Alan Greenspan gets religion.
The question now confronting us is how large a current account deficit in the United States can be financed before resistance to acquiring new claims against U.S. residents leads to adjustment.There are still a few holdouts and dead-enders who think that the USD is actually undervalued, but the vast majority of observers agree that for the US current account to begin moving towards balance (nobody is actually predicting or even recommending actual balance), the dollar will have to fall. And fall it will. What no one knows is how far and how fast.
. . . A continued financing even of today's current account deficits as a percentage of GDP doubtless will, at some future point, increase shares of dollar claims in investor portfolios to levels that imply an unacceptable amount of concentration risk.
This situation suggests that international investors will eventually adjust their accumulation of dollar assets or, alternatively, seek higher dollar returns to offset concentration risk, elevating the cost of financing of the U.S. current account deficit and rendering it increasingly less tenable. If a net importing country finds financing for its net deficit too expensive, that country will, of necessity, import less.
The FT reports today (sub. only) that currency speculators worldwide are having a field day shorting the dollar since there is so little downside risk.
This is one of the rare times that the currency markets and most academic economists speak with one voice. The pressure on the dollar is downward. While most hope that any falls occur gradually, giving the world time to adjust, no one should be surprised if, at some point, the currency realignment becomes rapid and destabilising. . . .Up until this point, the US always could count on the Bank of Japan and the People's Bank of China to prop up the dollar when it trended downwards too far and too fast. Clearly the speculators know this and are wary about when to pull the trigger and try a run on the dollar.
The black market money-changers that hover by the kerb outside one Beijing bank have grown so established in recent years that they now give out name cards. . . .
The dynamics of the Beijing kerbside market are mirrored worldwide. Speculators in Singapore's renminbi futures market and investment bankers in London, Hong Kong and New York are betting on an imminent appreciation of China's currency against the US dollar.
Japan and China seem to be engaging in a very delicate dance. China supports to dollar to fight inflation, promote investment and cultivate its Wal-Mart fueled export market in the US. Japan supports the dollar as much to keep its exports competitive in the US as in China. The upshot is that Japan need not intervene dramatically to support the dollar if China relaxes its peg (either recalibrating, widening the variation bands, moving to a basket, or some combination). After all, if the dollar can fall as the renminbi rises, then Japan is not as concerned about the dollar falling.
Much seems to depend on what China and Japan can together agree upon. They can together move away from the dollar or together stay with the dollar, but they cannot move in separate directions. What this suggests, of course, is that the dollar is much more likely to  stabilize or  crash than it is to  conduct a steady orderly decline.
The dollar is hovering today around �103. In comments at AngryBear, Brad Setser notes that
the BOJ stopped intervening in the spring, and subsequently has been buying longer-term treasuries out of the bank accounts/ cash holdings it built up in the spring. at some point, it will need to start buying $ again (intervening) to keep on buying treasuriesAdjusted for US inflation and Japanese deflation, the �105 of late 2003 is now the �100 of late 2004, so we might not see much action until then -- unless the Chinese have something up their sleeve that will make us all start scrambling.