HOUSE OF CARDS ECONOMICS
Dollar at mercy of central banks

From the London Financial Times courtesy of J. Orlin Grabbe:

In 2003, the most recent year with full international statistics, central banks financed 83 per cent of the US current account deficit, with Asian central banks accounting for 86 per cent of flows.

A similar picture is emerging for 2004. Despite a good start to the year, when the private sector was a large net purchaser of dollar assets, central banks came to the rescue again. The People's Bank of China has let it be known that China increased dollar reserves by $207bn (€159bn) in 2004, financing nearly a third of the US current account deficit, estimated at $650bn.

Self-interest has supported much of this flow of cash. The US has lapped up cheap finance to fund its unquenchable appetite to spend. Asian governments have until now been keen to oblige, in order to keep their currencies from appreciating. But all investors have their limits and they may start worrying about their degree of exposure.

If new official flows to the US were to be curtailed, the dollar would plunge, creating a huge hole in the accounts of central banks holding dollars.

And

Until recently there had been little evidence to back up these fears but this has begun to change.

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The US dollar has value only becaue it is perceived as representing a strong American economy and financially sound US government. It appears as though that perception is (rightly) about to change for the worse. The conventional wisdom is that cheaper dollars equal more US exports--a less expensive dollar makes American goods less expensive relative to other currencies, and therefore more appealing to buyers in overseas markets. The catch here is that for the last twenty years, multi-national corporations have been madly outsourcing US manufacturing to other countries! We don't really export that much any more. So there is no benefit at all to a cheaper dollar; there's only downside: inflation the likes of which we haven't seen since the 1970s, worse perhaps.

Okay, maybe there's one benefit. Wal-Mart as we know it will cease to exist.

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