Growing unease about dollar as US deficits grow

http://www.forbes.com/feeds/ap/2009.../ap6261566.html

4/7/2009

There's growing unease about the dollar around the world as the United States struggles to right itself from its worst recession in decades.

The prospect that massive stimulus spending will produce ballooning budget deficits - on top of years of red ink in trade balances - has many forecasting a bleak future for the greenback. Is the dollar in danger of losing its global glitter?

Pessimists like U.S. analyst Peter Schiff, president of the Euro Pacific Capital brokerage, believe the dollar could plummet in value against other currencies and lose its dominance in trade, foreign reserves and commodity pricing.

"I think the dollar will continue to drop," Schiff said in an interview. "Based on what we've done, it could lose 70 to 80 percent of its value over the next five to 10 years.

"The dollar is no longer as good as gold. It's no longer better than any other currency."

Other analysts counter that it's too early to write off the dollar, noting that it has strengthened against other currencies this year - including Europe's euro and the Japanese yen - in part because the Obama administration is moving aggressively to boost U.S. credit markets and stimulate the economy.

"The dollar continues to be best of breed of the major currencies," said economist Ed Yardeni of Yardeni Research Inc. "Despite all of our flaws and faults and economic and financial woes, the dollar still looks as though it should remain a strong currency relative to the euro, the yen, the British pound and other currencies."

The dollar's current strength hasn't kept officials in China and Russia from dropping strong hints that the world needs to look for alternatives. Both developed and developing nations are especially concerned about their reserves, which are essentially national savings invested in gold and foreign currencies, mainly dollars.

China has used its massive profits from foreign trade to become the world's largest investor in the United States, with an estimated $1 trillion in holdings of U.S. Treasury securities and other government-backed notes.

Last month, Chinese Premier Wen Jiabao said he was "concerned about the safety of our assets," making it clear China is loathe to see its dollar holdings drop in value. His central bank governor, Zhou Xiaochuan, went further, advocating creation of a new global currency to end the dollar's dominance.

Zhou's suggestion: a synthetic currency created by the 185-nation International Monetary Fund.

Also in March, Igor Panarin, a dean at the Russian Foreign Ministry's school for future diplomats, suggested that the United States may implode amid deepening financial and credit crises, leaving Russia and China as the backbones of a new world economic order.

What has China, Russia and other countries spooked is the massive deficits that are likely because of U.S. government spending to prop up faltering banks and insurance companies and to stimulate economic growth.

The U.S. budget deficit is projected to shoot up to $1.8 trillion this year and moderately decrease to $1.4 trillion next year, while the national debt rises to $8 trillion in 2009 and $12.6 trillion five years later.

One worry is that the United States could eventually let the dollar depreciate to reduce its costs of paying off such massive debt. Another is that the stimulus and deficit spending will set off inflation and make the dollar less valuable.

Either way, the value of foreign nation's dollar holdings would drop.

On the other hand, if the Obama administration's massive $787 billion recovery package works, the U.S. may come out of its recession faster than other nations. That will give the U.S. a head start in getting its financial house back in order and strengthen the dollar, at least in the short run.

C. Fred Bergsten, a former U.S. Treasury official who is director of the Peterson Institute for International Economics in Washington, D.C., points out that after losing about 25 percent of its value on a trade-weighted basis from 2002 to early 2008, the dollar has regained about 12 percent in the past year.

It has gained even more against Europe's currency - the euro now fetches $1.34, down from $1.60 a year ago. And the dollar is up more than 10 percent against the yen since mid-December.

Bergsten predicts the dollar will go up "for a while" as the U.S. trade deficit narrows because of recession-reduced demand for imports and there's less spread between U.S. interest rates and those in other countries, including Europe, where the central bank has been slower to bring rates down than the Federal Reserve.

"In the longer run, as the trade deficit moves back up ... it depends on how that compares with the other major countries," Bergsten said.

Bernard Baumohl, executive director of The Economic Outlook Group, believes the dollar will be vulnerable in 2011 and 2012, as other countries begin to come out of the global downturn.

"They'll need capital to finance their recovery, and that will draw some foreign capital away" from the United States, he said. "And there's likely to be new concern about the (budget) deficit here in the United States and the enormous demand for the Treasury to borrow from foreigners."

Still, Baumohl doesn't expect the dollar to disappear soon as a global reserve.

"I liken the dollar to an aging boxing champ in terms of being a reserve currency," he said. "It survives because there's no other contender out there."