Financial Times Editorial - Dollar dynamics are an economic danger

Financial Times Editorial - Dollar dynamics are an economic danger
Copyright The Financial Times Limited 2006
Published: November 28 2006 02:00 | Last updated: November 28 2006 02:00


Movements in the currency market are best described as a random walk: unpredictable, like a drunk staggering home. But whereas most of the time the movements are gentle, swaying like someone who has shared a decent bottle of chianti with a friend, at present they are lurching like a 16-year-old swigging a bottle of tequila. The economies of Europe, Asia and the US would all be at risk from further dollar falls.

The greenback fell close to its all-time low against the euro last Friday, although it has held up against Asian currencies. The level of the dollar affects the sustainability of the world economy's most striking feature: America's current account deficit, now running at about 7 per cent of gross domestic product.

That deficit suggests that the dollar did not fall simply because the US markets were off eating Thanksgiving turkey. The eurozone's economic performance has been improving; the US economy, and the housing market in particular, have got weaker. Interest rates in the US appear close to their peak, whereas they are still rising in the eurozone and just beginning to rise in Japan, so yield-hungry investors have ever less reason to hold dollars.

Such a story suggests dollar weakness as well as euro strength. But against Asian currencies the dollar has not fallen so fast: China still pegs the renminbi to the dollar, while others - like the Bank of Korea - have a record of currency intervention. By buying dollars, however, all they do is increase their stockpile, their dependency on exports to the US and their vulnerability when the dollar eventually falls.

For their own sake, therefore, Asia's central banks need to allow currency appreciation. China should take the lead - its neighbours will follow their biggest competitor - and Japan should resist the temptation to defend the yen.

By doing so, they would also help Europe. If the dollar continues to fall, and Asian banks keep their own currencies down, all the adjustment will be to the euro. That could harm exports and growth in the resurgent eurozone. The only response open to the European Central Bank and to the Bank of England, which is in a similar position, would be to factor the level of the dollar into interest rate decisions as an unwelcome economic distortion.

The US, meanwhile, may be able to cope with a fall in the dollar. Its debts are denominated in its own currency, and while rising import prices could push up inflation, foreign firms tend to price to keep their share of the US market. But if the dollar falls further, the economy will have to rebalance to-wards exports and away from consumption. That is a necessary process. But the worry is whether America's exporters, battered by years of foreign competition, would be able to do so quickly. If they cannot, the US could suffer a recession while it adjusts. That really would have people reaching for the drink.