The dollar exchange rate

WORLD MONEY

Over much of the current year, the dollar has been depreciating on the currency markets, often at an accelerating pace as the year advanced, recording successive multiyear lows.

In real effective terms, it has fallen approximately 14 per cent over the year. Clearly, the huge and growing deficit on the current account is at last weighing on the currency "" perhaps it required a deficit number like $ 500 billion, which is difficult to overlook and hits you in the eye, before currency market participants begin to recognise its implications.

The problem, of course, has been there for a long time, but earlier the dollar had kept rising. The rationale then was that the US economy is growing much faster than that of the European Union (EU) and Japan, hereby making the dollar more attractive.

In the current year as well, the US economy's growth has been much faster, but the exchange market story is now different "" so much for the consistency of cause and effect.

There has been no dearth of commentary on the phenomenon of dollar depreciation. One of the more original comments on the subject has come from Richard Duncan, author of The Dollar Crisis: Causes, Consequences and Cures, who has earlier worked with both the International Monetary Fund and the World Bank.

In a recent interview, Duncan argued that "the US current account deficit has reached $ 500 billion, meaning a deficit of $ 1 million per minute amounting to 2 per cent of world GDP. And this is the amount at which the US is subsidising the world." A more grotesque misrepresentation of facts is difficult to imagine.

It is true that exports to the US do create jobs and keep many Asian factories working. But subsidy? My foot! In substance, the Asian economies are exporting real goods and services to the US in exchange for a fast depreciating currency, which may have a way to go before it stabilises.

Recently, even Warren Buffett, the guru of equity investors, tried his hand at suggesting ways and means to stem the red ink on the current account, which has led to a staggering net deficit of $ 2.5 trillion between the US's external assets and liabilities! Buffet has a simple solution to the problem "" a US edition of the "exim scrip" introduced by Manmohan Singh in India back in 1991 at the height of the balance of payments crisis. Buffet clearly hasn't heard of the WTO, its rules, or the inflationary impact on the US economy of limiting imports to exports to achieve a zero deficit on the current account!

The more balanced view on the subject, as usual, has come from Alan Greenspan. First, he is quite bullish that, given the depth of financial markets, the deficit would not lead to a "stress in funding" it. Second, he remains optimistic that "current imbalances will be defused with little disruption".

Third, while cautioning against "creeping protectionism", Greenspan also punctures the myth that it is the exchange rate of the Chinese currency, which is pegged to the dollar, that is the root cause of US deficit and unemployment.

Greenspan argues that, "A rise in the value of the renminbi would be unlikely to have much, if any, effect on aggregate employment in the United States.... If the renminbi were to rise, presumably US imports from China would fall as China loses competitive position to other low-wage economies," and these will replace Chinese imports.

Coming back to the growing US economy, Martin Wolf wrote in The Financial Times that "It is the best recovery foreign money can buy. [But] how long will the foreigners continue to oblige?" Already, net inflows of foreign investment in the US have fallen from $ 110 billion in May to just $ 4 billion in September 2003. There has also been a reduction in the proportion of other countries' reserves held in dollar.

Clearly, Wolf is not as optimistic as Greenspan about the smooth financing of the deficit. On balance, one is inclined to agree with him "" which means that the dollar probably has some more way to go down further. (Against the rupee as well?)

Even as the price of gold crossed $ 400 recently, its highest level for many years, in euro terms, the price was highest in Q1 2002. If the dollar remains weak, would commodity markets shift to pricing in the euro? A trillion dollar question, that!

Tailpiece: Is the WTO mightier than the UN Security Council? While President Bush merrily defied the latter when invading Iraq, a couple of weeks ago, he withdrew the import tariff on steel he had imposed some time back "" after the WTO found that this was a contravention of its rules, and the EU threatened to impose penalties on imports from the US.

It seems to me a belated recognition on the part of the lone surviving super power that it is not so super in economic matters; that it needs cooperation of other countries; and that unilateral actions can be costly. Perhaps our own swadeshiwalas, who blithely recommend a withdrawal from the WTO, should spend a moment pondering over the incident.

Email: avrco@vsnl.com