November 07, 2004

The Coming Collapse of the Dollar?

At the moment, the U.S, is running large trade deficits as foreigners take dollars they would otherwise use to buy exports and use them to buy property, stocks, bonds, and other assets in the U.S. But someday foreigners will conclude that they have enough invested in the U.S. Their appetite for dollars to fund investments in America will diminish. The trade account will move back into balance. And a declining demand for dollars will push the value of the dollar down. Odds are that when foreign investors are satiated with dollar assets--whether that comes one, five, or twenty years from now--the value of the dollar in terms of other countries will be 30 to 60 percent less than it is now.

And so we get to one of the deep mysteries of today's economy: if the dollar today is indeed above its expected long-run equilibrium value by so much, why don't investors demand a premium return--an extra 3% or more in the current interest rate--in order to be happy holding the dollar assets they do? Since dollar interest rates are about equal to those outside, what business does the dollar have being above its long-run fundamental value? All our models say that--given the low level of U.S. interest rates--the dollar should *already* have collapsed to perhaps 2/3 of its present value.

The best answer I've come up with is that the dollar is above its fundamental value because most people who might place very large bets on a rapid decline in the dollar thinks such bets are still too risky, but the risk associated with them is falling every day, and someday...

Meanwhile, Treasury Undersecretary John Taylor gets to play the part of the Little Dutch Boy: Dollar Falls On Fears of U.S. Deficits: The dollar continued its decline in global currency markets yesterday, intensifying worries among some economists that mounting U.S. budget and trade deficits could send the U.S. currency into a tailspin. But John B. Taylor, the Treasury undersecretary for international affairs, defended the Bush administration view that the deficits pose no danger of a dollar collapse. He issued a detailed rebuttal of what he called "scare stories."

The dollar fell yesterday to within a fraction of a cent of its all-time low against the euro of $1.2930 , trading as low as $1.2898 before rallying slightly to close at $1.2867. It fell modestly against the Japanese yen, and continued a sharp slide against the Canadian dollar, which rose to 83 U.S. cents yesterday for the first time in 12 years.... "As the dust settles after the U.S. elections, the one theme that is developing is the growing recognition [in the markets] of the need for more dollar depreciation," economists at J.P. Morgan told clients yesterday, citing as one major reason the likelihood that "there will be no serious new policies to trim the U.S. budget deficit." Behind such sentiments is the belief that the U.S. economy is too dependent on foreign investors, and that they may balk at pouring money into U.S. securities if the country's debt continues to soar.... "One of the big drivers in the whole big picture the markets are looking at now is our being dependent on foreign sources of funds," said David Solin, managing partner at Foreign Exchange Analytics in Essex, Conn. "Obviously, if the foreigners step back [from investing in U.S. bonds and stocks], there are going to be serious problems, not only for the dollar, but for all financial markets."...

Those scenarios were dismissed as fanciful by Taylor, who spoke yesterday at an American Enterprise Institute seminar on the current account deficit, the broadest measure of the trade gap. The large influx of foreign money shows that "sound, growth enhancing economic policies are continuing to make the U.S. an attractive place to invest," he said. Taylor said administration policies already in place will help shrink the trade deficit. One is President Bush's pledge to cut the budget deficit in half, as a percentage of the U.S. gross domestic product, by 2009. That would decrease the trade deficit because lower government spending or higher taxes would reduce the amount of money consumers spend on imported goods.

Taylor pointed out that the Treasury is also prodding foreign governments to achieve faster economic growth, which should increase demand for U.S. exports, and it is trying to persuade China to change its fixed-exchange rate policy by allowing its currency, the yuan, to rise. A higher yuan would be likely to slow the flood of Chinese goods into the U.S. market because those products would become more expensive for U.S. consumers.

"Even if those policies take some time" to reduce the trade deficit, Taylor said, "there is no reason to think there will be problems in the meantime" in continuing to obtain enough money to cover the gap.... Taylor's views were seconded by some of the other speakers at the seminar, including Allan H. Meltzer, a professor at Carnegie-Mellon University. But others maintained that the current account gap is certain to drive the dollar down one way or another -- either gently and gradually, or suddenly and sharply. ... President Bush's news conference yesterday did little to lessen concerns over the deficits, Wall Street analysts and currency traders said. Bush simultaneously promised not to raise taxes under the guise of tax simplification, to pursue a costly restructuring of Social Security and to cut the budget deficit in half by 2009...

