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  1. #1
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    War Bucks: Will the Iraq conflict cause the dollar to collapse?
    By Robert Shapiro

    For months, the prospect, and now the reality, of war with Iraq have unnerved but not yet disrupted global currency markets. The odds are still small that the war will trigger a currency crisis. If it does, you'll see it in a fast-falling dollar; and given our current sour relations with much of the G-7, we might not be able to do much about it.

    In the international economy, more money is made or lost from currency movements—or at least, more money is made or lost faster—than any other way. Speculators such as hedge funds can sometimes make or lose a fortune overnight in currency bets, but the value of the dollar, the yen, and the euro are fundamentally driven by the normal transactions of the global economy. When a London bank buys U.S. Treasuries or shares in a U.S. company, or a Spanish firm buys computers from a U.S. maker, it has to use pounds or euros to buy dollars, so it can pay the American seller. The more demand for dollars to carry out the daily business of trade and investment, the more euros or pounds it takes to buy them.

    The war has not been good for the dollar. Since last November, the greenback has fallen nearly 7 percent against a basket of other major currencies. First, Middle Eastern investors converted a lot of their dollar holdings and took them home: By the New Year, all the imponderables about the coming war left European and Asian investors reluctant to expand their U.S. holdings. The result has been less foreign investment in the United States, translating into less demand for dollars in world markets.

    The war gave the dollar a shove, but it's been sliding for more than a year—down almost 15 percent since early 2002. That makes French wine and Swedish cars a little more expensive here (though wartime feels like the right time to buy domestic). A falling dollar also leaves some Americans, and companies who employ a lot more of us, a little poorer. In 2001, private American holdings abroad were worth nearly $6.7 trillion—a third in direct foreign investments like factories and companies; another third in foreign stocks and bonds held by U.S. pension funds and others; and a third in various claims reported by U.S. banks and others. The dollar's decline in the last four months has reduced the dollar value of these holdings by $445 billion; its fall over the last year cost more than $950 billion.

    A falling dollar is bad news for a lot of people because greenbacks are also the global economy's principal medium of exchange. Foreign producers of oil and many other commodities, along with a goodly share of global manufacturing companies, prefer payment in dollars to Saudi riyals or South Korean wan. Foreign governments, or at least their finance ministries, also usually like a steady dollar, since dollars make up two-thirds of the reserves they hold to back up their own currencies. The 15 percent fall in the dollar has made a lot of people in a lot of places a little poorer.

    A weaker dollar, however, is good news for U.S. exporters because it makes their products cheaper in foreign markets. It also helps U.S. companies that compete with foreign imports, because a stronger euro or yen—the other side of the weaker dollar—makes imports more expensive in the United States.

    The worst is probably yet to come, because the dollar's decline reflects not only all the uncertainties about the war's impact on U.S. growth, but also increasing concerns about a structural imbalance in the American and global economies. The core of the problem is that we don't save enough. To keep spending and investing at the rates we have, we have to tap the savings of foreigners. The bookkeeping expression of this undersaving, or the amount we have to borrow, is the current account deficit—$503 billion last year. The biggest part of that is the trade deficit: In 2002, Americans consumed $435 billion more in goods and services than the United States produced, and we paid for the difference by selling hundreds of billions of dollars of assets to overseas buyers and borrowing the rest from abroad.

    The currency and interest-rate markets usually police such undersaving. If any other country ran up $1.55 trillion in trade deficits over the last five years, as the United States has, foreign lenders and investors would step back, expecting overconsumption to heat up inflation or underinvestment to drive down growth. As they back off, the value of the overspending country's currency would fall, interest rates would rise to attract lenders back, and growth would slow, until the country's imports fell enough and its exports rose enough to correct the trade deficit.

    Until recently, we ran large trade and current-account deficits without the dollar falling much, because our economy and our policies were so sound. Foreigners were perfectly happy to lend us funds or buy our assets, because the U.S. economy looked like the closest thing to a sure bet in the world. Moreover, we needed foreign investors less in the '90s because the government's shift from deficits to surpluses boosted our saving.

    After three years of stock-market declines, stalled business investment, weakening consumer confidence, and low interest rates, the returns on investing in the United States look a lot less promising. The government's U-turn in fiscal policy is just as worrisome to global investors. The return of large budget deficits will keep the trade deficit growing by stimulating spending, and it will guarantee that public and private credit demand will far outstrip our own saving.

    The dollar's fall in the last year tells us that, given these concerns, foreign lenders and investors have decided that they shouldn't expand their U.S. claims and assets—$7.9 trillion at the end of 2001. So, they're slowing the rate at which they buy here. Our choices are to cut the current account deficit by saving more and consuming less—that's a positive spin on the current slowdown in consumption—or letting interest rates rise to ensure a more attractive return for foreign lenders.

