Catch a falling dollar, wait for a US crash

It sounds eerily like the worst economic nightmare for President Bush’s second term. Bogged down in a costly war that shows no sign of ...

It sounds eerily like the worst economic nightmare for President Bush’s second term. Bogged down in a costly war that shows no sign of ending, the US faces a gaping budget deficit and ballooning foreign indebtedness. The dollar plunges against other major currencies, while turmoil in the Middle East sends oil prices soaring. The rest of the decade is plagued by rising inflation, increased joblessness and sky-high interest rates. But the President under fire was Richard M. Nixon, not George W. Bush. The war was in Vietnam, not Iraq. And the dollar crash was in 1973 rather than 2005. Could it

happen again? With the dollar down more than 40% against the Euro since 2002, and hitting new lows since Bush’s re-election, economists are debating whether America’s foreign indebtedness could lead to a collapse in the dollar and a global financial crisis.

The US is spending nearly $600 billion more a year than it produces, almost 6 % of its annual GDP. Much of that spending has been financed by Asian governments, which bought more than $1 trillion in Treasury securities and other dollar assets in the last two years.

There are at least three schools of thought on whether a dollar collapse is likely and, if it happens, what it would mean. One group, which includes the Federal Reserve chairman, Alan Greenspan, contends that global financial markets are awash in so much money that the US can borrow much more than seemed possible 20 years ago. The dollar may well decline in value, but it would be gradual and would help reduce American trade imbalances by making exports cheaper and imports more expensive. A second school of thought holds that foreign governments like China and Japan will continue to finance American borrowing and keep the dollar strong because they are determined to sustain their exports and create jobs. But a third school, which includes IMF officials, worries about a collapse in the dollar that would send shock waves through the global economy. That group argues that the dollar needs to depreciate another 20% against the other major currencies but warns about a run on the dollar that could reduce its value by 40%. A collapse of that size would affect Europe and Asia .

The current account deficit, which encompasses annual trade as well as the balance of financial flows, has gone from zero in 990 to nearly $600 billion this year. The accumulated debt to foreign investors is $2.6 trillion, or 23% of the annual output of the economy. But where foreign investors in the ’90s poured trillions of dollars into American stocks and corporate acquisitions, investment from abroad now comes mostly from foreign central banks and goes heavily to buying Treasury securities that finance the federal deficit.

The New York Times