OTTAWA -- Exchange rates are telling the world what central bankers have been warning about for years.
The relentless consumption habits of Americans are no longer sustainable, nor are the saving habits of Asians. The precarious balance that the world economy has lived with for the past few years is crumbling.
And according to many experts, the precipitous fall of the U.S. dollar is a symptom, or perhaps the latest trigger, of the brutal but necessary rebalancing that the world has to endure to get back on course.
"It's the year of reckoning," said Barry Eichengreen, an economics professor at the University of California, Berkeley, and a leading researcher of global imbalances.
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But will this unwinding mean deep, widespread pain across the global economy, or will the damage stay contained? Some leading global economists fear the former, mainly because China is reluctant to participate in the adjustments.
"It's definitely a delicate moment," said Kenneth Rogoff, an economics professor at Harvard and a former chief economist at the International Monetary Fund.
For Mr. Rogoff, things get worse from here. In his research, he has stress-tested the global economy to see what would happen if the U.S. current account deficit shrank rapidly. His scenario is playing out.
"If the rest of the world continues to grow at a good clip, that helps to cushion the global retreat," he said, but he's not confident that will happen. "I think we have yet to see the other shoe to drop."
Namely, since many Asian and Middle Eastern countries - the ones with the big current account surpluses - have refused to let their currencies float freely, the economies with flexible floating exchange rates are having to absorb the global adjustment. That means Canada, Europe, Japan, Australia and New Zealand.
Canada, in particular, has had to suck up much of the U.S. dollar depreciation, mainly because other major commodity exporters don't have floating exchange rates, says Don Drummond, chief economist at Toronto-Dominion Bank.
As the U.S. dollar continues to depreciate, and American exports flood the world, if Asia doesn't allow its currencies to appreciate and its domestic demand to pick up the slack and buy, there is bound to be a fallout, Mr. Rogoff argues.
"There are going to be tremendous pressures politically on the Asian economies to respond. They don't seem to have the [inclination] to deal with it," he said. "I'm very worried that we have a big round of protectionism coming out of this."
That's probably the worst-case scenario: a U.S. recession that spills over into much of the rest of the world. The "decoupling" of the world economy from the U.S. economy evaporates, and Canada, Europe and other industrialized countries see parts of their economies flat-line.
It's a scenario that Bank of Canada Governor David Dodge has been warning about for years. He and other central bankers have argued long and hard that the U.S. current account deficit was growing too fat, and that Asia, especially China, was not being flexible enough in stimulating domestic demand to carry its own weight in the global economy.
One day, they warned, these imbalances will unwind. And it seems that day is here.
"We can't delude ourselves into thinking that economic imbalances will be resolved in an orderly way through exchange rate adjustments alone," Mr. Dodge said last year.
It will take more than a day, and probably a few quarters, but the world will eventually come through the adjustment, says Mr. Eichengreen. In the meantime, "it's pretty brutal for the world economy."
Still, it will probably take a few more triggers to push the world economy to that point, economists say.
The U.S. dollar still has a lot of room to weaken further, and not just because speculators tend to overshoot, said David Rosenberg, chief U.S. economist for Merrill Lynch. The housing crisis is becoming a consumer crisis, and demand in the United States will soon drop off, he said.
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March 22
Speculation that the Federal Reserve will cut interest rates drives the greenback to its weakest point in two years against the Euro.
April 26
The greenback falls to near record lows against the euro again, as concerns about U.S. debt and current account deficits take their toll.
Aug. 10
A liquidity crisis stemming the souring of the subprime mortgage market in the U.S. plays havoc with the markets and drives the U.S. dollar down..
Sept. 20
The Canadian dollar reaches parity with the U.S. dollar.
Oct. 12
Crude oil hits a record $84.05, driving the loonie even higher.
Nov. 7
Speculation that the Fed will lower rates for a third time this year drives the U.S. dollar to near record lows. The loonie flirts with $1.10, before falling back.
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UNWINDING THE U.S. DOLLAR: WHAT'S THE WORST THAT COULD HAPPEN?
Worst-case scenario
Crash
The U.S. dollar crashes, Japan and Germany falter, Asia doesn't co-operate.
Crunch
The credit crunch returns with a vengeance, and investors can't handle the double exposure to a slowing global economy and shaky markets.
DefenCe
Industrialized economies get defensive, throw up trade barriers, and the global economy grinds to a halt. Eventually it recovers, as investors pour their money back intothe United States, but there is much carnage along the way.
Best-case scenario
Buying
The U.S. dollar weakens gradually, U.S. exports rise, but the rest of the world, especially Asia, buys them up willingly.
Growing
Emerging markets sustain world growth, and growth in Europe and Canada moderates but doesn't collapse.
Rebounding
By the middle of next year, the U.S. current account deficit is somewhat smaller, confidence returns to the U.S. economy, the currency rebounds, and crisis averted.
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