Dealing with a weaker US dollar

The G7 Communique focused the market's attention on propsects for a weaker dollar once more.

Although the currency markets reacted strongly to the communique, sending the yen to a three year low, it is important to state that this is not a rerun of the plaza accord, nor will the statement necessarily prevent Asian central banks from intervening to weaken their currencies in the future.

But what it did demonstrate was that both the market and policy markers now agree on the need for a weaker dollar. This need is something that we have long maintained.

The key reason is the current imbalances in the US economy, in particular the economy's structural reliance on foreign funding. That is evidenced by the huge current account deficit which is running at over 5% of GDP - or USD1m a minute.

That reliance can not continue indefinitely. There are three ways this can be rectified. In order of preference, they are: 1) Strong non-US global growth, 2) a weak US dollar or 3) a weak US economy.

While we are optimistic about the near term economic outlook in Asia ex-Japan, the bigger economies still look relatively weak. Japan has
had a stellar year in 2003 and we now expect it to grow by 2.6% for the full year.

However this is unlikely to be improved upon. Elsewhere the picture is even gloomier with Europe, the world's second largest economy, bordering on recession. Hence the need for a weak USD.

However a dollar collapse is in no ones interest. This could derail the world recovery by pushing up US long term interest rates and producing a US recession. Instead, the status quo - a gradually correcting USD - is in everyone's interest.

Unfortunately, a gradual USD depreciation may not be sufficient to close the current account deficit. What is required is sharply lower
demand for imports and/or strong export growth.

With the rest of the world, and therefore demand for US exports, subdued this may take a US slowdown. What is clear is that the current level of the US current account deficit is unsustainable. A solution is needed and whether it will be 2 or 3 the market should be prepared for it.