The dollar hit a fresh three-year low against the euro and sterling yesterday as economists and bankers in Davos for the World Economic Forum (WEF) warned of further turbulence ahead.
A senior official of the Bank of China warned of "very volatile" exchange rates and, in particular, further falls in the dollar, which closed at €1.075 in Europe yesterday.
Last year the dollar fell more on a trade-weighted basis than in any year since 1987. The slow but inexorable fall of the dollar so far this year has been driven by mounting tensions between the US and Iraq.
In the WEF's opening session, there was general agreement that the outlook for the world was, for the immediate future at least, synonymous with the outlook for the US.
As Mr Stephen Roach, chief economist of Morgan Stanley, put it: "The world is more US-centric now than it has ever been." While economists accepted there were significant risks to the outlook, most notably from the record level of household debt, they forecast that the US might grow by between 2 and 3 per cent this year. If it does, it is likely once more to be the best performer of the world's five biggest economies, with some expecting growth of just 0.8 per cent in the euro zone.
The Japanese government expects growth of about 0.6 per cent this year. In nominal terms, allowing for the continuing fall in prices, GDP is expected to fall.
The one significant bright spot is China, which grew by about 8 per cent last year. But as it provides less than 4 per cent of total world GDP, its impact is relatively minor.
If those expectations are fulfilled and global growth is unbalanced for another year, then the US current account deficit, already about 5 per cent of GDP last year, will continue to grow, hitting 6 per cent, says Mr Roach.
The problem for the dollar is that the deficit is becoming increasingly difficult to finance. Capital flows from Europe and Japan to the US have been falling, and by last year's fourth quarter the main inflow was from Asian countries other than Japan.
Mr Zhu Min, general manager of the Bank of China, said he did not believe those flows could be relied on. "Asia has been exporting to the US, and buying US Treasury bills, and so far everybody has been happy. But I don't think it is sustainable," he said. "Dependence on Asian capital flows to sustain the deficit is not healthy."
He argued that when short-term interest rates were 4 per cent in the UK and 2.75 per cent in the euro zone, compared with only 1.25 per cent in the US, capital flows from Asia were subject to change.
The inflows to the US were increasingly financing not business investment but the budget deficit would be an extra problem for sentiment.
Not everyone believes the dollar must fall. Ms Gail Fosler, chief economist of the Conference Board, the business research group, predicted "a very sharp recovery" to higher levels than in the 1990s once the Iraq crisis has been resolved.
Mr Glenn Hubbard, top economic adviser at the White House, would soon be leaving his post, administration officials said yesterday.
His departure as chairman of the Council of Economic Advisers (CEA) would complete a turnover of the administration's top economic team following the dismissal of Mr Paul O'Neill, Treasury secretary, and Mr Larry Lindsey, National Economic Council chairman, in December.- (Financial Times Service)
