Investment Markets » Banking and Finance
Where Will The Buck Stop?
Will the plunging dollar prove a temporary hiatus, or have we reached a dangerous tipping point in currency markets?
Movements in the currency markets are best described as a random walk: unpredictable like a drunk staggering home. Most of the time, they involve no more than a gentle swaying. At present they are lurching like a 16-year-old swigging a bottle of tequila.
The dollar, which began its sudden descent last week, is now close to its all-time low against the euro and the prospect of a $2 pound looms ever closer.
The rout began while most Americans were preoccupied with Thanksgiving and there was no discernable trigger. That in itself is significant, highlighting the greenback's inherent fragility. Snap up the chance of cheap New York shopping while you can. If this adjustment gets violent, and the dollar plunges, it will send economic shockwaves across the globe.
No one should be surprised - the dollar has been an accident waiting to happen. Firstly, the US is running a colossal current-account deficit, which it funds by borrowing from the rest of the world. Secondly, its economy is clearly slowing. Thirdly, the future course of US rates is out of kilter with the other major economies.
Despite its anti-inflationary rhetoric, the Fed will not rise again. For the first time since the euro launched in 1999, foreign exchanges thus face a situation in which the two big European banks are tightening, but the next move in US rates will be downwards. In the short term the dollar is a blatant sell.
It all happened at an awkward moment for US Treasury chief Hank Paulson, who was recently found lecturing the CBI. But he can take heart from international solidarity - the last thing either the Europeans or the Chinese want is a run on the dollar. True, Beijing keeps reminding markets that China needs to diversify its foreign reserves, but when you're sitting on $500bn of US treasury securities... you're at least dependent on the US a it is on you.
But the efforts of the world's financial leaders to soothe the markets are just so much "sweet-talking". Sooner or later the dollar will have to sink further: economists reckon it needs to fall 20-30% against the euro to reduce the US trade deficit to a sustainable level.
Were that to happen quickly, there would be carnage. But even if the move is gradual, we are in for a challenging shift.
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