Global dollar zone should prevent greenback crash 

By Neil Behrmann

London, May 06: Alarm bells are ringing in Europe and Japan because dollar devaluation is hurting exporters, economies and jobs. Long awaited revivals in Germany and Japan are in danger of being snuffed out.

The downwave of the US dollar since March will supposedly help reverse the US' trade and current account deficit as currency depreciation is aimed at boosting American exports and lowering imports. This fashionable remedy, espoused by numerous economists, has failed so far to do the job. This is hardly surprising. The US trade and current account deficits have remained at near record levels simply because of inadequate US dollar depreciation against the Asian bloc, which is the cause of the biggest proportion of the current account deficit. Since the greenback peaked early 2002 until April 2006, the trade weighted dollar index of the Federal Reserve Bank of Atlanta has fallen by 17 per cent; but the devaluation against European currencies has been a whopping 28 per cent, against only 11 per cent for the Asian Pacific region.

Indeed Asia, excluding Japan, is effectively part of the international US dollar bloc because currencies are carefully managed to keep China and other nations competitive with the US. Thus any country that is effectively a member of the dollar zone, including Middle Eastern nations and commodity producers such as South Africa, gain at the expense of Europe and to a lesser extent Japan when the greenback slides. Their exports become more competitive. Thousands of jobs are outsourced from Europe to cheaper currency Indian and Asian nations, increasing the prosperity of those regions at the expense of Europe. Inflation is a disadvantage for those choosing the currency devaluation route. Yet since most raw materials are priced in dollars, currency changes have minimal impact, although dollar weakness has encouraged speculators to boost commodity quotes.

Yes, some Asian currencies have appreciated against the dollar. Yet their gains have been minimal compared with the surge of the euro, sterling, Swiss franc, Scandinavian currencies and the yen. Take the most recent bout of dollar weakness. From the beginning of March to Friday March 19, the US dollar depreciated by 9 per cent against the British pound, 7 per cent against the euro and 4 per cent against the yen. Against the euro, the Indian rupee has slid by 8 per cent, Chinese Renminbi, and Hong Kong dollar have fallen by 7 per cent and Singapore dollar by 4.5 per cent. Indian and Asian currencies have also depreciated against the yen.

A fascinating paper by Stephen Jen, an economist at Morgan Stanley, spells out why an analysis of the greenback outlook should consider the global dollar zone of the US, Asia, Middle East and other nations. Virtually all of the intra-regional Asian trade is priced, invoiced and settled in US dollars, and this is not likely to change any time soon, not even with some adjustments in the exchange rate vis-à-vis the dollar, contends Mr Jen. In other words, there are ample reasons to believe that much of Asia will remain in this de facto dollar zone.

The US trade deficit as a percentage of gross domestic product, is 6.6 per cent, but when you include the Asian bloc, the effective trade deficit, that has an impact on the dollar, is a much smaller 2.7 per cent, calculates Mr Jen. Including Middle Eastern nations the deficit dwindles to a mere 1.9 per cent, which is easily manageable. With countries such as South Africa and others that price their commodity and other exports in dollars, the effective dollar bloc trade deficit is even lower.

It can be argued that dollar zone central banks will continue to diversify and place a growing proportion of their assets in euro, yen and other currencies. But such is the flow of dollars and size of their monetary reserves, that they are limited in what they can do. Foreign exchange reserves of the US amounted to US$38 billion at the end of 2005. This compares with China's official reserves of US$854 billion and the rest of Asia, excluding Japan, US$620 billion. The Gulf Cooperation Council that includes, Saudi Arabia, United Arab Emirates and Kuwait held US$66 billion at the end of last year.

The Asian Development Bank has been investigating whether an Asian Currency Unit, or ACU, should be formed as a bulwark against a sagging greenback. But Mr Jen believes that it will take at least a decade before that index is manageable and can absorb sizeable volumes. Like it or not there is little alternative, but for Asian central banks and other investors to keep the bulk of their reserves in dollars. Indeed IMF figures show that in the past two years, diversification hasn't been extensive. The greenback accounts for 67 per cent of total global central bank reserves, compared with 24 per cent for the euro and small allocations to the yen and sterling. Assume there were to be sizeable allocation of funds into the euro, the inevitable currency surge would cripple the German, French, Italian, British and other European economies, ending in a terrible currency crash and the possibility of dissolution of the euro currency bloc. Gold enthusiasts have recommended a move into bullion, but the price gyrations of the past few weeks illustrate that the market is too narrow, relative to currency markets, to accommodate huge flows. The same applies to emerging Asian currencies.

Indeed the huge US dollar zone and its status as the leading international medium of exchange and reserve status, help explain why the dollar hasn't collapsed despite the massive US external imbalances and overwhelmingly bearish sentiment in the market. Instead the dollar has weakened from time to time, as is happening now, for cyclical reasons, notably a slow down in the US economy and expectations of lower interest rates. Other factors include geo politics e.g. Middle Eastern countries, such as Iran, deciding to dump dollars when they fear confrontation with the US.

Bottom line a dollar crash would be bad for the global economy, so if any bear run accelerated, central banks would step in and support the currency. French and Japanese finance ministers have already begun jawboning.

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