International Herald Tribune Editorial - Dollars for sale

International Herald Tribune Editorial - Dollars for sale
Copyright by The International Herald Tribune
Published: August 26, 2007


During the worst of the markets' recent volatility, many investors moved their money into supersafe U.S. Treasury securities, temporarily boosting the dollar against the euro and the British pound. But of late, the dollar has resumed its downward trend of the past several years. And policymakers and currency traders are once again hypervigilant for signs that Asian central banks might redeploy part of their dollar-based debt holdings into non-American investments.

Such diversification - particularly by China, which is believed to have some $1 trillion - could further weaken the dollar, presaging higher interest rates and higher prices in the United States.

But Asian bankers, it turns out, are not the only ones to watch.

According to a new study by Stephen Jen, a currency economist at Morgan Stanley, American investors may be a more powerful force than their foreign counterparts in driving the dollar down.

Jen notes that since 2003, American mutual funds have increased their allocation of overseas equities from 15 percent to 22.5 percent, a pace he describes as "gradual but determined." If America's other big institutional investors, such as pensions and insurance companies, have invested elsewhere at the same pace, he calculates that the outflow of dollars would now amount to $1.16 trillion, about the same as China's total foreign reserves.

The outflow is not necessarily a thumbs-down on the dollar's prospects, says Jen. Instead, it may reflect an increased willingness to invest overseas in a prudent attempt at broad diversification.

But in a recent analysis of Jen's study, the Economist magazine points out that a negative view about the dollar may underlie the urge to diversify. The Economist cites a Merrill Lynch survey showing that downbeat expectations for the dollar have been common among fund managers for the past five years.

The push to diversify out of dollars was strongest three years ago, but persists today.

If dollar wariness among American investors were a recent phenomenon, it could be chalked up to temporary forces. But because the unease has been marked for many years, it must emanate from something more entrenched. One probable source is concern about America's huge ongoing foreign indebtedness.

Currency markets generally punish heavily indebted nations by pushing down their currency. In the absence of policies to boost domestic savings - and thereby slow the build up of debt - a steady decline of the dollar implies a steady decline in American living standards. A sharply accelerating decline would imply severe economic distress. By diversifying out of dollars, American investors seem intent, at least in part, on reducing their exposure to either eventuality.

Policymakers should spend less time worrying about what foreign creditors could do to harm the dollar, and more time working to improve savings at home, both public and private. That way, the United States would be less reliant on imported capital and less vulnerable over all, come what may.