Dollar weakness major cause of concern.

As I write the US trade deficit stands at $544,839,708,414.77. What does this number represent? The difference between the goods and services Americans sell to foreigners and the goods and services that Americans purchase from foreigners. A trade deficit with one country or in one year is not necessarily worrisome, and according to standard economic theory, will correct itself over time. But the theory has been proved wrong over the last 30 years as the United States has run consistent and increasing trade deficits. The enormous size of the trade deficits over the last several years raises the possibility of a severe international economic crisis should foreigners begin to dump the dollars they hold in world currency markets. The trade deficit is calculated on an annual basis, so the number above was $0.00 on January 1st, 2007.

One way to control trade deficits is to allow your currency to lose value (depreciate) this way your home produced goods (exports) become cheaper to overseas markets and imports from these countries become more expensive at home. However this is a short sighted view and in the case of a foreign country opening up a factory and investing in the United States the profits made in the United States end up in the pockets of foreign capitalists what I am trying to say as the late Earl of Stockton famously said “The longer America runs a trade and current account deficit, the more of its family silver will end up heading abroad” We saw this in the 1980’s when film Studio Columbia Tristar ended up being bought by Sony, we are also seeing middle eastern purchases of the Nasdaq and the major ports of the United states. Japanese dominance in the once American dominated car industry now sees Toyota as number car manufacturer in the US.

So why should be concerned? Periods of sustained dollar decline have never really been happy occasions for the world economy. In the early 1970’s, when the dollar came unstuck following the collapse of Bretton Woods, inflation, exchange rate volatility and commodity price shocks became the major economic challenges, creating a nirvana for speculators but a nightmare for everyone else. In the late 1980’s the dollar’s decline contributed to the stock market crash, Japan’s economic excesses and the depth of the European recession in the 1990’s.
So what awaits us in the future well the half point cut in US interest rates was a gamble by Ben Bernanke the dollar has declined in response to this cut it will fall further as the fall out from the housing market spreads through the rest of the economy. We have seen record car repossessions and now job cuts from the banks that lost billions in sub-prime debt. What we are also seeing is the slow down on the high street, car sales, electrical goods, etc. We could be seeing a consumer led recession, much more woe in the housing markets as mortgages that reset later this year and early next year will lead to more home foreclosures.

We are seeing dollar losses against the Euro, Yen and Sterling, but more alarming is Saudi Arabia not cutting its interest rates inline with the Federal Reserve, signalling that the oil-rich gulf kingdom is preparing to break the dollar currency peg in a move that risks setting off a stampede out of the dollar across the Middle East. Saudi Arabia holds a staggering $800bn in US treasuries and what they don’t want is a inflation threat added to the recessionary conditions in the United States. The threat now is global investors will start to shun the US bond markets. Just last week the latest US government data on foreign holdings showed a collapse in purchases of US bonds from $97bn to just $19bn in July, what the US does not want is to be starved of capital inflows to cover its current account deficit expected to reach $850bn this year or 6.5 of GDP. Foreign investors are funding 25pc to 30pc of US credit and they are gradually pulling out.

In a nutshell falling US rates could trigger a reversal yen “carry trade” causing massive flows from the US back to Japan and China.

Bush’s fiscal policies are at the heart of these problems. A policy of a weaker dollar might seem like a solution for the US but the longer term consequences might prove to be quite a lot more painful for all concerned.

E-Money