Greenback’s Pain Is Euro’s Gain

05/14/2007 12:00 am EST

Focus: GLOBAL

Mary Anne & Pamela Aden

Co-Editors, The Aden Forecast

Pamela and Mary Anne Aden, editors of the Aden Forecast, say the US dollar could continue to fall and the euro would be the chief beneficiary.

The poor US dollar. It’s in real trouble now and hit a new all-time low based on the Fed’s trade-weighted dollar index, and it looks like things are going to get even worse for the greenback.

The massive trade deficit is one important factor. It just hit another record, jumping up to $764 billion for the year. That’s over 6% of GDP, making it the second highest deficit level out of 48 countries. Only Greece is higher at 7.8% of GDP. These extreme levels have always coincided with currency weakness, happening to the dollar since 2001 when it started its current decline.

Since then the dollar has dropped 33% and it’s plunged 70% since it began trading in the free market in the early 1970s. But the International Monetary Fund (IMF) recently warned that a further substantial dollar decline is necessary to bring this deficit to more sustainable levels. Some experts say the dollar must still fall another 20% to 40% in order to accomplish this.

For the past couple of years, high US interest rates compared to some of the other major countries have kept the dollar somewhat firm. But those days are over. With US interest rates now beginning a major decline, the dollar will become more unattractive and this will keep downward pressure on the dollar. That’s especially true combined with the huge trade and budget deficits, and the ongoing out-of-control government spending. Fiscal irresponsibility + low interest rates = a weak currency. It’s that simple.

Yet another problem for the dollar, which we’ve also often discussed, is the growing number of countries that don’t want so many dollars, even though the dollar is still the reserve currency of the world. But reserve status is a privilege belonging to the world’s largest, most economically sound country. And with the biggest debts in world history, the US dollar is unfortunately losing its credentials.

Central bank dollar reserves dropped 3% over the past year, down to 64.75%. That’s a decline of 10% in just five years. It wasn’t that many years ago when central banks had 80% of their reserves in dollars, so this long-term trend for countries. So this long-term trend for countries to diversify out of dollars continues. This, too, will keep downward pressure on the dollar.

We’ll see what happens but for now, we’re watching the 80 level on the US dollar index like a hawk. This is the dollar’s last support and if it declines and stays below this level, the dollar will be in record low territory and it could drop sharply.

This month the euro hit an all-time high against the dollar. The British pound, New Zealand,
Australian and Singapore dollars all hit [multiyear] highs. Best of all, it looks like the currencies are going even higher. The euro could rise much further before this bull market runs its course.

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