Friday, September 21, 2007

Dollar collapse looms

Northern Rock’s problems are a mere blip by comparison with the crisis now emerging on the other side of the Atlantic, where the fall in the value of the once almighty dollar threatens to bring down not just the American economy but the entire global trading system with it. Ironically, Saudi Arabia, one of America’s staunchest allies, could have started what may become a domino-type collapse of the dollar. The US has relied on foreign funders to finance the gigantic $800 billion annual deficit between exports and imports by investing in American assets. The money markets have also enabled the US government to run a massive budget deficit by showing a willingness to buy what are known as Treasury bonds – effectively lending Washington the money to finance activities like the occupation of Iraq. Without these sources of finance, the United States – which is the world’s most indebted nation – would be bankrupt.

Behind the dollar’s plunge to a 15-year low against other major currencies, including the Euro, is the credit crisis which was itself prompted by the collapse in the US subprime mortgage business. This in turn is depressing property prices in America and Robert Shiller, a Yale university economist, told a US congressional panel this week that he feared “the collapse of home prices might turn out to be the most severe since the Great Depression”. Alan Greenspan, former Federal Reserve chairman, told the Financial Times that double-digit falls in house prices from their peaks would not be surprising. The Congressional committee heard from experts who said a 15% fall in house prices would wipe out $3,000 billion of household wealth.

Within hours of the hearings, the Federal Reserve took panic action and slashed interest rates by 0.5% in an attempt to resuscitate the American economy before it collapsed into recession. For the money markets, as well as those countries like Saudi Arabia loaded down with dollar bills, the rate cut was a signal that perhaps this was the right time to cut and run and the currency’s value plummeted. Historically, the Saudis have linked their currency to the dollar and have always matched US interest rates. Not this time, however. The Saudis’ refusal was taken as a signal that the oil-rich feudal kingdom is preparing to break the dollar currency peg in a move that risks setting off a stampede out of the dollar across the Middle East. As if that wasn’t enough, only last month the Chinese started a concerted campaign of economic threats against the United States, hinting that it may liquidate its vast holding of US treasury bonds if Washington imposes trade sanctions to force a Yuan revaluation.

"This is a very dangerous situation for the dollar," said Hans Redeker, currency chief at BNP Paribas. "Saudi Arabia has $800 billion in their future generation fund, and the entire region has $3,500 billion under management. They face an inflationary threat and do not want to import an interest rate policy set for the recessionary conditions in the United States," he said.

There is also evidence that global investors are shunning the US bond markets. Foreign investors have been gradually pulling out of the long-term US debt markets, leaving the dollar dependent on short-term funding. "This is nothing like the situation in 1998 when the crisis was in Asia, but the US was booming. This time the US itself is the problem," he said. Financier Jim Rogers commented: "If Ben Bernanke [chairman of the Federal Reserve] starts running those printing presses even faster than he's already doing, we are going to have a serious recession. The dollar's going to collapse, the bond market's going to collapse. There's going to be a lot of problems."

Paul Feldman
AWTW communications editor

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