Posted by DeLong at November 7, 2004 03:58 PM | TrackBack

I've been picking up rumors among currency trading folk that Middle Eastern and European financial big-wigs were waiting to see the results of the election, and that if W won, they would start dumping their dollar assets, fearing that another W turn would mean more fiscal insanity and foreign policy bullying. The last few trading days have seen large drops in the dollar vis-a-vis gold, silver, and the Euro, which gives credence to these rumors.

Posted by: FDRLincoln at November 7, 2004 04:38 PM

So, have super-rich americans shielded their assets against a dollar fall?

Posted by: yesh at November 7, 2004 04:47 PM

Suggestions needed!
How do you suggest someone with $x in a Fidelity account respond? I need some practical advice. The answer can include any US stocks, mutual funds, bonds or anything available through Fidelity.

Posted by: Too Much Cash at November 7, 2004 04:49 PM

Too Much Cash,
Don't expect anyone to rush to your aid with good advice. I have asked the same question on several blogs and gotten nothing. People want to rant but not to detail any ideas of how to survive and maybe thrive in the next 4 years. Economics blogs seem to be able to do a lot of doom and gloom but nothing in the way of practical advice.
Good Luck

Posted by: dilbert dogbert at November 7, 2004 05:01 PM

Why not simply hold the Europe Stock Index? European companies have been restructuring for some time, valuations are reasonable, and though Europe is growing slowly I find no reason to avoid a long term investment in the index. The Europe Index seems a nice low cost long term hedge against the dollar.

Posted by: anne at November 7, 2004 05:11 PM

So, Brad: if you were tasked (purely as a hypothetical debating exercise) with making a case that a substantial overseas holder of Amercian public debt should NOT sell, but continue to hold, how would you make that case?

Posted by: Frank Wilhoit at November 7, 2004 05:12 PM

To hedge against a decline in the dollar, the average investor could buy either of the following foreign bond funds (investing primarily in euro bonds):

BEGBX (hedges no more than 25% or so of currency risk)

PFUAX (PIMCO fund, completely unhedged)

These funds will do well if the dollar falls against the EURO, and they have medium durations, so the interest rate risk is relatively small.

As someone already mentioned, you could also buy euro equity index funds, but that is less of a pure currency play.

Posted by: steve at November 7, 2004 05:23 PM

Vanguard offers the Europe Stock Index, though the index can be bought as an exchange traded fund.

Posted by: anne at November 7, 2004 05:24 PM

I agree with Anne (hold Euro index funds). Maybe I would go with some sort of Emerging Market Index too, but that's going to involve more risk.

In the past, international diversification has never seemed particularly important -- most large cap American companies give you indirect diversification and you lose out on strong US growth anyway. Now, it feels much different, and I feel like I'm in a race with the dollar to figure out what's best.

Posted by: Drew at November 7, 2004 05:25 PM

The other poster is right about what to do to hedge the declining dollar. Mostly, trade your paper dollars for tangibles, including commodities like PCRIX, the gold mutual fund referenced or any other good gold/PMs fund, natural gas and oil. Get into other currencies. Just about every other currency is rising in value against the dollar. Get a basket of currencies via something like Everbank, or bonds via the other poster's fund, or PSAFX. US stocks might even go up in the inflation, so maybe the stock market will be ok. There are one or two really good places on the web to educate yourself. Check 'em out.

Posted by: sculpturearts at November 7, 2004 05:39 PM

An advantage of the Europe Stock Index is the low cost, and reason to consider the index as a long term investment. If the Value and Growth portions of the Europe Index could be bought as an exchange traded funds, I would favor one or another, but the full index will suffice.

Posted by: anne at November 7, 2004 05:40 PM

Too much cash,

In general, if you believed the dollar was going to fall sharply you want to own US companies which export product (or compete in commodities), foreign companies that don't mostly export to the US, and also stuff like foreign bonds.

