What do finance ministers and central bank governors talk about when they get together? At the next big powwow, the G-20 get-together in Cape Town in South Africa next week, the dollar will be “top of the agenda,” in the words of Canadian finance minister James Flaherty.
The Canadian loonie is up by 9% against the dollar since the beginning of September, even after falling 2% on Monday. That will be tough on Canadian exports. The sterling is up about 10% against the dollar in a year and the UK reported a record monthly trade deficit last week.
But the biggest long-term risk from a fast-falling dollar is financial, not industrial. Foreigners are owed a net $8 trillion (Rs315.2 trillion) by US debtors—the cumulative effect of decades of trade deficits. The dollar-denominated deposits, loans and bonds constitute the financial backbone of the globalized economy. If traders came to doubt the value, in foreign currency terms, of their dollar assets, many cross-border financial markets could freeze up. Think of the troubles that have followed doubts on mortgage-backed securities and multiply by eight.
A dollar tumble cannot be ruled out. The US trade deficit has stabilized, but at a monthly level of $57 billion. In other words, to keep the dollar from falling, foreigners have to be willing to add almost $700 billion annually to their dollar portfolios. That’s a big bet on an economy with falling interest rates and signs of sharply slowing growth.
The answer to this threat is for foreign governments not to shift too fast out of dollars. More, they should buy enough dollars to keep the currency’s rate of decline moderate. The dollar supporting governments might lose some money, but the alternative is worse.
Nothing like that can be counted on if the US authorities do no more than express a pious belief in the virtue of a strong dollar. The US central bank has weakened the currency by cutting interest rates. Foreigners aren’t going to be anxious to help a country that won’t even try to help itself. The conversation in Cape Town could be lively.