- The Washington Times - Monday, July 1, 2002

The almighty dollar has become the latest victim of the crisis of confidence on Wall Street.
The greenback is nearing parity with the euro for the first time in two years, last quarter declining 10 percent against other major world currencies and signaling the end of a seven-year run during which it seemed to go nowhere but up, often despite adverse news.
The dollar's fall makes imports from Japanese cars to French wine more expensive. But so far, because of the impact it is having on the stock market, it is not hurting consumers so much as it is investors.
The dollar's movements have closely tracked the stock market this year, which had its worst first-half performance since 1970. Both have been dragged down by a parade of corporate scandals from Enron to WorldCom, zapping foreign enthusiasm for American stocks the same way it has hurt confidence in the United States.
"Nobody wants to invest where the next accounting bomb is going to explode," said Hans Redeker, head of foreign-exchange strategy at BNP Paribas, reflecting the views of European and Asian investors.
While many overseas stock markets have done little better than the U.S. market this year, foreign investors often feel they understand their own markets better and are more comfortable putting their money there.
They are not alone in shunning the U.S. market. American investors also have been steering clear of stocks, with a lot of their money piling up in bank savings and money market accounts in recent months. Investors also have been dabbling in a range of alternatives from bonds and gold to fine art and the Swiss franc.
Among currencies, no major alternative to the dollar has emerged. Analysts say the dollar's reign as the world's predominant currency is far from over, but they cite a number of factors that could continue to make the going rough now that the bloom is off the dollar.
The International Monetary Fund warned last week that the slow walk away from the dollar could turn into a flat-out run by foreign investors because of America's twin deficits: a record $409 billion trade deficit and the $160 billion federal budget deficit that emerged this year.
Both of those deficits, to be sustained, require an inflow of funds from overseas, since Americans do not save enough to finance such large deficits on their own. The inflow was strong through the end of last year because of record foreign interest in U.S. stocks, bonds and other assets, but it slowed suddenly this year.
The European-led IMF's dire concerns reflect not only the angst of Europeans and other foreign investors about America's chronic buildup of foreign debt, but also their ambivalence about the possibility of a reversal in the U.S. economy.
The dollar was undaunted by a recession last year and its decline this year has come despite signs of an economic recovery. That is why the IMF and some investors and analysts fear that the dollar's sudden reversal is signaling a crisis of confidence that could turn into a rout.
The IMF stressed that because the U.S. economy has been the engine of growth in the world economy for many years, any sudden collapse in the dollar that hurts the U.S. economy also jeopardizes world economic growth.
While many U.S. economists say the foreign view of the U.S. economy is overly pessimistic, such perceptions can nevertheless have a critical impact on the dollar.
The dollar's fall accelerated last month when the Commerce Department announced that the trade deficit ballooned to a monthly record of $35.9 billion in April.
Most economists agree with the IMF that America's trade deficit, which requires inflows of $1 billion a day to finance, is too high. But they say a modest softening of the dollar is not unwelcome after years of unusual dollar strength.
The dollar's decline this year has mainly hurt countries in Europe, Asia and Latin America that depend heavily on exports to the United States for economic growth, while it has provided a welcome economic boost for U.S. businesses, they say.
"A sliding dollar is of much concern in financial circles, but its impact on the real economy is not all bad," said Nariman Behravesh, economist with the DRI-WEFA forecasting group.
"The redirection of some capital away from the United States will depress asset prices slightly, but it will improve the competitiveness of U.S. businesses," he said. "Long term, the United States cannot do all the consuming while the rest of the world does all the producing."
The IMF and foreign investors are right to be worried about the bloated trade deficit and its impact on the dollar, he said, calling the trade deficit the "one glaring imbalance" in the U.S. economy. In all previous recessions, the deficit declined because of a drop in imports.
The trade gap could "finally take its toll on the dollar" and cause a precipitous 20 percent drop in the dollar over the next year, he said. But, he added, the chances that will happen remain slim because the overall strength of the U.S. economy will continue to make it a magnet for investors.
Economists say the modest decline in the dollar to date helps to resolve several major problems fed by its unusual and unrelenting strength throughout the recession. It boosts industries whose export sales languished, while dampening higher-priced imports, thereby lowering the trade deficit.
A lower dollar also enables globally operating businesses to bring home higher profits in dollars, while the higher prices of imports enables domestic businesses such as auto companies to raise their prices a bit and plump up profits.
The risk for the U.S. economy is that price increases by businesses could get out of hand, causing an uptick in inflation and elevating interest rates. This eventually could force the Federal Reserve to raise interest rates even further to quell inflation.
But with inflation for now at comfortable lows and the economy still emerging from recession, Mr. Behravesh said any inflation flare remains a distant concern for the central bank.
"The Fed is unlikely to object to a lower dollar" unless the downturn turns into a rapid slide that disrupts financial markets, he said.
The Fed did join the Bank of Japan and European Central Bank in a modest effort to prop up the dollar on Friday, selling yen at the request of Japanese authorities. But so far, top officials at the Fed and U.S. Treasury have signaled little concern about the dollar's decline.
Edward Yardeni, chief investment strategist with Prudential Securities, said his clients in Europe are concerned about the weakening dollar, but he sees it as a positive development.
"The weak dollar is actually helping to boost profits now," helping to correct the fundamental problem that has frightened both U.S. and foreign investors away from the stock market, he said.
"Profits earned overseas by U.S. corporations will be worth more in dollars," he said, while stocks in health care concerns and companies that make such consumer staples as tobacco and beverages are likely to prosper from the better pricing environment.
Richard Berner, chief economist with Morgan Stanley, said the dollar is not likely to crash, even though markets often overshoot when a currency turns. Foreign investors remain interested in American investments other than stocks, he said, as evidenced by the steep rise in U.S. bond prices this year.


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