How that translates into fidelity is hard to say because each fund involves so many holdings, but they do have offerings which have interesting themes if the dollar fell such as the Fidelity Export and Multinational Fund or the China Region Fund and the Emerging Markets Fund. One thing that should also work if Prof Delong's scenario pans out is energy. I know that's had a good run, but if the dollar plummets as the Prof. suggests then it's not over since emerging market countries like China will more easily compete with the US for oil.

I think the majority of the fall from this point will be against Asia and emerging markets, not the Euro, but that doesn't mean a well diversified portfolio shouldn't also contain European stocks or bonds.

Posted by: snsterling at November 7, 2004 05:41 PM

Don't consider this investment advice, but in my rollover account I currently hold FDIVX (along with two others) and in my 401k I hold VDMIX (along with two others). The problem I see with these is that a dollar collapse will tank overseas stock markets as well as American because, like it or not, everyone on the planet is exposed to the American market. If you are really paranoid, an inflation-protected fund like FBIPX or VIPIX might be up your alley. SBGLX is one of very few international inflation-protected funds listed at Yahoo, though it seems to hold a lot of Italian notes. Be warned that any inflation-protected security has a good chance of underperforming other investments - you "pay" for the risk reduction.

Posted by: Tom DC/VA at November 7, 2004 05:48 PM

I mentioned the PIMCO fund PFUAX, which is completely unhedged. This fund is so new (started earlier this year) that the symbol isn't always recognized (I just tried E*Trade and it wasn't listed, but WSJ and Yahoo!Finance had it).

Those PIMCO guys are smart - I think they anticipated demand for a clean way to hedge US dollar risk.

I also own their commodity fund PCRCX:
For the one-year period ended September 30, 2004, PIMCO Funds:Commodity Real Return Strategy/C had a total return of 32.8%, versus a total return of 13.9% for the S&P 500 Composite Index.

Posted by: steve at November 7, 2004 05:51 PM

Thanks all.
I was beginning to think you all were great at micro and macro but had nothing to say to pico or femto.

Posted by: dilbert dogbert at November 7, 2004 06:06 PM

dilbert, do you see warren buffet posting on blogs?

i'm not being facetious: the fact is, it's easier to diagnose what ails the economy than it is to determine the best way to play the markets (there are, in short, many more smart economists than there are smart investors).

i personally, for instance, am pessimistic about many aspects of the u.s. economy, and i really don't have much of a clue about how to invest with that in mind, because i see no undervalued asset class, nor any with a sure prospect of success.

as a result, i'm largely holding cash until the smoke clears and buying opportunities present themselves. Bear in mind that real money is made when there's blood flowing in the markets, not when markets are at highs. (small example: the last smart move i made in the market was loading up on Time Warner when it dropped to around $8.50 just over 2 years ago, on the grounds that when a share of time warner stock sells for the same price as a movie ticket, that's a buying opportunity. but these chances have been few and far between over the last several years.)

Posted by: howard at November 7, 2004 06:07 PM

Remember that the big mutual funds like the Vanguard European stock index will be hedged in terms of exchange rate risk. So they are unlikely to gain when the dollar depreciates -- but they won't lose either. Putting a pure exchange rate play in the portfolio requires more effort.

Intellectually, the question is why a previously good economist like John Taylor is now spouting stuff that he has to know is wrong.

Posted by: P O'Neill at November 7, 2004 06:11 PM

Turning back to 1985 and the Plaza Accord, the soundest investments as the dollar declined sharply were international stocks.

Posted by: anne at November 7, 2004 06:12 PM

Remember, we engineered a 40% decline of the dollar in September 1985 with the Plaza accord. James Baker, close friend of George Bush, was responsible for the agreement. We might well be willing to have just such a decline in the dollar now.

Posted by: anne at November 7, 2004 06:22 PM

Howard makes a good point - between real estate (bubbly in major markets), stocks (broad P/E ratios are still pretty high and many companies will be hit by rising interest rates), and bonds (set to fall if interest rates rise, though they still might be considered a safe haven if the economy goes down), no asset class looks very appealing. Commodities are a possibility (my FSNGX has done nicely in the past 6 months) but they've rallied a lot over the past few years and with China cooling off, growth opportunities may be limited.

