Tuesday, July 1, 2008

Disorderly Dollar Drop Can't Be Ruled Out, BIS Says

Disorderly Dollar Drop Can't Be Ruled Out, BIS Says

By Kim-Mai Cutler

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A disorderly decline in the dollar remains a possibility as losses on U.S. assets pile up and the current-account deficit triggers ‘‘a sudden rush for the exits,'' the Bank for International Settlements said.

A plunge in the currency may happen even after its ‘‘remarkably orderly'' 14 percent slide against the euro in the past year, the Basel, Switzerland-based BIS said in an annual report today.

‘‘Foreign investors in U.S. dollar assets have seen big losses measured in dollars, and still bigger ones measured in their own currency,'' the BIS said. ‘‘While unlikely, indeed highly improbable for public-sector investors, a sudden rush for the exits cannot be ruled out completely.''

Officials from the Group of Seven nations said after a meeting in Tokyo on Feb. 9 that ‘‘excess volatility and disorderly movements in exchange rates are undesirable,'' signaling policy makers may intervene to prop up the U.S. currency. U.S. Treasury Secretary Henry Paulson said in a radio interview in Moscow today ‘‘a strong dollar is a good thing.''

Implied volatility on options for the dollar was at 10.3 percent today, according to a JPMorgan Chase & Co. index. It was 14.5 percent on March 17, the same level at which the G-7 stepped into the market in 1995 to influence prices.

Widening Deficit

The U.S. current-account deficit, the broadest measure of trade in goods, services and investment income, widened in the first quarter to $176.4 billion, the Commerce Department said on June 17. The U.S. needs to attract $1.9 billion a day from overseas to fund the gap. Foreign buying of U.S. assets rose in April to an 11-month high as total holdings of equities, notes and bonds increased by a net $115.1 billion, the Treasury Department said June 16.

The Dollar Index, which measures the currency against six major counterparts, declined 5.7 percent this year. The U.S. currency fell to an all-time low against the euro on April 22, when it reached $1.6019. Against the yen, it dropped to a 12- year low of 95.76 on March 17.

The declines have raised speculation that economies with fixed-currency systems will end their pegs and that central banks will reallocate foreign reserves away from the dollar, the BIS said. The U.S. currency made up about 64 percent of total reserves in 2007, a figure unchanged from the previous year, according to the International Monetary Fund.

Yen to Strengthen

The yen may also strengthen this year, raising deflation risks for the Japanese economy, which ‘‘remains a significant and worrisome outlier,'' the BIS said.

The Japanese currency has appreciated 5.6 percent versus the dollar this year. It has weakened 2.4 percent against the euro.

‘‘With the effective value of the yen close to a 30-year low, a large current-account surplus and massive exchange-rate reserves, the yen could eventually rise further,'' the BIS said. ‘‘In this case, against a backdrop of sagging trade and continuing sluggish growth, a return to deflation could by no means be ruled out.''

The Japanese currency is forecast to rise to 100 per dollar and 148 against the euro within a year, according to the median of analysts' estimates compiled by Bloomberg. The world's second-largest economy shrank at an annual 0.4 percent pace in the second quarter, a separate Bloomberg survey of 17 economists showed.

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