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Experts See Weaker Dollar, but No Collapse, as Result of Financial Crisis


• Losses in US credit meltdown likely to top US$ 1 trillion
• Asian, Middle East demand for dollar assets expected to remain strong
• De-leveraging of US, European banks poses deflationary risks, but inflation threat also seen
• The dollar may rebound against the euro and sterling in 2009, as economic downturn in Europe worsens

Tianjin, People’s Republic of China – The financial crisis in the US banking system and the proposed US$ 700 billion government rescue package now being drafted in Washington both pose risks to the stability of the US dollar, according to leading bankers and economists gathered at the World Economic Forum’s Annual Meeting of the New Champions 2008. However, a lack of investment alternatives, combined with the likelihood that the economic downturn will spread to Europe, should limit the downside for the US currency.

David Hale, Chairman of Hale Advisors, a US-based consulting firm, said the package should be sufficient to stabilize the US financial system, citing IMF estimates that another US$ 500 billion in US loan losses remain to be written down, on top of the US$ 520 billion in losses already taken. He acknowledged that the costs of the bailout will increase the already bloated US federal budget deficit, forcing the Treasury to step up the pace of its own debt issuance. Given the low US domestic savings rate, foreign investors will need to absorb the bulk of those sales.

Hale dismissed fears that foreign buyers will not be willing to absorb this additional supply. In the short run, he said, demand for US debt and the dollar is supported by the extreme levels of fear in the markets, as Treasuries remain the preferred safe haven in times of crisis. In the longer term, the huge current account surpluses of the Asian exporting countries and the major oil-producing nations, as well as the currency pegs many of those countries maintain to the US dollar, will force them to continue investing in US assets, including Treasuries. “If they are going to run big current account surpluses, the money will have to go somewhere,“ said Hale. He acknowledged that the Treasury’s borrowing demands and pressure on the dollar could lead to higher US bond yields over the coming year, but predicted the US economy would be strong enough to overcome them – as long as the bailout package is approved and confidence in the financial system is restored. If those things happen, he added, “I think we can finance these deficits, hold the dollar in a trading range and set the stage for a recovery next year.”

Sayanta Basu, Chief Executive Officer, Dubai Financial Group, United Arab Emirates, agreed saying Middle East investors remain confident in the ability of the US economy to weather the storm. He also predicted that the United Arab Emirates and other regional oil producers will defend their existing pegs to the dollar, although some may wish to shift to a dollar-euro currency basket over the longer term. “You look at the size of the US economy, and the military power it has, it’s going to be difficult to move the dollar away from a leadership position,” Basu said. “People understand that the US will come out of this. In the end, I think, in hindsight, people will look back and say it was a great buying opportunity.”

Other participants, however, were more pessimistic. Zhu Min, Group Executive Vice-President, Bank of China, argued that the price tag for the US bailout ultimately was likely to exceed US$ 1.8 trillion – an amount too large for either private or official foreign investors to swallow. “Today Uncle Sam will save Wall Street, but who will save Uncle Sam tomorrow?” Zhu asked. He estimated that as a result of their currency interventions, foreign central banks already hold US$ 1.5 trillion in US Treasuries and nearly US$ 1 trillion in US agency securities (obligations of the now-defunct US mortgage giants, Fannie Mae and Freddie Mac).

“Can you ask them to absorb another US$ 1.8 trillion? Absolutely not,” Zhu said. “In the end, the Fed (Federal Reserve) is going to have no choice but to fire up the printing presses. It’s going to create a huge inflationary situation” – both for the US and for those countries that peg to the dollar, many of whom already have serious problems with inflation.” This is likely to lead to significant dollar weakness over the next 18 months, he added.

While dollar weakness is not likely to be severe enough to develop into an even more serious global financial crisis, it will have significant effects on the real economy, Zhu predicted.

Antony Leung, Senior Managing Director and Chairman of Greater China, Blackstone Group (HK), Hong Kong, argued that the inflationary impact of dollar weakness could be offset or even overwhelmed by the de-leveraging of the global financial system, as banks and other institutions reign in their risk levels and/or are forced by regulators to raise their capital ratios. Credit contraction and reduced liquidity, in turn, could produce a deflationary shock to commodity prices, deterring investors from shifting from Treasuries and other dollar-denominated paper assets to gold and other hard assets.“

While global de-leveraging and deflation could endanger global economic growth, it would not necessarily be a dollar negative, suggested Oki Matsumoto, Founder and Chief Executive, Japan’s Monex Group. When Japan fell into its own banking crisis in the early 1990s, the impact on bank balance sheets and asset values was devastating. Yet, the yen did not weaken during the crisis – and actually appreciated sharply against the dollar in 1995.

The size and depth of the US economy and capital markets give the dollar a unique edge as a global reserve asset, one that no other currency can currently match, argued Leung. Although the US share of world GDP has declined with the economic rise of China and other emerging countries, US financial assets still account for about half of total global market capitalization, he noted. “Even if you would rather hold yen or euros, there aren’t a lot of things you can put your money in,” Leung said.

While European capital markets are an obvious second alternative to dollar assets, the euro may also suffer from the delayed effects of the credit crisis, Hale suggested. Although the US economy has born the brunt of the slowdown so far, the major European economies are likely to follow the US into recession or near-recession next year, forcing both the European Central Bank and the Bank of England to cut interest rates aggressively. “If I had one bet to make, it would be to short sterling,” Hale said.

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