Dollar torment could match earlier crises

 

The dollar's fall from grace as global financial markets are roiled by fears the US economy is at risk of recession threatens to turn into a full blown crisis equal to any, analysts said.


"We are living through a historic banking and financial crisis, combined now with a real foreign exchange crisis," said Veronique Riches-Flores, economist with French bank Societe Generale.

In the past year, the dollar has fallen 18 per cent to record lows of nearly 1.57 against the euro and is down a very sharp 10 per cent in just one month as investors desert the US currency and look to greater returns and safety in the single European currency.

"Forecasts for US interest rates ... are being constantly revised downwards (whilst it is the opposite for the European Central Bank) ... which has firmly closed the door on cutting lending costs," said Riches-Flores.

This growing divide between the US and the Eurozone is increasing the speculative pressures on the dollar just as the US economic outlook goes from bad to worse on an almost daily basis.

The latest blow came Friday when, battered by the subprime mortgage crisis, US investment giant Bear Stearns said it had had to seek an emergency loan from JPMorgan Chase backed by the Federal Reserve to avert a collapse.

Bear Stearns said its liquidity position had "significantly deteriorated," sparking fears that the problems caused by the collapse of the US property market have a long way to go before everything is out in the open.

"Everything is in place for the dollar to fall away," said Riches-Flores.

The dollar's problems are broad based.

On Friday, it fell below one Swiss franc for the first time ever and was below 100 yen, "a level not seen since 1995, which does not bring back happy memories," said Eric Vergnaud of BNP-Paribas.

As the dollar falls, key exporters find their goods ever more expensive in their most important market -- the United States -- resulting in slower growth and potentially, as in the case of Japan in the 1990s, deflation as the economy goes into reverse.

Significantly, both China, now the world's workshop, and Japan have reported some slowing recently in their export performance attributed to the currency effect and the overall US economic weakness.

The dollar is now at its lowest since the Bretton Woods post-World War II financial system fell apart in the 1970s when the US government abandoned the gold standard and thereby introduced the era of freely floating currencies.

"We are near to historic (low) levels (for the dollar)," said Charles Wyplosz, economics professor at the University of Geneva.

Given the massive trade and budget deficits in the United States, a fall to a euro/dollar rate of 1.50 was both likely and necessary -- a weak currency would boost US exports and curb its craving for imports -- but "it would be worrying if it went much further," said Wyplosz.

"However, it is possible because the logic of the market is not the same as the logic of economics."

Some economists have begun to think that central bank intervention on the currency markets could now be possible, although this option has been out of favour for some time given the risks and costs.

"Any intervention has to absolutely be successful or it risks undermining the credibility of the monetary authorities," said Vergnaud.

"For it to work, it has to be carried out when speculative activity has died down for a while," he added.

For his part, Wyplosz said he did not think "they will do that or that it would actually achieve something because intervention on the currency markets has only limited impact if monetary policy does not back it up."

On Friday, EU leaders significantly called on banks to help stabilise the markets whilst also sounding the alarm about the euro's record-breaking gains.

"We would like to invite financial institutions to help reduce the instability on financial markets within their limits," Slovenian Prime Minister Janez Jansa said after chairing a summit of EU leaders.

EU leaders said sharp swings in exchange rates "are undesirable for economic growth" and that "in the present circumstances we are concerned about the excessive exchange rate moves."

European Commission chief Jose Manuel Barroso noted that "thanks to the fact that we have a stable currency, the European Central Bank has been responding to the turbulence through timely provision of liquidity.

"This is evidence that the European Central Bank will do what is necessary to secure stability." (AFP)

 

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