The fate of the dollar

A US recession could mean a weak dollar

Now that America's economy appears to heading for a recession, will the dollar go with it?

The slowing economy has not only shaken Americans confidence in the strength of their currency but foreign investors' as well.

That could be good news for the euro, the single currency used by 12 countries in the eurozone. The euro had by declined by more than 30% against the dollar since its launch in 1999.

A declining dollar would have both benefits and costs for the US economy.. For American consumers, it means such things as overseas travel become more expensive. But for American business it creates new opportunities to sell cheaper goods in foreign markets.

But a drop in the exchange rate for the dollar threatens the buying power of Americans, who have become accustomed to buying foreign goods at bargain-basement prices.

"A sharp dollar decline would bring real inflationary consequences," says C. Fred Bergsten, director of the Institute for International Economics in Washington, DC.

Speaking at a meeting at the Centre for Economic Policy Research, Mr. Bergsten added the US could be hit by a triple whammy of rising prices, rising interest rates and a falling stock market, thus threatening confidence in the economy of the world's only superpower and reducing foreign investment.

Trade deficit puzzle

Also of concern to financial analysts is the currentaccount deficit, the debt accumulated by trade and foreign investment, which in the US now stands at $500 billion, or 5% of the nation's gross domestic product -an historic high.

But the deficit's effect on the dollar is debatable, with analyst opinions varying on whether it is a bad thing at all.

"Whether a current-account deficit is a problem . . . depends in part on a chicken-and-egg judgement - what you think is causing it, and how sustainable the trends are," says Alison Cotrell, analyst at UBS Warburg.

A large deficit is caused by increased demand for imports and investment in the US by foreign investors, among other things. The US has seen vast flows of capital into the country in recent years as foreign investors tried to cash in on a booming economy and hungry American consumers.

Much of that investment has been spurred by outstanding growth within the US, which ran at an annual clip of 6% in the first two quarters of 2000. Now an economic slowdown threatens to throw the country into recession.

"The prospects still point to a soft-landing scenario" for the US economy, said Goldman Sachs managing director Gerald Corrigan.

Speaking to reporters at an economic forum in Taipei, the former New York Federal Reserve president said he expects growth in the US of around 2.5% for the year.

Slowdown looms

Some economists are more pessimistic.

Mr. Bergsten warned that given the outstanding growth experienced in recent quarters a slowdown to growth of around 2% could feel abrupt. Liken it to a car speeding down a highway at 90 miles per hour only to suddenly slow to 30 miles per hour.

The US may not technically see a recession, viewed as two back-to-back quarters of negative growth, but the slowing would be quite noticeable, Bergsten said.

The rapid recovery of the euro also threatens confidence in the dollar. In recent weeks, the euro has surged against the American dollar, trading lately at around US$0.9460 in New York.

The euro remains extremely undervalued, Bergsten argued. He said the euro would achieve balance with the dollar when it trades at 1 euro per $1.25, about 33% above its current trading level.

But he warned an appreciating euro faces a reluctant European business community, content with the euro remaining undervalued.

A cheap euro ensures European goods will remain inexpensive in America. It is a proposition that appeals to American consumers, whose voracious appetite for foreign goods is not likely to be slowed unless prices rise - and the dollar falls.

Many analysts expect the European Central Bank to try and intervene to boost the euro further, especially as the date for the launch of the euro as a retail currency approaches at the end of 2001.