Dollar, oil prices send Dow lower

Wall Street markets were shaken yesterday after oil prices shot up to $51.42 a barrel and the Bank of Korea became the second central bank worldwide to announce it is diversifying out of U.S. dollars.

The Dow Jones Industrial Average plummeted 174 points to 10,611, its biggest point drop since May 2003, and the dollar fell against dozens of currencies amid fear the developments will stoke inflation and make it more difficult for the United States to finance its giant budget and trade deficits.

Asian central banks have been the primary force propping up the U.S. dollar in recent years, and they have been subsidizing low interest rates in the United States by holding collectively nearly a quarter of the U.S. government’s $4 trillion in public debt.

South Korea, which has $200 billion in dollar holdings including $70 billion of U.S. Treasuries, is the first Asian bank to declare its intent to sell dollars and switch into the currencies of Australia, Canada and other nations from which it increasingly imports raw materials.

The South Korean bank’s move must be approved by the country’s parliament. But anticipation that South Korea, with the world’s fourth-largest currency reserves, soon will embark on sales of dollars and U.S. bonds sent U.S. interest rates higher yesterday.

Robert Lynch, currency strategist at BNP Paribas, said South Korea’s move “is a wake-up call.” He expects diversification of foreign reserves “to be an issue” in the next several years.

Russia’s central bank, with more than $100 billion in dollar holdings, last year was the first to announce a program to diversify out of dollars into euros and other currencies. Its announcement helped send the dollar plummeting to new lows against the euro.

Analysts said other central banks in Europe and the Middle East may follow suit, although most predicted that the largest holders of U.S. debt — China and Japan — will not move out of dollars anytime soon. Both countries have strategies of propping up the U.S. currency to keep their exports competitive in the U.S. market.

Europe’s fledgling currency has been the main beneficiary of moves out of the dollar, which remains the world’s predominant reserve currency. Stephen Jen, a currency analyst at Morgan Stanley, predicts the euro will become “the anti-dollar” in the years ahead.

Reserve currencies get many benefits from the perennial strength that comes from being stockpiled by banks, businesses and consumers worldwide. Chief among the benefits is a flood of foreign investments in stocks, bonds and other assets of the host country.

The predominance of the U.S. dollar for the last half-century has been a key ingredient lifting the performance of the U.S. stock and bond markets, scholars say.

That’s why the dollar’s renewed fall yesterday “was not good for stocks,” said Ed Keon, chief investment strategist with Prudential Equity Group.

“Inflation may not be a big problem yet, but … the dollar, after stabilizing, has now weakened. The bond market has finally weakened … And of course, oil prices are rising.”

Rising prices for oil, which is denominated in dollars worldwide, are the inevitable result of a weakening dollar. Yesterday’s jump in prices, prompted by cold weather in regions of the United States and Europe that are heavy users of heating oil, was the first surge over the psychologically significant threshold of $50 since the fall.

Analysts said the resurgence of oil is a reminder of how sensitive the U.S. economy is to high oil prices, which raised inflation and curbed economic growth last year.

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