Everyone loses if decline of dollar turns into a rout

FIRST comes euro parity to the dollar. But then what?

History suggests a simple outcome: overshoot. A 20% drop in the dollar-euro exchange rate eliminates the overvaluation that several studies suggest still exists. Then comes another 20% on top of that.

This is not as outlandish as it might sound. The euro started life at 1.17 to the dollar, and many believed it undervalued then. Further back, the synthetic euro traded as high as 1.34 in 1995. The only real question is what will stop the dollar falling back there again.

Central banks are already trying to slow its decline, at least against the yen. But such support cannot stop a secular trend - and, indeed, the consensus is that this is a new trend.

Usually it pays to be suspicious of a consensus. But probably not this time.

It does not require active dollar selling for the currency to weaken, merely that foreigners stop buying.

The US requires $10 billion of fresh foreign financing a week to cover its current account deficit. And foreign investors are full up with dollars. Even without accounting scandals, they don't want any more.

The US government has shown little stomach to try to stop the dollar falling.

After all, it loosens monetary policy and so boosts growth. What is surprising is that President Bush's government has not come out more strongly against the strong dollar policy it inherited from the previous administration.

The reason for this? Fears, perhaps, that the dollar's decline will turn into a rout.

This would help no one - especially not Europe where rapid euro appreciation would kill off what little growth the Continent's struggling major economies have left.

Copyright 2002
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