Reversing the dollarÆs decline

Panelists at a Credit Suisse investment conference say the US must reduce consumption and increase savings.
History teaches us that reserve currencies have staying power, Steve Hanke, professor of applied economics at Johns Hopkins University and Senior Fellow at The Cato Institute, said in a panel discussion yesterday. And based on average longevity, he reckons the greenback should have another 200 years in that role. There is a ôfirst mover effectö which will make it hard for rival currencies to supplant it any time soon.

Hanke made his comments during the opening debate at Credit Suisse's annual Asian Investment Conference in Hong Kong, which focused on ôThe Dollar Dilemmaö.

Tim Adams, managing director of The Lindsey Group, called the dollarÆs decline the ômost unsurprising event in recent historyö, which has been precipitated by the US consumer ôliving beyond its meansö û a sentiment shared by all three panelists. The dollar adjustment began in 2002, but was orderly, said Adams, who is a former US Undersecretary of Treasury for International Affairs. It was also consistent with a ôstrong dollar policyö û meaning that the US authorities would not use currency depreciation as a tool to gain competitive advantage in trade markets. Now, the ôdepreciation has acceleratedö, pointed out Yu Yongding, director-general of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences.

Yu identified two possible adjustments to the aggregate demand equation in order to remedy the worldÆs imbalances. The first course of action would be to let a devalued dollar correct the current account deficit. But this would not reduce domestic demand and it would likely fuel inflation and lead to a real appreciation of the currency. A second and more effective course of action, said Yu, would be for the US Federal Reserve to raise interest rates to force consumers to cut spending and increase savings. A weakening dollar and high US inflation, he added, is the ôworst combination for Chinaö.

Hanke also argued that the US should target a sustainable final sales (or aggregate demand) figure of 5.4%, rather than inflation, and warned against capital controls. Finally, he suggested that there needs to be joint action to stabilise the dollar, including a pledge by sovereign funds not to rock the boat.

The future holds many uncertainties, but ultimately Adams believes ôfundamentals will support the dollarö. He emphasised the innovative features of the US economy, its nimble financial markets and the countryÆs strong institutions underpinned by the rule of law.

But poor policy decisions by a new administration in 2009 could undermine the dollar, and he cited inflation, protectionism, regulatory initiatives in the financial sector, foreign exchange policy and climate change as the main risks. ôCapital is a coward,ö said Adams, and it will desert the US dollar unless it is treated well.
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