I need to make this year's IRA contribution, and at this point I really have no idea where to put my money either.

Posted by: Tom DC/VA at November 7, 2004 06:24 PM

This should not be considered investment advice, but if you are content to stash currency in a non-interest-bearing Euro account, you can use an outfit called EverBank that I read about in BusinessWeek a few years ago. I put $2500 in an account in early 2002, when I saw which way W's policies were going, and pulled out $3270 a couple of years later.

Of course I honeymooned in Paris last month which wiped out any net gains I made on the decline in the dollar.

I have no affiliation with the company or official recommendation to make, but it is something on my mind.

Posted by: Brittain33 at November 7, 2004 06:25 PM

The crack about Buffet and blogs is a bit unfair. The poster was willing to *assume* the dollar will tank and wants to know how to hedge against it. So, we are really just providing technical advice - not calling the direction of a market.

To take it to an extreme, someone mentioned you could just directly buy a basket of foreign currency at Everbank and hold it as cash. If you are *sure* the dollar is going to plummet that is all you need to do.

Posted by: steve at November 7, 2004 06:25 PM


Sound sound comment.

Posted by: anne at November 7, 2004 06:27 PM

anne - many thanx.

steve, really, i wasn't trying to be unfair. the fact is, none of us is "sure" about anything; even the best investors get things wrong. I was only pointing out that sussing out economic trends is not the same as sussing out market trends: markets can be over or undervalued for very long times, although as ben graham tells, in the short run, markets are a voting machine, but in the long run, they are a weighing machine.

Posted by: howard at November 7, 2004 07:10 PM

Despite comments above, Vanguard does not appear to hedge their international shares funds (according to what I read on their website). That's why they mark them as 'aggressive': because they are exposed to currency fluctuations. I'm sure a simple e-mail to Vanguard would answer the questions for you for sure.

Had I money (instead of mortgage) that's what I'd buy - Vanguard total International fund. Having mortgage, I am paying it off instead (9 more months!).


Posted by: meno at November 7, 2004 07:39 PM

I'm glad this topic came up and that others seem to have the same instincts I do. I actually sold my Vanguard treasury fund and bought one of their international funds (can't remember which one at the moment - not an EU fund, more international). Maybe I'm being tin foily, but I figure if in doubt diversify. . .

I've always liked Vanguard funds since I was first recommended them by the Motley Fool guys years ago. Ever since, I've noticed that whoever is being investigated or fined for market timing and other malfeasance, it isn't Vanguard. Not that that means anyone will make money, but at least it isn't being siphoned off illicitly.

Posted by: Emma Anne at November 7, 2004 07:56 PM

If you are with Fidelity, I think you are much better off with PFBDX instead of PFUAX. They are the same exact fund, except PFUAX has a load and PFBDX has no load. PFBDX may have a slightly higher expense ratio...

Speaking as one of the lesser super rich. I think that Bush is going to make me somewhat more rich.

Posted by: HeeHateMe at November 7, 2004 08:00 PM

Stupid question from non-economist: If the dollar depreciates, will it make the deficit less serious in real terms? Inflation is bad for investors, but how will it affect the average person in America, with debts rather than "too much cash"?

Posted by: Angelica Oung at November 7, 2004 08:10 PM


To the extent that the dollar gets weaker, it will take higher interest rates to justify turning this around, or increasing the demand for the dollar. So to the extent that interest rates have to rise in order to see off a major decrease in the value of the dollar (so that there is more demand for USD), then the average joe holding debt will be affected by higher interest rates on their adjustable mortgages and other debt.

Posted by: Jake Walker at November 7, 2004 08:29 PM

another good play is the templeton foreign bond fund. (TGBAX) decent income and cap appreciation if the $$ falls....

Posted by: marku at November 7, 2004 08:36 PM

Thanks for the explanation, Jake.

Posted by: Angelica at November 7, 2004 09:37 PM

As far as the story goes -- one thing I fear is that China will sell dollars until the right people are scared, and then offer to stop in return for a political quid pro quo.

