The Dollard Plunges
US dollar plunges, tips deflation fears Europe's way
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WASHINGTON (AFP) - Nerves gripped investors worldwide after US Treasury Secretary John Snow appeared tacitly to abandon an eight-year policy of supporting a strong dollar.
The perceived shift raised fears that further dollar declines would erode the value of foreigners' US investments, economists said.
And while soothing concerns of deflation in the United States, it also ramped up those same fears in Europe, and complicated the long deflation battle in Japan, they said.
"What the United States has made clear is that they are not going to undertake any efforts to try to defend the currency," said Citigroup global currency strategist Robert Sinche.
"We think that is exactly appropriate in this environment," he said.
"In a world where the major concerns appear to be about deflation rather than inflation, the last thing the world economy needs is to have the United States trying to artificially tighten policy."
US Treasury Secretary John Snow described recent currency fluctuations as being "really fairly modest" during a weekend Group of Seven finance ministers in Deauville, France.
A "strong dollar" policy did not mean that the currency should be at any particular exchange rate, he said, emphasising that it incorporated other values such as confidence, or being a good medium of exchange.
The euro rose to 1.1720 dollars in late morning deals in Europe, against 1.1581 on Friday in New York.
In Japan, already battling deflation for four years, the authorities in Tokyo intervened heavily to prevent a yen appreciation. The dollar tumbled to 115.13 yen from 115.90 on Friday.
"I think for the longest period of time in effect the dollar exchange rate has been market-determined," said Moody's Investors Service chief US economist John Lonski.
Chronic deficits in US financial dealings with the outside world -- shown by a current account shortfall of more than half a billion dollars last year -- might have caught up with the currency, Lonski said.
"We are simply not able to attract as much foreign capital as we need to prevent the dollar exchange rate from moving lower. I wonder how much of this is really the product of any change in policy," he said.
Major investors in dollar-denominated assets also might have decided to diversify because of heightened geopolitical concerns, Lonski said.
In addition, the US Federal Reserve (news - web sites) had cut the key federal funds target rate to a four-decade low of 1.25 percent. Lower rates reduce the returns on US investments, eroding demand for dollars.
For now, the slide in the dollar worked in favor of the US economy, where underlying inflation fell to a 37-year low of 1.5 percent in April when compared with April 2002.
"One of the perfect antidotes for deflation is a weaker currency," Lonski said.
But "in Europe, it has the opposite effect," he added.
The appreciation of the euro, and the higher risk of deflation, might force the European Central Bank to cut rates sooner, the analyst said.
"The attack against deflation becomes globalized if the ECB decides that it has no choice but to cut rates pretty soon." The ECB holds its next meeting June 5.
In Japan, the Bank of Japan had waged a long battle in vain against deflation. "The last thing they need is a further appreciation of their currency," Lonski said.
Snow would still step in to support the dollar if the decline ran out of control, leading to a flight of funds from both the equity market and the bond market, he predicted.
"Snow made it perfectly clear, the strong dollar policy has been abandoned up until we reach that point where expecations of further dollar weakness prove to be disruptive to US financial markets," Lonski said.
Wall Street tumbled Monday. The Dow Jones industrials average of 30 top stocks plunged 171.33 points or 1.97 percent to 8,507.64 by early afternoon. But the bond market held up relatively well, Lonski said.
"If both equity and credit markets deteriorate together, chances are the dollar depreication will no longer be tolerated by the US government," the economist said.
The good times are about to roll off here in the US, things are already at an all time high and with a weaker dollards thing are bound to get tougher.
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