BIS says further dollar decline 'almost inevitable'
06.27.2005, 07:15 AM

 

BASEL (AFX) - The Bank for International Settlements said a further decline in the dollar is 'almost inevitable' as part of the correction of global current account imbalances.

The dollar has declined in an orderly manner so far, but mostly against currencies that are truly free-floating, and overall it is no lower than its average of the last 30 years, it said.

The dollar declined 22 pct between Jan 2002 and Dec 2004 but has regained some ground in recent months.

'Given how little the US trade deficit seems to have been affected to date by dollar depreciation...some further movement seems almost inevitable,' the BIS said in its annual report.

The BIS said the US current account deficit, which reached 6.4 pct of GDP in the first quarter, is a serious long-term problem.

'It is unprecedented for a reserve currency country to have a current account deficit of such magnitude,' it said.

And the US deficit poses serious risks.

'It could eventually lead to a disorderly decline of the dollar, associated turmoil in other financial markets, and even recession,' it said.

But this does not mean that such an outcome is imminent, it said.

A correction of current account imbalances has so far been impeded by foreign exchange reserve accumulation by Asian emerging economies in order to thwart the appreciation of their currencies against the dollar, so greater exchange rate flexibility on their part would help the adjustment process, the BIS said.

The Chinese yuan and Asian currencies linked to the yuan are obvious candidates for revaluation, it said.

Greater exchange rate flexibility in China would help curb massive capital inflows into the country and give more scope for monetary policy to counter inflation pressures, it said.

While China is concerned that revaluation could adversely affect its financial system and the income stream of domestic farmers, these concerns should be dealt with through domestic policies rather than by maintaining the yuan's peg to the dollar, it said.

On top of the current account problem, the global economy is exposed to risks related to a series of 'internal imbalances', the BIS said.

Real interest rates are close to zero, long-bond yields are remarkably low, household savings have been declining sharply, debt levels are at record levels and house prices in many countries have never been higher, it said.

Any or all of these imbalances are liable to be corrected at some stage, with consequences for global growth.

'Such an unwinding might be gradual, and possibly benign, but it could also be rapid and disruptive,' it said.

But there is probably still time to take action to avert such a risk.

Ths BIS said deficit countries like the US need to curb spending and allow their currencies to depreciate, while surplus countries need higher exchange rates and more domestic spending.

Primarily, the US has to cut its fiscal deficit by trimming expenditure and raising taxes, but it has not yet done enough on this score, it said.

'While the administration has set a deficit reduction objective, the specific policies required to implement this remain to be put in place. That is a pity, since without early fiscal action, the burden will fall more heavily on tighter monetary policy,' it said.

US rate rises will be helpful in curbing consumer spending and household borrowing, although their main purpose is to respond to concerns about future inflation and to rising capacity utilisation rates.

But the tightening of US monetary policy will need to be conducted 'with some delicacy', it said.

Higher rates could restrain corporate investment, and there is considerable uncertainty about the impact of rate rises on house prices.

There is also a risk that the tightening of monetary policy will cause disruption in financial markets if inflation pressures mean that rates have to rise more rapidly than currently expected, it said.

The BIS said Europe and Japan have no room for rate increases because of weak economic growth, but raising rates in other parts of Asia would be easier.

China is trying to deal with overheating in its economy through administrative measures, but higher interest rates might be a better solution, it said.

'As in the United States, the concern in Asia must then be that an inadequate degree of monetary tightening will lead to either inflation or growing internal imbalances, or both,' it said.

The BIS said the world economy appears to be well into the boom phase of a cycle which started in the mid-1990s, with the upward momentum having transferred from equities into the housing market in recent years.

Global growth is expected to be robust again in 2005, with inflation remaining subdued, but further rises in oil prices would weigh on economic activity, while rises in bond yields would curtail household spending.

And inflation could still accelerate, as a result of the significant monetary stimulus of recent years and growing debt levels, it said.

'A continuation of steady, non-inflationary growth might seem the most likely outcome...however, it is by no means guaranteed,' it said.

steve.whitehouse@afxnews.com

 

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