So you're starting to feel a bit queasy from the U.S. dollar's tumble? Two syllables of advice: Gravol.
The wild ride may be far from over — and it could be bumpy. That might seem hard to imagine, given that the world's most important currency is already down 29 per cent against seven major world currencies over the past 33 months.
In the past three months alone, the greenback has slumped 12 per cent against the euro, 8 per cent against the Japanese yen and 9 per cent against the Canadian dollar. How much worse could it get? Much.
Despite the plunge, experts warn, the dollar — for years, the darling of foreign exchange markets — is probably still overvalued. More importantly, they say, the U.S. dollar is in the midst of a long-term correction needed to rebalance a global currency and trade picture that is dangerously out of whack.
The correction poses sobering risks for global financial markets and probably has a few more years and another 15 to 20 per cent before it's over. No less an authority than former U.S. Federal Reserve Board chairman Paul Volcker warns that there's a 75-per-cent chance of a dollar-fuelled financial crisis within the next five years, unless Washington adjusts its economic policies.
The moribund dollar, of course, is only the most visible symptom of a more systemic disease: the dangerously bloated U.S. current account deficit. This deficit — a broad measure of all U.S. trade in goods and services — is now running at more than $600-billion (U.S.), over 5 per cent of U.S. gross domestic product and a value equal to the entire GDP of India.
These numbers are signs of an unbalanced economy that is consuming far more than it is producing, spending far more than it is saving. Record-low personal savings rates have been exacerbated by the massive U.S. federal budget deficit. To cover the shortfall, the United States must rely on increasing amounts of foreign investment dollars entering the country — an estimated $2.6-billion each and every business day.
As Mr. Volcker said in a television interview last week: "We are increasingly reliant on the goodwill of strangers." Because the exodus of dollars to buy foreign goods and services so far exceeds the influx of dollars from sales of U.S. exports, the currency's decline was inevitable.
A cheaper currency would also help cure the current account imbalance. It would discourage U.S. demand for imports, while making U.S. exports cheaper for foreign buyers. That's part of the best-case scenario, in which U.S. and global markets navigate safely through the treacherous waters of a long-term dollar retreat, relying both on remarkably good luck and co-operation from foreign investors willing to keep investing in U.S. assets to finance the deficit.
But all sorts of pitfalls might cause these investors to lose faith. The worst-case scenario is much less pretty: Foreign investors, losing confidence in the U.S. dollar's stability and increasingly doubtful that the American economy can absorb the current account imbalance, yank money out of U.S. government bonds, in favour of safer harbours.
This exodus sends the dollar off a cliff. Interest rates spike higher, reflecting plunging demand for U.S.-dollar debt and the rising risk perceived by investors.
Stock markets tumble, as investors flee U.S. stocks to avoid the currency losses tied to U.S.-dollar-denominated stock prices, as well as the rising interest rates that imply less competitive returns at current stock valuations and the drag on corporate profits from rising credit costs. Corporate and consumer spending slump under the weight of rising interest rates and import prices. The U.S. economy slows to a recession, dragging the rest of the world down with it. Policy makers stand by helplessly; if the Federal Reserve Board were to cut interest rates to stimulate the economy, it would only put more downward pressure on the dollar.
Far-fetched? Maybe. Martin Barnes, who described just such a chain of events in his independent research report The Bank Credit Analyst, acknowledges that the scenario — he called it his "ugly" case — is "overly gloomy." But it has happened before.