    The rest of the world, with its big investment in a stable dollar, could help, too. One win-win solution would be for other countries to open their markets to more service imports—banking services, engineering, information services, and so on. America leads in many service areas, so market opening would help our trade deficit; and imports of efficient services would make other countries more productive. Liberalizing service markets is part of the current round of trade talks. Unfortunately, our current sour relations with Germany, France, and others aren't likely to inspire them to offer trade concessions that help U.S. service companies.

    Given a bulging current-account deficit, slow growth, and a prospect of years of huge budget deficits, a bad war might just trigger a real currency crisis. In 1997 and 1998, Thailand, Malaysia, Indonesia, and South Korea found out how fragile prosperity can be when it depends on foreign capital that can be yanked when a currency weakens. We're in a stronger position because our underlying economy is so much sounder and because foreign investors have so few other, plausible places to park their money.

    But a currency crisis could still hit us like a hurricane. Suppose two or three of the top 10 things that could go wrong for us in the war do go wrong and the liberation of Baghdad begins to look like the siege of Stalingrad. That kills hopes for a quick victory-bounce in the U.S. economy, and foreign investors accelerate their shift from U.S. to European securities. As the dollar sinks along with our stock market, more foreign investors rush to sell, and the declining dollar turns into a run and finally a rout.

    There are two ways to end a currency crisis like that: Hike interest rates far and fast to draw back capital, stalling economic growth as a consequence; or get the world's major central banks to intervene in the currency markets by buying dollars. In the current diplomatic deepfreeze, I wouldn't count on the European Central Bank. Instead, we would have to rely on Japan, China, and other Asian countries to bail the dollar out. These are all high-saving nations with large foreign-exchange reserves, and, more important, export-based economies that would be hit nearly as hard as we would by a cheap dollar. But that's not a favor that an American president with his sights on North Korea might want to ask for.

  2. #2
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    A weaker US$ (vs AU$) is A GREAT THING!!!


  3. #3
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    Pete,
    That wasn't the point of my post, but nevertheless, I think that you got it wrong. I suppose that you are an affiliate, and that you earn money from US merchants? If so, the stronger the dollar, the more local currency you will be able to get, thus increasing your puchasing power. With a weaker US dollar, you will get less Australian dollars, meaning that you will have less money to spend in Australia.

  4. #4
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    Nope.. As the US$ drops, my AU$ earnings increase.
    US$0.59 approx ='s AU$1

    If you went the other way, where US$1 buys AU$1.69 then a decrease is good.

    depends on the wording. In my wording.. a decrease in the US$ is good for me.

  5. #5
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    Now I realize what you are trying to say... but you are wording it VERY wrong. Anyway, the article suggests exactly the opposite of what you think it's saying. Just to avoid any confusion: are your earnings in USD or AUD?

    Let me put is simpler. Let's say that on Friday 1 US Dollar was 1.693 Australian Dollar. Since Friday, the value of the US Dollar has decreased (meaning an increase in the value of AUD), so for 1USD, you will get 1.672 AUD. See that you will get less AUD?

  6. #6
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    Could you post a URL to that article please?

    Jimmy James fan club membership # 3312

  7. #7
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    Hello. this is very interesting. I don't think the dollar will actually collapse (if it did it would be disaster for the world economy), but it is possible that it could go down a lot more.

    The us dollar is the world currency despite the euro. If people actually lose confidence in the US dollar this could trigger panics and massive consequences for the world economy. There are more and more countries that essentially use US dollars as their currency (or equivalents). Russia's black economy is all US dollar. Half of Latin and Central America is US dollar. What is very interesting is that they actually use US dollars in Cuba despite the fact that there is an embargo on Cuba ... hillarious. There are so many US dollars outside of the US. This is a great boon for the US, because the US government has totally control over this money. If for example there is deflation in the US, the US can print more money and the effects of doing this will be spread out over the various countries that use US dollars. In other words the government gets free money, and the rest of the world pays for half of it (if we say that half of the US dollars are outside the US which is probably an overestimate, but you get the point). Very clever on the part of the US ... how to get a free 1 trillion dollars! Of course the effects would still be felt in the US itself, so it would be only possible if the US had deflation.

    Please argue my point if you understand what I am saying but disagree.

  8. #8
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    >I don't think the dollar will actually collapse (if
    >it did it would be disaster for the world economy),
    >but it is possible that it could go down a lot
    >more.


    >The us dollar is the world currency despite the
    >euro. If people actually lose confidence in the US
    >dollar this could trigger panics and massive
    >consequences for the world economy.

    Read the article AGAIN. Many other countries have ALREADY lost confidence in the US dollar. And if this war drags on as much as they're now STARTING to admit, and costs for it escalate, the US Dollar MAY collapse.

    If that happens, it will no longer be the "world currency". Gold will come back, or the Euro will take over.

    >Please argue my point if you understand what I am saying but disagree.

    Done. Just be aware, that the author of that article was the U.S. Undersecretary of Commerce for Economic Policy - before the current administration built the deficit out to its current record high.

    So I guess he might just know what he's on about.

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  9. #9
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    Vote Republican, It's Easier Than Thinking

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