If they waited until November 5 to sell dollars, obviously they wanted Bush elected, right?

Posted by: Zizka at November 7, 2004 09:38 PM

Howard: I agree with your macro vs market comments. It is not easy to turn trend observations into profitable trades. But, there is a technical question, which is: IF I know the dollar is going down vs. (e.g.) Yuan over some timeframe, WHAT trade should I make. I think we were working under that assumption.

BTW, here is something I got from an FX trader. (See my blog for more detail:

"Interesting read. As tomorrow's FT article points out below, if the dollar doesn't rally on strong payroll #s, something fundamentally may be changing.What is it ?Potentially foreign governments cutting exposure to US assets. Article cites China, India, Russia and other Middle Eastern countries selling $s. Widening US budget and current account deficits can't be helping either on a 'secular' basis."

From FT: Many currency traders were taken aback on Friday when the greenback fell in spite of bullish data showing the US economy created 337,000 jobs in October. "If this can't cause the dollar to strengthen you have to tell me what will. This is a big green light to sell the dollar," said David Bloom, currency analyst at HSBC, as the greenback fell to a nine-year low in trade-weighted terms.
Speculative traders in Chicago last week racked up the highest number of long-euro, short-dollar contracts on record. Options traders have reported brisk business in euro calls - contracts to buy the euro at a pre-determined rate. However, the market has been rife with rumours that the latest wave of selling has been led by foreign governments seeking to cut their exposure to US assets.

Posted by: steve at November 7, 2004 10:54 PM

"Inflation is bad for investors, but how will it affect the average person in America, with debts rather than "too much cash"?"

If your debts are mostly in terms of a fixed-rate mortgage, then you are okay. Those dollars which you owe today (and which you used to buy your house) will be worth less when you have to pay them back. Moreover, a weakened dollar (except in armageddon scenarios) is good for American employment, so you're more likely to keep your job. If your debts are in terms of adjustible rates, then it's possible you are about to pay the piper.

As to the question what to buy with the idea that the dollar will go down...

First, if you're looking at foreign instruments, you want to buy bonds, not equities.

Secondly, you have to ask what is the reason for wanting to do something: is it for speculative or hedging purposes? If it is speculative, buy gold, and speculate with the best of them. If it is for hedging (you're worried that your future payments - college bills, medical bills, etc. - will be higher because of a weakened dollar), you're basically worried about inflation, so you can buy TIPPs. (The expense of a European vacation gets included in the relevant inflation index, doesn't it? Honest question, not sure... If it doesn't then you need to buy some euro-denominated assets, basically with a term that equals the average of when you are planning to take your vacation(s).)

And thirdly, don't get trapped in thinking that Europe is the rest of the world. The fundamental imbalance in the world is not us-europe trade or forex, it's us-asia. Asia just holds a lot of dollars. I agree that this will play out against euro, but at 1.50+ europe becomes very uncompetitive vs. US. Euro will IMHO go higher, but there's a limit how long it can stay higher - it won't be forever. Asian currencies, on the other hand, are out of whack in a fundamental way.

Posted by: Andrew Boucher at November 8, 2004 01:06 AM

A little nit-pick on the graph.

When the Euro was introduced, it was supposed to be at USD 1.10 = 1 .

Instead it fell to $ 0.82 = 1 .

Now it has come back to it's original start position and then continued to become stronger yet.

But your graph shows mainly down, down, down...but some of that down is natural, as the Euro was undervalued.

For investment tips: It's already too late for the big gains. You should have bought back in 2000/2001. I had Australian dollars and Euros.

I guess you can still bet that the US dollar will fall some which case any foreign stock denominated in dollars is okay, or just foreign currency.

Posted by: Aaron at November 8, 2004 01:23 AM

Also, why do the Asian central banks keep buying T-bills?

Because the nightmare of workers protesting lost export jobs in Shenzhen and Shanghai is worse than making poor returns on investments in the USA.

Posted by: Aaron at November 8, 2004 01:27 AM

Also, why do the Asian central banks keep buying T-bills?

