greenback slide a 'time bomb'

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    The Age Newspaper 28/11/2004

    Greenback slide a 'time bomb'
    November 28, 2004

    Asian banks have racked up huge debt propping the $US, writes Richard Webb.

    The plunging US dollar is potentially the most explosive situation seen on world financial markets since the technology bubble at the turn of the decade, economists have warned. It is developing into a $US1 trillion ($A1.3 trillion) time bomb.

    That's the value of US debt Asian central banks hold after propping the greenback over the past two years. They have accumulated the debt by effectively lending money to the US to enable it to buy Asian imports and in doing so have funded more than 90 per cent of the US's ballooning trade deficit.

    ANZ chief economist Saul Eslake says they have been running "the greatest vendor financing scheme the world has seen".

    The problem is that the Bush Administration now appears intent on letting the greenback fall to solve the US's trade and budget deficit problems, as this is a far easier solution than the alternative of reducing budgets and lifting tax rates. The US wants Asia and Europe to take on the economic burden of its budget and trade problems through a higher euro and yen. But as the $US falls, the capital losses on this $US1 trillion of US debt held by the Asian central banks mount and at some stage these banks are likely to stop buying US debt and start selling. And none of them will want to be the last one out.

    Advertisement"At some point, the Asian central banks, who have almost single-handedly financed the massive US external deficit and propped up the $US, will get tired of doing so," Mr Eslake said. "The risk is that they are holding over $US1 trillion, and if the $US starts to fall they will suffer capital losses."

    There were signs of this on Friday night when the euro hit a record high against the $US on a report that a Chinese central bank official had said his country had trimmed its holdings of US treasuries. This report was later denied but the $US finished 2.1 per cent lower for the week against the euro and 0.5 per cent down against the yen.

    Bank of England chief economist Charles Bean warned on Friday night that international investors were unlikely to keep buying US assets indefinitely, resulting in a "possible substantial" drop in the $US, echoing similar comments from Federal Reserve chairman Alan Greenspan a week earlier. Currency traders predicted the $US selling will accelerate this week.

    "What we are seeing now is far more than just speculation - these are real fundamental shifts in portfolio allocations from official and private entities, and that could continue and see the dollar selling accelerate," said Derek Halpenny, a currency strategist at the Bank of Tokyo-Mitsubishi in London.

    Even if the $US makes an ordered depreciation, it will slam the brakes on the already slow economic growth within the economies comprising the European Monetary Union and will hurt Japan.

    The euro and the yen have been taking the weight of the recent shift in global currency money away from the greenback and have surged higher. The $A has been rocketing ahead too, and has climbed 15 per cent over the past two months. Mr Eslake predicted it will be at 84 US cents by the middle of next year, a further 6 per cent rise from yesterday's close of 79.07 US cents.

    This is bad news not only in relation to Australia's trade with the US, for our major exporters and domestic companies battling imported products, but with Australia's trade with China, which is also $US denominated.

    But the Australian economy is motoring along at a 4.1 per cent growth rate and can take a little bit of pain, while economic growth in Europe is 1.9 per cent. That is why ECB president Jean-Claude Trichet described the recent $US depreciation as "brutal". Japan is growing at a 3.9 per cent rate but its economy is showing signs of slowing to a around 2.1 per cent. It is none too happy, either.

    A stronger currency is bad news for an economy because it reduces its export competitiveness and export returns, and also hurts domestic production because imports become more competitive. The reverse is also true and that seems to be the reason why, unofficially, the Bush Administration is doing little to prevent the greenback from falling further.

    The US trade deficit is running at $US665 billion ($A838 billion) a year, and while it is, at 5.7 per cent of GDP, proportionately a little less than in Australia, it is something like 15 times the value.

    ABN Amro chief economist Kieran Davies says the US economy has taken more than 70 per cent of all the money flowing around the world in the last year, whereas Australia accounts for 4 per cent of global capital flows.

    The latest Reserve Bank bulletin said that in two years there had been a 10-fold increase in money going into the US - from $US25 billion in 2001 to $US250 billion in 2003 - and in the March quarter of this year, these inflows had reached an annual rate of $US500 billion, practically all of which was from Asian banks buying US government securities.

    Shares are expected to move to a record high tomorrow and stock specialists are now tipping an All Ordinaries index over 4,000 points before Christmas. Local stocks will rise despite a lacklustre session on Wall Street on Friday night because of the buying momentum carried through from last week, CommSec chief equities strategist Craig James said.

    The S&P500 gained 0.89 points, or 0.1 per cent, to close at 1182.65 yesterday morning, the Dow added 1.92 points to 10,522.23, but the Nasdaq slipped 0.57 points to 2101.97.

    The greenback rebounded a little, enabling the Australian dollar to ease to 79.07 US cents from Friday's close of 79.42 US cents. Gold hit a 16-year closing high of $US451.95 an ounce in New York.

    - with Bloomberg

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