Less Hungry for Dollars: <http://graphics10.nytimes.com/images/2006/12/09/business/10VIEW.L.jpg>
<http://www.nytimes.com/2006/12/10/business/yourmoney/10view.html> December 10, 2006 Economic View As the Dollar Falls, Some Dominoes Don't By DANIEL ALTMAN EXCHANGE rates are changing — and fast. While American consumers may not react right away — say, by buying fewer imports and thus narrowing the trade deficit — investors may be a different story. When the dollar drops, several things happen. Returns on dollar-denominated assets become less valuable to foreigners. The dollars they receive in interest, dividends and other distributions don't buy as many euros or yen. And dollar-denominated assets become cheaper to buy. If foreign investors think that the dollar will recover someday, or if they are seeking a combination of risk and return that still looks good with a lower dollar, they may go on a shopping spree. Other effects occur with a bit more time. For example, if investors are predominantly selling their American assets to buy foreign ones instead, the demand for dollars will drop. That pushes the dollar's value down further, and the effect can start to snowball, perhaps uncontrollably. So, are any of these things happening now? The dollar has certainly taken a big tumble since its highs of February 2002 — a whopping 18 percent in a broad measure calculated by the Federal Reserve, both in raw exchange rates and after adjusting for differences in the prices of goods at home and abroad. The dollar has moved substantially more against some currencies. Say you are a German who bought an American bond paying 8 percent four years ago, when the euro was about one to one with the dollar. Now that bond is paying only 6 percent, as far as you're concerned. Different types of investors may react to this effect in different ways, said Richard Portes, a professor of economics at London Business School. "You've got two categories of investor," he explained. "One is the central banks, which have been putting their reserves in the dollar securities, typically Treasury securities. The other is the private sector. The private sector has not, in the past couple of years, net been putting its money into American securities. In fact, there's been a net outflow in equities." Central banks will eventually take the same cue, he added, if they continue to see the value of their dollar-denominated reserves plummet. "People say central banks don't care if they lose money," Professor Portes said. "That's just not true. I've talked to central bankers who have said, 'I'm not going to be the last one out of this room if a fire breaks out.' " Indeed, central banks have already started to diversify holdings away from the dollar, which is a factor behind its drop. But this process hasn't created a crisis yet, nor has it substantially cut the funds available for businesses and consumers in the United States. "Asian central banks have already diversified and will continue to do so," said Kathleen Stephansen, director of global economics at Credit Suisse. "But that's not putting into question the fact that the dollar remains the predominant currency in the basket, and I'm thinking particularly with regard to China." Ms. Stephansen pointed out that new sources of funds for the American market are popping up all the time. "There are a lot of emerging markets that are extremely good at creating gross domestic product, and they don't really have the financial wherewithal at the moment to invest the proceeds," she said. "The U.S. still remains the most liquid market. And that's why I think we'll continue to see capital flows coming here." Even with more money rolling in from developing countries — and, more recently, oil exporters as well — you might expect savvy American investors to start putting their money overseas. After all, if you had bet on the euro five years ago, you would have earned a 50 percent return by now. Though investors have been shifting money overseas, they haven't moved as much as you might expect. Ms. Stephansen said that American investors still had a significant homeward bias, and that, given market realities, their portfolios were still "very much skewed towards the U.S." And what of the opportunity for foreigners to do some bargain-basement shopping for American assets and companies? Ms. Stephansen said the dollar would probably have to fall further before a wave of rate-driven foreign direct investment occurred. It might not be too far away, though; she suggested that a climb by the euro to $1.40, compared with $1.32 on Friday, could be enough. In the meantime, the dollar's plunge may have actually had a salutary effect on investors' view of the United States. Professor Portes remarked that as the dollar falls, so does the value of the nation's debt in international markets. In fact, he estimates that the value of the nation's debt, restated in terms of other currencies, has fallen enough this year to offset the entire trade deficit — which, after all, is a collection of debts as well. "That should be reassuring to foreign investors, that the weight of this debt overhang has been reduced very substantially," he said. "Roughly speaking, this valuation effect has just about accounted for the current account deficit. Talking about what foreign investors see, I'm suggesting they see a picture that is not as grim as you would have seen a year ago, even." With all of these counterbalancing effects, the dollar's decline could continue in an orderly and relatively benign fashion. The economy could see what, under the circumstances, would be the best of all possible worlds: a lower dollar helping to support American exports, while foreign money continues to rush into the country. Even this outcome wouldn't be entirely painless, though, since consumers and businesses would have to pay more for imported goods and services. Right now, Ms. Stephansen said, the principal danger is an outside shock that would dent foreigners' confidence in American markets. In the absence of something so significant, shifts in trade and investments will happen gradually — though it's hard to tell how far along the process is. "It's difficult to draw any clear-cut conclusion here," she said. "I don't think that we'll have much in terms of a clear picture until we get more data. What does that sound like? A typical economist, right?" -- Yoshie <http://montages.blogspot.com/> <http://mrzine.org> <http://monthlyreview.org/>