Because the nightmare of workers protesting lost export jobs in Shenzhen and Shanghai is worse than making poor returns on investments in the USA.

Posted by: Aaron at November 8, 2004 01:28 AM

It is nice to see the small fry getting their chance to carp along the same lines as those who stride the halls of corporate power. Dilbert doesn't think much of economists unless economists answer the question he wants answered. The honest and correct answer when CEOs demand that economists (or anybody else) answer questions they are not qualified to answer is "not my job." The same applies here. The reason economists don't generally call themselves investment advisors (though there are some investment advisors who are also economists) is that economists do economics.

Anne, Steve, Drew, Scultpurearts, SNSterling, HeeHateMe have come to the rescue, offering a fair demolition of the premise that denizens of economics blogs offer "doom and gloom but nothing in the way of practical advice." Nevertheless, we have here a misunderstanding of the intellectual division of labor. Many economists manage their own investments, and so have (one hopes) views on how to deal with troubles in markets, but the same can be said for dentists. Economist make their input to the investment decision process, but (unless they hang a shingle that says "investment advisor"), economists are not investment advisors. Howard has the broad flavor of the problem, Andrew a good set of supporting points.

Posted by: kharris at November 8, 2004 04:34 AM

Can the G8 be a political shield for the US against the market? Unlikely, the powers of the G8 are now greatly weakened - see the article in last month's Economist. (

" [The US Treasury undersecretary for international affairs] pointed out that the Treasury is . . . prodding foreign governments to achieve faster economic growth, which should increase demand for U.S. exports, and it is trying to persuade China to change its fixed-exchange rate policy by allowing its currency, the yuan, to rise."

Such is unilateralism.

Posted by: IJ at November 8, 2004 04:38 AM

The dollar doesn't "collapse" (whatever that means) because the US economy is still the best thing going in the global economy and the risks elsewhere are greater. As long as this is true, it won't matter too much what the fiscal deficit is.

I'm not defending the deficit, BTW.

Posted by: Jim Harris at November 8, 2004 04:40 AM

Economics Question1 : If China and India loom as manufacturing and services clout over years, does Chinese Yuan and Indian Rupee improve against dollar in the future ?

For eg : One dollar is 45 rupees now... if India continues to do all the software for us, does One dollar has any chance of becoming 20 rupees ?

Posted by: Novice at November 8, 2004 05:01 AM

What do you think of this fund?

Prudent Global Income Fund (formerly Prudent Safe Harbor Fund) is a no-load mutual fund currently structured to benefit from a falling dollar and rising gold prices. The fund primarily invests in foreign and domestic bonds and gold stocks. The fund is similar to many international bond funds but there are a number of important differences.

The Prudent Global Income Fund seeks the highest credit quality primarily by investing in government (as opposed to corporate or agency) securities.

The Fund seeks to limit the risk of rising interest rates by keeping maturities relatively short (1-3 years).

The Fund maintains an exposure to rising gold prices.

A significant portion of the fund's assets are typically invested in foreign government securities. The fund may also hold U.S. Treasury Notes and common stocks of gold and silver mining companies and/or gold bullion. Debt issues typically have a maturity of 1 to 3 years. Foreign debt issues are primarily those issued by our major European trading partners and/or countries with currencies we expect to increase in value against the dollar. If the dollar weakens against these currencies as we expect, the foreign securities in the fund will increase in value.

The fund's investments in gold mining companies primarily include those already mining gold (senior producers) as opposed to exploration or "junior companies." The fund generally seeks those gold stocks paying dividends.

Posted by: Kosh at November 8, 2004 06:40 AM

> the US economy is still the best thing going in the global economy and the risks elsewhere are greater.

To get good returns from a market, you need consumption growth, don't you?

Yet Americans are currently spending just about every cent they can get their hands on, whereas in the other major economic blocs the citizens save from 12 to 30% of their income.

So who has more potential consumption growth? The economic zones with consumers with a great deal of surplus cash in hand, or the US?

Posted by: a different chris at November 8, 2004 07:25 AM

Can seriously different political objectives exist in a global economy? The EU is thinking about this again.

