There are plenty of big economic questions that will be answered in 2007. Will there be a global trade deal? Can the German economy shrug off the impact of higher taxes? Can China continue to grow at 10% a year? Will oil prices stay high or come crashing down? But they are all sideshows to the main event. The really crucial question for 2007 is whether it is the year when there is a run on the dollar. There are plenty of people out there – me included – who think the US currency is going to take a beating over the next 12 months.
… A high dollar meant exports into the US were cheap, and that kept both inflation and interest rates low. Easy credit terms meant that the US has had not one but two speculative booms over the past decade, the first in dot com shares, the second in the housing market. Growth has been artificially boosted and the trade deficit has exploded.
Now, though, things have started to change.
The dollar tumbled to a fresh 20-month low against the euro Tuesday after a government report showed demand for U.S.-made durable goods declined much more than forecast last month.
But the U.S. currency edged slightly higher versus the yen after data showed an unexpected increase in sales of existing U.S. homes in October and a solid reading from the Richmond Fed’s manufacturing index.
Analysts say sentiment toward the dollar remains negative.
One of the enduring oddities of the international economy is the willingness of foreign investors — both private, official, and quasi-state — to hold dollar assets despite the very low returns on such assets, even when comparing in common currency terms. It is this anomaly that Krugman disucusses in an academic paper asessening the possibility of a dollar crisis.
Concerns about a dollar crisis can be divided into two questions: Will there be a plunge in the dollar? Will this plunge have nasty macroeconomic consequences?
The message appears to be that the dollar’s value is out-of-whack–too high–because nobody expects it to decline by a lot in the near future, and that expectation means that demand for dollar-denominated securities is high because U.S. interest rates are higher than interest rates in Japan and Europe. One again, it looks like there may well be lots of money left on the table.
In other words, we can avoid a recession even as we move to fiscal restraint if we allow currencies to float.
When the dollar falls, it means that everything from other countries costs much more. This supposedly is great for American manufacturers because our goods will cost much less to others, and we can start exporting (and hiring) again. Possibly even heading off a recesion. But my question is, how much has our manufacturing infrastructure eroded? CAN WE start manufacturing for domestic and export to pick up the opportunity of a plunging dollar?
Growing pessimism over the dollar facilitated a sell-off Friday that plunged the greenback to a 19-month low versus the euro and a nearly two-year low against the U.K. pound.
[. . .] There is also mounting concerns that central banks around the globe might begin to aggressively diversify their foreign reserves into euros and away from dollars, the long-standing reserve currency of choice.
On Friday, China warned other countries that holding excessive dollar reserves may not be a good idea.
Wu Xiaoling, a senior People’s Bank of China official, said Friday that continued weakness in the U.S. dollar poses a risk for East Asia’s foreign-exchange reserves, Market News International reported.