Will Uncle Sam let the dollar collapse?


By Liam Halligan

The dollar is taking a pounding. With the US sinking deeper into recession, the greenback recently hit an all-time low against the euro and a 12-year low against the yen.

Last week, America's currency fell again - dropping more than 2 per cent in euro terms, to $1.5779. On a trade-weighted basis, the dollar is now south of its late-70s low point and close to its historic nadir of the mid-1990s.

The markets sense the US Federal Reserve, having already slashed interest rates by 300 basis points to 2.25 per cent since the credit crunch erupted last summer, will soon cut rates even more.

The European Central Bank, in stark contrast, looks determined to keep rates at 4 per cent - where they've been since sub-prime broke. Eurozone inflation, at 3.3 per cent, is still way above target. And with ECB Chairman Jean-Claude Trichet stressing upside price pressures last week, eurozone rate cuts seem unlikely.

In other words, the gap between euro and dollar rates looks set to get wider - making the US currency even less attractive.

And, last week, just as fresh data showed America's housing and manufacturing sector weakening further, business confidence in Germany - the eurozone's largest economy - jumped up. That suggested an even bigger euro-dollar interest differential, piling still more pressure on the greenback.

advertisementBut a falling dollar is not necessarily bad news for the American economy. The underlying reason for the currency's weakness, beyond the current woes on Wall Street, is that years of over-consumption have resulted in a massive US trade deficit - which, in 2006, reached 6 per cent of GDP.

The dollar's decline has lately helped address that - by making US goods more competitive. Over the last two years, American exports have risen 17 per cent in value terms, cutting the trade shortfall to 4.7 per cent of national income.

In other words, as has often happened in recent decades, a falling dollar has shoved the burden of America's adjustment onto the rest of the world. And now - as the White House knows well - a further dollar slide will play a large part in rescuing the domestic economy.

The US takes a dim view of other countries - such as China - allowing their currencies to remain weak against the dollar. But when it comes to old-fashioned beggar-thy-neighbour exchange rate policy, the Americans are past masters.

There are limits to this process. The euro has risen some 17 per cent against the dollar over the last year, with much of that rise happening since January. This makes life tough for the eurozone's exporting economies - which, apart from Germany, are now suffering badly.

That's why Trichet now expresses "concern" at the drooping dollar. French president Nicolas Sarkozy has gone further - describing America's ailing currency as "a precursor to economic war". Elsewhere, too, the complaints are getting louder. Japan's Finance Minister, Fukushiro Nukaga, says the dollar's decline is now "excessive".

Such statements are preparing the ground for a meeting in two weeks' time - when finance ministers and central bankers from the G7 gather in Washington. The headlines will be about post sub-prime regulation. But the meat of the summit concerns the dollar.

The big question is whether to intervene in foreign exchange markets to prop up the currency. When co-ordinated among several large central banks, such initiatives have worked quite well. The 1987 Louvre Accord helped halt a sliding dollar, as did joint intervention by the US and Japan in 1995.

But, if the G7's upcoming dollar dialogue is conducted in whispered tones, another much bigger question won't be discussed at all - the dollar's status as the world's reserve currency.

Central banks everywhere use the dollar to stockpile wealth. While the share of sovereign foreign exchange holdings in dollars has fallen slightly, still stands at 65 per cent.

This reserve currency status brings America huge power. It puts the dollar constantly in demand, meaning the US can secure cheaper debts and run bigger deficits at everyone else's expense.

The US currency has enjoyed this privilege for decades. But America has lately made a habit of abusing its reserve currency status, periodically allowing the greenback to fall to bolster an increasingly sluggish, debt-prone US economy.

Other countries then not only lose out via more competitive US exports. Having used the dollar to store their reserves, they also incur massive balance sheet losses.

The cracks are now starting to show in the dollar's reserve currency status. For the first time, Saudi Arabia now refuses to cut interest rates in line with the Fed - the first step towards a break in the kingdom's dollar peg. If that break happened, it would spark a massive flight of Middle Eastern assets away from the US currency.

Chinese exporters are also now shunning the dollar in non-US transactions. Again, that's a worrying sign for the States. With its $1,400bn of reserves, China is the biggest investor in dollar-denominated assets by far.

With the Fed expected to cut rates by at least another 25 basis points at its next meeting on April 30, the dollar can only get weaker in the coming month. So the US may be forced into a G7 initiative to strengthen its currency.

The trouble is, since the last joint-intervention, the balance of world power has changed. Today, around 75 per cent of the world's foreign exchange reserves are held not by the West, but by the likes of China, Russia and Brazil.

So any initiative will have to involve them - even though they're not in the G7. And that will expose the grouping for what it is - an anachronistic hark-back to a world that no longer exists.

Surging cost of rice is food for thought
The most important economic headline of the week wasn’t about housing, “sub-prime” or any of the central banks.

You may not have read that “Rice prices hit $760 a tonne” in the mainstream press. But it’s a trend everyone needs to notice

Rice is the staple food of more than 3bn people. Only a few days ago, it was $580 a tonne. So the price of the crop relied upon by half the world’s population, many of them close to the poverty line, just surged 30 per cent.

Global food prices are now caught in a “supercycle” – on an inexorably upward trend. Apart from rice, corn prices just hit a 12-year high. Earlier this year, wheat prices jumped 90 per cent in a single month.

Inclement weather and the increased use of land to cultivate biofuels has caused food shortages across the globe. World rice stocks are at their lowest since 1976.

Yet, with humankind growing by 70m each year, with the emerging economies of the East producing ever-richer consumers, global food demand keeps rising.

Sky-high food prices are now stoking fears of serious social unrest across Asia and parts of Africa. And with leading rice producers now imposing export bans to keep local prices down, the shortages are likely to get even worse.

My defence against house price brickbats
Phil Spencer criticised for market comments advertisementLast week, I had the audacity to argue that the annual growth of UK house prices is likely to “flat-line” for a few years, or may go “slightly negative for a while”.

I reasoned that “in some areas, buy-to-let has been overdone” and too many flats have been built, leading to a “glut” – which could cause “quite significant” falls in the price of such properties. But I concluded that talk of a 30 per cent “crash” in annual house prices was alarmist.

We could see such a drop in America – due to more prevalent “sub-prime” lending, but also a housebuilding boom sparked by years of ultra-low US interest rates.

It’s this massive “overhang of excess inventory”, in my view, which has driven US house prices 10 per cent lower over the past year.

UK mortgage lenders are, of course, now also exercising more caution. That’s one reason new Nationwide figures show annual price growth down to 1.1 per cent.

However, I maintain that, in most parts of the UK, a shortage of housing, and lack of permission to build more, means “most buyers waiting for the big house price drop are likely to be disappointed”.

Perhaps that’s why my article provoked so many comments on various internet forums – including some (though not on the Telegraph website) that were rather rude. Be that as it may, I still can’t see UK house prices falling by 30 per cent.