"In a way, Americans or Chinese or Indians have it easier, because they go for growth and competitiveness and that's it".
Europe should in no way abandon its prized social model, which combines the desire for economic growth with concern for welfare and the environment, insists Wim Kok.
"I would not like to copycat the Americans by saying that social welfare systems are just a luxury that we can do without", said the former Prime Minister. (

Posted by: IJ at November 8, 2004 07:31 AM

There does seem to be something afoot in the financial industry with regards to international funds. Lots of new funds. I have some stuff with MFS, saw they just came out with a fund, MFS - International Diversification Fund. (geesh, nice job marketing)

So far it's simply a fund of 5 other MFS intl funds, but it has only been around since the first of October. It will be interesting to see how the fund evolves. I bought in of course!

Posted by: S0C7 at November 8, 2004 07:36 AM

Vanguard international indexes do not hedge. I chose the Europe Index as a reasonable investment in the time of a week dollar, because I think Indexing in Europe will offer a decent return even if the dollar does not lose value against the Pound and Euro. However if the Japanese were to allow the dollar to depreciate against the Yen, there would be reason to own Pacific Index. The question is whether the Japanese are prepared for an strong increase in Yen value. I wonder?

Posted by: anne at November 8, 2004 07:36 AM

"US economy is still the best thing going in the global economy "

Jim, what measure are you using to make that statement? The stock market is less than when Bush took office 4 years ago, as is employment. I am sure many countries have less uninsured.

Here is Georgia were are celebrating the republicna majority by proudly kicking old folds out of nursing homes and kicking 45,000 needy children off of PeachCare.

If only central banks buy all the debt issued this week you had better rethink your statement.

Posted by: me at November 8, 2004 07:40 AM

Again, it is worth pointing out that the Administration may well wish to have the dollar decline in value against European and Asian currencies. Jim Baker, who is most influential as an economic policy adviser, has found no advantage in a strong policy when America needs to gain in export competitivenss.

Posted by: anne at November 8, 2004 08:19 AM


"Here ii Georgia were are celebrating the Republican majority by proudly kicking old folks out of nursing homes and kicking 45,000 needy children off of PeachCare.

Same in Mississippi.

Posted by: lise at November 8, 2004 08:47 AM

But w will protect us from those gays and Muslims.

Posted by: me at November 8, 2004 10:05 AM

All of this talk about declining dollars with no mention of the international petrodollar standard. Why do Asian central banks use the dollar as a reserve currency? It might have something to do with dollars ability to purchase oil from OPEC. OPEC will not allow oil purchases in euro's or yen or any currency other than US dollars. Why is the dollar seriously overvalued when one looks at economic fundamentals? The answer might be that it currently acts as the international reserve currency which is directly linked to its role as international energy currency.

Standard economic models tend to lump all types of commodities into the same catagory. These models ignore that some commodities are more important than others. The most important commodity in the modern industrialized world is energy. If the worlds bottleneck commodity is only priced in terms of dollars, it makes sense that the dollar is overvalued (at least compared to how it should be valued considering international trade flows).

What keeps the dollar as international energy currency? The US's promise to make sure that the oil monarchies stay in control of the world's oil reserves and the US's providing security for international shipping. The current land grab in the mideast brings both of those promises into doubt, more than any continuation of trade and spending deficits. If the US military has bitten off more than it can chew in Iraq, the Saudi's hold on power looks even more tenuous than it did in 2002. If the US military breaks itself trying to hold Iraq then they will not be able to protect international shipping.

The dollar is weakening because the petrodollar standard has nearly broken. I expect that this decline will continue.

Sorry that I didn't tell you which mutual funds can help you profit from this upcoming crisis.

Posted by: Ed at November 8, 2004 10:12 AM

The notion that the dollar is well protected by the relatively better performance of US assets looks a little shaky. Most major European bourses have outperformed the US so far this year, both in domestic and in dollar terms. Just venturing as far as Canada's TSX would have more than tripled gains seen from the S&P. (OK, I cheated. Canada is doing great this year, beating just about all the major markets, but the FTSE is beating the big 3 US major indices, as is the Dax and the CAC and the IBEX.)

