Dollar Declines Sharply

The Americas: Dollar Declines Sharply, But Has Further to Fall Global Finance
Anonymous
March 01, 2004

Despite expectations of strong US economic growth throughout 2004, analysts are nearly uniformly bearish on the dollar, which dropped to record lows against the euro in January.

"The economy will be strong enough to keep the trade deficit wide, but not strong enough to move the Federal Reserve off the sidelines for the foreseeable future," says Lara Rhame, senior currency economist at Drown Brothers Harriman in New York.

"This means that neither growth differentials nor interest rates will be supportive of the dollar anytime soon," Rhame says. "And that means that dollar-negative capital flows are likely to dominate in 2004."

The slide in the dollar has been driven by a net outflow of money from the US over the past two years, as private-sector foreign investment into US Treasury and agency securities has largely dried up with US interest rates at 45-year lows, says Michael Woolfolk, senior currency strategist at Bank of New York.

"The question now is not if the dollar will continue falling, but how far it will fall and at what pacc,"Woolfolk says.

To determine what the Group of 7 industrial nations considers to be an orderly decline, he examined annual changes in all G-7 currency pairs since 1980. In no instance did a G-7 currency devalue more than 30% against another G-7 currency in any year.

"More importantly, there were only two instances in which a 20% devaluation was recorded outside of the dollar's coordinated devaluation following the Plaza Accord of 1985. They were the devaluation of the Italian lira in 1992 and of the euro against the Japanese yen following the launch of the single currency in 1999,"Woolfolk says.

"In light of this, it appears that the maximum speed limit for the devaluation of a G-7 currency is 20% a year," he says.

A 20% devaluation of the dollar in 2004 would result in a year-end rate for the euro of $1.58. If the G-7 were to refuse to provide policy guidance this year on the manner of the dollar's decline, another 20% fall might not be as ridiculous as it sounds,Woolfolk says.

Look for the dollar's decline to gather pace in February when it becomes clear that the G7 is far from responding to the slide in the dollar against the euro, says David Gilmore, partner and economist at Essex, Connecticut-based Foreign Exchange Analytics.

"With the US policy mix steadfastly accommodative, it is the dollar that must fall and fall far to drive adjustment," Gilmore says.

"We see one outcome for the dollar in 2004: lower by another 20% to 30%," he says.

*****For further information about the economy and it's impact on interest rates call Anthony Pipitone at 312-492-3239.*****