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One of the reasons I intend to reduce my US holdings. A falling dollar frightens me !!
Regards
Harmy

http://www.morganstanley.com/GEFdata/digests/20020111-fri.html

The first thing I did when I arrived in Frankfurt this week was to get some euros. There's nothing like the look and feel of newly minted coins -- especially of a currency that heretofore existed only on our screens. When I emptied my pocket at the end of the day, it was not too difficult to separate the euros from my American currency. Shiny and sleek, they stood in sharp contrast to the worn and wrinkled greenbacks. My mind started racing.

I have long felt the strong dollar is an accident waiting to happen. If anything, my conviction is deepening. The reason: America's external imbalance has plunged into the danger zone and is about to get worse. The current-account deficit -- the broadest measure of any nation's international financial position -- hit a record 4.6% of nominal GDP in late 2000. That was more than a full percentage point wider than the previous record deficit of 3.5% hit in late 1986. While the deficit narrowed a bit in 3Q01 (to 3.7%), that was an aberration traceable largely to foreign insurance payments associated with the destruction of the World Trade Center. The bad news is that the current-account deficit appears set to get a good deal worse in the years ahead. Our baseline scenario for the US economy has America's external shortfall rising to the astronomical 6.2% share of GDP by late 2003. Such a deficit would bear an eerie resemblance to those that plagued a pre-crisis Asia in the mid-1990s.

This is a stunning and worrisome development for a US economy in recession. Normally, cyclical downturns are just what the doctor orders for current-account deficit economies. The resulting slowdown of domestic demand produces a concomitant reduction in imports, whereas resilience elsewhere in the world allows exports to keep on expanding. That's exactly the way it worked in the recessions of the mid-1970s, the early 1980s, and again in the early 1990s -- as the business cycle transformed external deficits into balance. Not so this time. The synchronicity of this world recession has prevented such an outcome. With the rest of the world marching quickly to the beat of the US economy, exports plunged by 11.5% (in real terms) over the four quarters of 2001. And with a relatively contained shortfall in domestic demand, imports were down an estimated 6% over the same period. With the dollar value of imports of goods and services fully one-third larger than exports, the normal cyclical math of the current-account adjustment simply doesn't add up; it would have taken a much larger reduction in imports -- or an even greater export offset -- to take the external gap toward balance.

This same math -- a by-product of the so-called current-account legacy effect -- produces the even more dire outcome of our recovery scenario. The value of imports is simply too large to allow the likely rebound in exports to put a dent in the external imbalance. Nor does America's high import propensity help matters any. Our baseline case for 2003 calls for export growth (13.9%) to be more than 50% faster than import growth (9.0%). And yet because imports are so much larger than exports, the current-account gap is still projected to go from 4.9% of GDP in 2002 to 6.1% in 2003.

This would leave America more dependent than ever on foreign capital to finance the ongoing operations of the US economy. The capital account is, of course, the flip side of the balance of payments. And if our baseline estimates come to pass, the United States will have to attract some $664 billion of foreign capital in 2003 in order to finance its current-account deficit. That's nearly $2 billion per day, close to double the daily financing requirements in 2001 (about $1.1 billion per day). Therein lies the great conundrum for the heretofore Teflon-like dollar. History is utterly devoid of examples when such a massive external financing requirement did not result in a sharp depreciation of the currency and/or a concession in the price of other assets -- namely stocks or bonds.


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