How moves abroad can force dollar's dive

The dollar today isn't so mighty.

Over the past year, it has declined more than 4 percent, on average, against the currencies of the trading partners of the United States.

The combination of a weaker dollar, lethargic economic recovery, and three years of a bear market on Wall Street is seen by some observers as a sign that American economic dominance in the world is declining.

"I'm not so sure that we are, or perhaps will be, the economic powerhouse we once were," said William Gross, managing director of Pimco, the world's largest bond-fund company, on his firm's website.

The threat of war with Iraq hasn't helped. Financial pages often note that the war clouds are making investors abroad jittery. They are keeping their money home instead of adding to their investments in the US. A small amount is going into gold and Swiss francs.

Unlike in the financial crises that wracked East Asia and Russia in the late 1990s, the US is not the big haven for frightened money this time.

There's no immediate economic challenge to the US, though.

Japan's economy remains in the doldrums. Possibly the appointment of a new governor of the Bank of Japan, due by next month, will change that.

The European Central Bank has not yet pushed hard to lift the slack Continental economy. In size alone, Europe's economy is a match to that of the US.

Since January 2002, the euro, the common currency of a dozen nations in Europe, has risen 21 percent against the dollar. Americans traveling in France now pay $1.08 for a euro, up from 83 cents, briefly, in 2001.

"American exporters find it easier to compete in Europe," says Richard Cooper, an international economist at Harvard University. They may also find it less hard to sell in other markets where US and European manufacturers battle for market share.

In the past 13 months, the dollar has slipped 9.5 percent against the yen. Fearing for its exporters, Japan's government is using yen to buy dollars and prop up the greenback's price.

One side effect is positive for Japan. The $6 billion Japan bought secretly last month should add to the nation's money supply, in time speeding up the domestic economy.

The currency of other major trading partners, such as Canada, China, and other East Asian nations have tended to track the US dollar. The Mexican peso and Brazilian riel have fallen in value.

A big reason for the strength of the dollar in recent years has been the eagerness of foreigners to buy dollars on the foreign-exchange market to invest in American assets.

By now foreigners own $1.7 trillion of US treasuries, about a third of the total held by the public. Foreign central banks have put more than half of that sum in their reserves. Foreigners also own about $1.3 trillion in US corporate bonds.

Most experts don't expect a sudden outflow of such investments, despite Iraq.

In addition, major international banks are now borrowing huge sums of money at low rates in the US and investing it at higher rates in Europe and other smaller economies, says Jane D'Arista, an economist with the Financial Markets Center. This "carry trade" - or less politely, speculation - depresses the dollar. But it can make the banks some profits.

Experts wonder what will happen to the dollar if foreigners cease to pump this amount of money into the US economy.

"This is a danger," says Peter Kenen, an economist at Princeton University. "The odds are increasing" of a more precipitous decline in the value of the dollar.

This year, the deficit in the US current account, that is, the balance in its international payments, is expected to reach a record $500 billion. That is almost 5 percent of gross domestic product, a level often seen as "dangerous" for nations.

To finance that deficit, foreigners must sink $1.34 billion a day into the US.

At current low interest rates, the cost of such financing of the deficit "doesn't create a problem for the US," says Michael Cosgrove, principle of The Econoclast, an advisory service in Dallas. One reason is that foreign central bankers will be reluctant to bail out of dollars.

For instance, the Bank of Japan owns $359 billion of US treasuries, the People's Bank of China $90 billion, the Bank of England $73 billion, and so on. If the dollar depreciates, they could take huge paper losses on those investments. Usually, though, such losses aren't discussed.

But in a few years, as the economy and interest rates rise, the deficits could become a big issue, Mr. Cosgrove warns.

Harvard's Mr. Cooper sounds less concerned. It's true, he notes, the US is a net debtor in the world. And the amount of foreign ownership of US assets has swelled enormously in recent years. It far exceeds by now the value of all US ownership of foreign assets. Yet the US earns almost as much on its established investments abroad as foreigners earn on their even larger stake in the US.

"There is nothing wrong with that," he says. Foreign investment in the US helped the nation's prosperity in the 1990s. It gives the older populations of Japan and Europe an asset for their retirement years.

But it troubles Dean Baker, an economist at the Center for Economic and Policy Research in Washington. If the current account deficit continues at the present rate, he calculates, the US net debtor position will reach $10 trillion by 2013. That comes to $30,000 per US resident.