Beyond that, currencies can swing far more than the underlying asset. Don't most models of currency overshoot include a bit about investors looking at what other investors are doing? Vicious cycle sort of stuff. The Treasury's longstanding brag about the US market being the most liquid, complete, transparent, blah, blah, blah...all true, but not really all that helpful if investors begin to think they are gonna lose their shirts by holding dollars.

Posted by: kharris at November 8, 2004 11:05 AM



Posted by: anne at November 8, 2004 11:15 AM

It doesn't matter which mutual fund you invest in if your currency collapses -- when the banks go down, they won't be worried about saving the asses of the small investors clamboring at their doorsteps, they will do what every other organization does when it hits the fan: corporate governance will go out the window.

Had an interesting conversation today with a colleague whose wife lived through hyperinflation in Montenegro. It didn't matter if people had your assets in USD or Gold, if the banks held them, they were lost.

Now surely the US isn't heading for hyperinflation unless one or two big banks go down. What's your hedge for that?

Posted by: Steve Wart at November 8, 2004 12:58 PM

Professor DeLong, please help out here. Most of what is being spawned in commentary below ranges from ill informed to conspiracy theory.

I wouldn't disagree with Obstfeld and Rogoff's recent analysis of the unsustainability of the US current account deficit. However I don't think that its so difficult to understand the dynamcis of the current temporary equilibrium without conspiracy theories.

First, much of the financing of the US C/A deficit is coming from central banks, particularly in Asia. These are buying dollars to prevent their currencies from appreciating. Nothing conspiracy or irrational here, purely utility maximisation. They are not buying US assets because they like the yields or the credit quality, they are buying them to prevent their currencies from appreciating in order to support their export growth. This is sustainable for the Asians and the US until this export growth creates positive output gaps and raises inflation to above policy thresholds in Asia. Once rises above these thresholds, the Asian governments will have to allow appreciation of their nominal effective exchange rates. But, really, it doesn't matter, because if they choose to allow inflation to rise rather than appreciate their currencies their real exchange rates will still appreciate. So part of the needed adjustment in the US real exchange rate will still come.

Second, the main financing item in the US capital accout has been inflows into US corporate credit. Again, no conspiracy theories about hedge funds too chicken to place bets are needed. US corporate credit fundamentals are currently the best in years. Default rates have plunged and net debt levels for the corporate sector have fallen. Many corporates are sitting on large cash positions.

So the strength of the dollar has come in part from the policy decisions of Asian and some other central banks and in part from the WILLING decision of the private sector to buy US corporate credit and, in the process, finance the US C/A deficit.

The above fits beautifully with why the dollar has fallen recently. The resurgence of concerns about the credit quality at GM combined with Elliot Spitzer's go at the insurance industry to cause a sell-off in US credit. As inflows into US corporate credit slowed at the margin, financing for the C/A deficit diminished on the margin, i.e. at the say mid-October value of the dollar, and so the price of the dollar fell to reestablish equilibrium. That process is still underway.

What about the Asian central banks? They are still buying dollars managing their currencies.
However, most are doing this on an effective exchange rate basis against the background of rising inflation in Asia. With the dollar weakening against the G10 currencies, and inflation in Asia now enough of a problem to make its governments wary of further imported inflation, the region needs to allow its currencies to appreciate somewhat against the dollar to prevent its effective exchange rates from depreciating.

I used to like this page for its economic analysis. Please, a little less Krugmanesque political agenda and a bit more serious economic analysis.

Best regards

Posted by: Ray Farris at November 8, 2004 04:57 PM

From a technicial analysis standpoint the double floor created around Jan '04 was taken out in this week's last move. Traders should buy Euro futures contracts at something like Oct04 + (Arp04-Jan04).

Also, about European stock indicies, many of the (large) compaines making up the index have substansial sales and profits in the U.S. When those profits go back to Europe they get converted to Euros and lose value. The value of bonds should move close to the Euro - though I forget if they move together or opposite each other.

Posted by: NotLiabile at November 8, 2004 10:00 PM

If the Dollar Collapses won't it bring down the euro also? If so then buying Euro's is not safe either... Right???

Posted by: Dan at November 9, 2004 02:13 PM