Hamish Mcrae: These are perilous days for the US

[babylonsister]

Hamish Mcrae: These are perilous days for the US
Published: 14 November 2007


I don't think Americans get it. I don't think they realise quite how serious the collapse of the dollar is for the global economy, nor the long-term consequences of this decline for the position of the US in the world. Sure, they grumble about prices in London and find it odd that US lawyers want to be transferred to the UK because they can earn more money here. But at a fundamental level, to judge by the conversations I have had in recent weeks, I don't think the US financial community appreciates quite what peril it is in.

There have been periods of dollar weakness before. The most notable marked the end of the fixed exchange rate system in the early 1970s. There have been periods of excessive dollar strength too, one of which led to the Plaza Accord in 1985 – so called because the agreement by the US and other major economies that the dollar needed to be capped was reached in the Plaza Hotel in New York.

Now it may be that in another five years the dollar will be strong again and Britons who used this age of the pound above $2 to buy property in the US will feel rather smug. Maybe. At some level, the dollar will become good value again and while currencies do overshoot their true long-term values, they do bounce back.

But there seems to be at least half a dozen reasons why what is happening now to the dollar is very serious indeed. Most obviously, the present fall is going further than previous declines. The most marked collapse is against the euro but if you measure even against sterling, a rate of $2.10 cannot be justified by the relative purchasing power of the two currencies. It may not happen, but you hear talk in the City that the rate may go to $2.40, which would be back to the old dollar/sterling rate under the fixed exchange rate system. The greater the decline, the greater the disruption to the world economy.

Why such a large fall? That leads to the second feature that distinguishes this bout of weakness: the US current account deficit is much larger both in absolute terms and as a percentage of GDP than in previous dollar cycles. Every year, the US has to borrow around 6 per cent of its GDP just to pay for its imports. Until a few months ago it was able to do so. Foreign investors were impressed by the sales pitch they got from the US banking community: buy these sophisticated financial instruments our brilliant maths experts have created and you will get a higher return than you can get from anywhere else. Now those US bankers don't look so smart and more than one non-US investor has indicated to me they felt they have been stuffed with rubbish. They won't trust those bankers again.

So, the third new element: trust in US financial sophistication has been shattered. The problem is not just the dollar; it is the integrity of US financial institutions. The pitch that the US has more transparent and more resilient markets than other countries is no longer credible.

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http://comment.independent.co.uk/commentators/hamish_mcrae/article3157764.ece