http://business-times.asia1.com.sg/views/story/0,2276,43413,00.html? THE US dollar is widely perceived to be overvalued, its vulnerability highlighted not only by a sudden decline against the euro and the yen but also by gold's recent rise by more than 10 per cent in dollar terms.
This is being attributed to the size of the US current account deficit, and to fears that recovery by the world's largest economy from a shallow recession may prove to be equally shallow. But there are more fundamental reasons for fearing a dollar debacle.
It is bad enough that the US should run a huge external deficit - meaning that it is critically dependent upon the outside world to finance its excess private consumption; but when the government budget also plunges into deficit and Washington embarks upon military spending that seems likely to push America's twin deficits to intolerable levels, then it becomes cause for real alarm.
What is worse, this strategy threatens to undermine that very stability in oil prices which has underpinned US prosperity for nearly two decades. A sustained hike in oil prices - made even more likely since Washington has antagonised Middle East producers by its policies towards Israel - also threatens the global economy.
If the US has appeared invulnerable on a military level, its soft underbelly is being exposed now by developments in the foreign exchange market and in the oil market. Both the IMF and the OECD have issued unusually explicit warnings about the dangers of a 'disorderly' correction in the record US current account deficit, but US officials have been inclined to dismiss these.
It is doubtful, however, whether they can afford to ignore the danger signals flashing in financial markets. The dollar has long been viewed as a safe haven - safer than gold even - because the US economy was previously perceived to have entered a virtuous circle of rising productivity and expanding economic growth. Good fiscal management under the Clinton administration produced a substantial budget surplus and added to the justification for a strong dollar. If the US ran a large external deficit, this was simply because the outside world was willing to finance it by investing eagerly in Treasury bonds and on Wall Street. How different things look now.
The US current account deficit is expected to rise above 4 per cent of GDP in 2002 (to US$470 billion) and to reach 5per cent next year. Such a position cannot be sustained for long, even by a country that's able to print money and have it universally accepted as the world's principal reserve currency. The Congressional Budget Office had estimated a deficit of US$46 billion in fiscal 2002 but tax receipts are already running US$40 billion below projections, and this could push the projected deficit even higher. Congress is also considering a US$27 billion supplemental spending bill; though only part of it would be spent in this fiscal year, the overall deficit could rise above US$100 billion - compared with a US$127 billion surplus in fiscal 2001.
Slower spending
The US depends upon foreign investors to fund its twin deficits; but the risk of the deficits going unfunded is rising. At the very least, the US might be forced to raise interest rates in order to continue attracting investments. The fact that the US economy grew at an annualised rate of 5.8 per cent in the first quarter is little cause for comfort since that growth was against a very depressed fourth quarter of 2001. Consumer confidence and spending have slowed and expectations of a robust recovery in corporate profits have waned.
This raises the prospect of a retreat from US equities just when the government bond market is also vulnerable. A government which apparently believes it can go it alone on military issues may be given a salutary warning of its dependence upon its allies to finance that strategy.