given that the US ships very few manufactured items to the east, this will hurt the US more than Japan and China in that it will cause inflation. Slow inflation growth, the death of any growth in the US in 2004.

Scenario 1A - Japan or China has internal problems that causes them to unload the US Treasury bonds they are holding. This causes rapid inflation in the US for the US Government could NOT borrow any more money or if it does at very high real interest rates. Japan or China has a revolution but the US Dollar may become worthless. This scenario is a very low probability of fully happening but parts of it will happen and all of it may happen.

Scenario 2 - Europe starts deficient spending, becomes attractive to investors do to increase growth. US again has problems raising funds do to the large deficients. In the US Inflation comes back, housing sales stall (do to interest rates approaching 10% to compete with the Europeans for investments) people file bankruptcy do to an inability to maintain their standard of living at the higher interest rates. Housing values go down, a long low depression.

Scenario 2A - OPEC switches to the Euro. Saudi Arabia dumps its holdings of US Treasury Bonds for Euros. The US can no buy oil overseas as the Dollar plunges. US has to rely on domestic supply of Oil for consumption (which is only 50% of what the US uses today). The Dollar bottoms out but at world wide oil prices above $10.00 a gallon.

Any combination of the above is also possible. I see Scenario 1 coming to play first, leading to 1A. I also see Scenario 2 than 2A. The question will both occur at the same time or right after another? I suspect at the same time as people abandon the Dollar as they lose hope is Bush being able to reduce the US Budge Deficient and thus 1 and 2 will start at the same time. A major military disaster may be the start (i.e. the US loses a battalion size unit somewhere in Iraq, Iran etc.). The only “weapon” that Bush still has is the military. His tax cut, cut out an ability to buy our way out of this mess, and his deficients has limited the other economic weapons he had on January 20, 2001. With the Military all tied up in Iraq no one needs to fear the US Military might, thus any military reversal will reduce whatever fear other countries have of the US, thus the switch to the Euro and/or adjustments to use Euros instead of Dollars as the world wide standard currency.

[smallprint]

6. Excellent post

Thanks for writing it. I'll have to read this several times...

It seems like a "perfect storm" is on the horizon, that's for sure.

[leftyandproud]

3. relax!!

Buy Gold!
Buy Silver!

Enjoy the ride! ;)

[smallprint]

4. haha

yes, i will be investing in precious metals

i'm just concerned about when the "ride" will really start getting bumpy...

[Lydia Leftcoast]

7. I'm paid in yen

becaues almost all my current customers are in Japan. They wire my payment into my bank account here, and it is converted into dollars at whatever the prevailing rate is. I'm okay at 120/dollar, sad at 135/dollar, and very happy at anything above 110/dollar.

The fall of the dollar is actually good for me, but not for other people. I'm afraid that it will trigger another round of Japan bashing, because last time, when the sudden rise of the yen caused the dollar value of Japan's exports to the U.S. to rise sharply (even though the volume of exports was practically unchanged), politicians and pundits started in on their demagoguing of "jobs lost to Japanese imports."