Monday, November 01, 2004

Warnings from The Economist. The short summary: "The wolf is licking his lips." And they aint talking about some stupid Bush campaign commercial.
MOST economists, and this newspaper, have been fretting about America's huge current-account deficit and predicting the dollar's sharp decline for years. The trouble with crying wolf too often is that people stop believing you. . . . Trust us, the wolf is real. . . .

Other economists, however, argue that America can sustain its large current-account deficit for at least another decade, without a sharp fall in the dollar, because it will be happily financed by China and other Asian countries. In a series of papers Michael Dooley, David Folkerts-Landau and Peter Garber at Deutsche Bank have argued that the present arrangements resemble a revived Bretton Woods, the system of fixed exchange rates after the second world war. . . .

An excellent paper by George Magnus, an economist at UBS, argues that the parallels with Bretton Woods are superficial. . . .

Mr Magnus reckons that the revived Bretton Woods is an illusion which will crack within a year or two. Even if it lasts longer, it is a dangerous way to run the world, for it encourages both China and America to pursue reckless policies. Excessive liquidity is causing the Chinese economy to overheat. Meanwhile, by buying Treasury bonds, Asian central banks are subsidising American borrowing costs, encouraging more consumer profligacy, and so allowing the current-account deficit to get even bigger. The inevitable correction will then be all the more painful. . . .

In the three years from 1985, the dollar fell by 50% against the other main currencies. Inflation and bond yields rose and, in October 1987, the stockmarket crashed. America's current-account deficit is now almost twice as big as it was then, so the total fall in the dollar´┐Żand the fall-out in other financial markets´┐Żcould well be larger. The wolf is licking his lips.

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