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Opinion: Consequences of dropping dollar
( 2003-12-27 09:17) (China Daily)

The slump in the exchange rate of US dollar to the euro and other major currencies will have complicated implications on the global economy.

Recently, the euro has become increasingly strong against the US dollar. It surged beyond 1.24 against the US dollar this week. The US dollar is also weak against the UK pound, the Australian dollar and the Canadian dollar.

The weak US dollar is now a hot topic across the world money markets. There are several factors contributing to the devaluation of the dollar.

According to international finance theories, a country's inflation rate, among others, has a major bearing on the exchange rate of its currency. The exchange rate tends to go downward if the country's inflation rate is relatively high.

Statistics from the US Government show that its inflation rate was 1.7 per cent in 2002 and is forecast to be 1 per cent in 2003, a historical low since 1949.

The dollar should remain strong if examined by the above-mentioned theories. But the US Federal Reserve has cut down the Federal fund rate 13 times consecutively since January 2001 and has decided to keep the interest rate at around 1 per cent for a considerable period of time. The relatively high interest rate of the euro, which is 2 per cent, has drawn in large sum of capital from the US market into Europe.

In November, the net capital outflow from the US securities and money market was US$2.3 billion while non-European investors put 800 million euros into securities and money market in euro zone markets during the same time.

The Canadian dollar and the Australian dollar both have higher interest rates than the US dollar, which weakens US dollar.

From the perspective of monetarism, the huge amount of deficit of US Government has had great pressure on the US dollar.

According to monetarist theory, if a country's fiscal deficit grows dramatically, supply of its currency will increase and its exchange rate will decline.

Although it has adopted a strong-dollar policy since the mid 1990s, pressure brought by the "twin deficit'' -- the fiscal deficit and trade deficit, on the value of US dollar has never eased.

Figures from the US Ministry of Finance show that the deficit in the 2003 fiscal year was US$374 billion, 3.5 per cent of the country's gross domestic product (GDP). The red number may exceed US$500 billion in the 2004 fiscal year.

To make things worse, the total trade deficit of the United States reached US$366 billion in the first nine months of 2003. And Goldman Sachs, one of the world's leading investment bank, predicted the United States will have a net foreign debt of US$5.8 trillion by 2006, 46 per cent of its GDP.

All of these add more weight to push down the dollar.

Besides these long-term elements, the exchange rate of US dollar is also subject to several short-term influences.

Given the possibility of terrorist attacks on the United States and its trade conflicts with other countries due to its protectionist policies, international investors now believe the dollar is likely to keep going down in the near future.

As a result, they are trying to restructure their portfolio to profit from a weakening dollar, which may push the dollar further down.

Meanwhile, the US Government has stated several times that the exchange rate of dollar should be decided by the market and the economic fundamentals, which is an obvious consent to the devaluation of the US dollar.

Economic recovery in European countries also contributed to a strong euro against the dollar.

The 12 countries in the euro zone and the 15 member countries of the European Union (EU) have all seen a 0.4 per cent economic growth in the third quarter, slightly higher than the same period of last year and is the highest this year.

The ZEW indicator for economic sentiment in Germany entered the 11th month of continuous rise in November, showing the biggest economy in the euro area is stepping out of the economic doldrums.

For EU, the dollar devaluation is not a bad thing.

On the one hand, euro could bolster its position as a leading currency.

On the other hand, a devalued US dollar will stimulate the US economy and in turn benefit the full recovery of the euro zone economy.

For the United States, however, the devaluation serves as a double-edged sword for the US economy.

With a devalued dollar, US products are more competitive on the international market, which will cut down its trade deficit and contribute to the further recovery of the US economy.

However, another side of the coin is that the confidence of international investors will be severely hurt if the dollar's slump is not curbed.

It may result in international capital exodus and dumping of US treasury bond in the market.

In that case, Bush's economic policies, which features major tax cuts, may probably fail its target, causing a worse imbalance in the US economy.

From the global perspective, devaluation of US dollar will bring about some positive influences.

With their currencies rising against the US dollar, European countries and Japan will become less competitive on the international trade market.

As a result, they may probably resort to economic restructuring to stimulate their long-sluggish domestic demand.

China has obviously suffered a lot from the dollar devaluation.

The United States, Japan and European countries have taken advantage of US dollar devaluation to pressure China to revalue renminbi. They have provoked a series of trade rows as a result with China.

And with two thirds of its foreign exchange reserve denominated in US dollar, China has seen remarkable losses in dollar devaluation.

The dollar is unlikely to turn strong by the year-half of 2004 for the real fundamental cause of the weak dollar is the attitude of the Bush Administration, which acquiesce in the dollar devaluation against other currencies. The variable will be the 2004 presidential election. Bush may change his economic platform to cater to voters.

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