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michael at intrafi.com
michael at intrafi.com
Fri Dec 31 10:59:27 PST 2004
- AN ARTICLE FOR YOU, FROM ECONOMIST.COM -
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FURTHER TO FALL
Dec 29th 2004
A new year is likely to bring a new low for the dollar
THE dollar ended the year as it began: heading downhill. It hit a new
low against the euro, below $1.36, on December 28th. Against the yen,
it was steadier: YEN103, slightly stronger than in late November. The
yen has risen by less than the euro because, although the Bank of Japan
has not intervened in the foreign-exchange markets since March, the
bank looks more likely to act than the European Central Bank. Japan's
finance minister, Sadakazu Tanigaki, gave warning this week that his
country's authorities would monitor foreign-exchange markets over the
New Year holiday. In contrast, Gerrit Zalm, the Dutch finance minister,
suggested that the euro's rise so far was acceptable.
Since early 2002 the dollar has lost 37% against the euro and 24%
against the yen. But it has shed only 16% against the Federal Reserve's
broad basket of currencies, because many Asian currencies are pegged or
closely tied to the greenback.
The cause of the dollar's decline is hardly a mystery: private
investors are less eager to finance America's huge current-account
deficit. The deficit widened slightly in the third quarter of 2004, to
a record $165 billion, or 5.6% of GDP. If the deficit remains so big,
America's foreign debt burden and hence its debt-service payments will
So far, America's mounting foreign liabilities have not harmed its
economy because the rise in its debt in recent years has been offset by
lower interest rates. As a result, America still enjoys a net inflow of
foreign investment income despite being the world's biggest debtor.
But, as interest rates rise, refinancing America's debt will become
more costly. Goldman Sachs forecasts that net foreign investment income
is likely to shift to a sizeable deficit during 2005, growing
thereafter. The investment bank estimates that, if America's
current-account deficit remains steady as a share of GDP and interest
rates average 5% in future, net foreign debt-service payments will
reach 4% of GDP by 2020--a significant drag on American living
By most measures the dollar is already undervalued, but experience
suggests that it will need to fall further still to cut the deficit to
a sustainable level, say 2-3% of GDP. Capital Economics, a London
research firm, forecasts that the dollar will fall to $1.40 against the
euro and to YEN90 by the end of 2005. But it expects the dollar to
recover against the British pound to $1.82 from $1.93 today, as British
interest rates are cut in the wake of falling house prices.
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