LONDON — "The dollar’s demise." "Dollar despair." "Gloom for the greenback." A casual glance through the headlines generated by currency pundits in recent years has a near-universal theme. The dollar is always, apparently, staring over the edge of a precipice. Yet, it carries on climbing. Up and up it goes, ignoring the siren calls of those who would like to see a stronger euro, ignoring the ever-widening US balance of payments deficit and ignoring the global slowdown that had its origins in the demise of the US tech bubble.

Can the dollar continue to rally? Obviously, the answer must be yes. Will it continue to rally? On the basis of history, again the answer might be yes. Yet there are a few straws in the wind that might — just might — suggest that the markets’ love affair with the dollar is beginning to wane. Oddly enough, some of these straws come from Europe, and are straws of a rather odd shape.

The Le Pen vote in France, the German metalworkers’ strike for better pay and conditions, the assassination of an Italian economist pushing for labor market reform — all of these would have been seen a year ago as reasons to sell the euro. In 2002, however, the currency markets do not appear to be unduly bothered. Sure, these events don’t exactly cast a favorable light over Europe. However, investors have generally preferred to shift — if only marginally — out of dollars into euros and even into yen. Put another way, people aren’t buying euros because they like the euro: Rather, they’re doing so because they’re having doubts about the dollar.

To be fair, the moves seen so far have been very small. They may, however, reveal some deep-rooted concerns about the performance and sustainability of the US dollar. Just as the psychiatrist has to take her time to extract the inner turmoil from a patient’s mind, so it may be that investors have had to wait a long time to tease out some of the potential flaws in the dollar. The reason for concern at the moment is not the dollar’s fall alone. Rather it is the consistency of the dollar’s decline with the relatively poor performance of US assets. Seemingly, investors are taking fright with all forms of investment in the US: whether it’s stocks or bonds, US assets are falling in value compared with their equivalents elsewhere.

Why is this happening? After all, the latest economic news from the US has, on the whole, been rather good. The economy expanded at a rapid rate in the first quarter, up an annualized 5.8 percent. The leading indicators for manufacturing are moving up nicely. Consumer spending has been generally buoyant. Housing continues to boom. And inflation is very well behaved.

All these things are absolutely fine. They do not, however, let the US economy off the hook. The problem lies with foreign investors. Over the last few years, they have been pouring more and more money into the US economy, in the hope that returns there would be better than returns elsewhere in the world. For some investors, that decision has been absolutely right: The Japanese, for example, would have been better off holding US bonds, for example, than Japanese equities.

For others, however, past investments may now be giving only a very limp return. Those that took over US companies in the hope of seeing a new paradigm of ever-rising profits may now be sorely disappointed. Those that bought US equities in the expectation of continued strong capital returns may be feeling rather bruised. Those that bought corporate bonds in the belief that credit risk in the US was lower than elsewhere may now be feeling a little nervous.

These things matter. The US economy may be growing but it is becoming increasingly difficult for foreign investors to benefit from this growth. With profits relatively depressed, with growing doubts about corporate governance and dodgy accounting and with the "buy to hold" strategy on equities now in shreds, foreign investors may be increasingly reluctant to keep throwing their money at the American Dream.

This leaves the US with a major problem. Past recessions have seen a significant reduction in US demand for funds from abroad. The most obvious way to see this is through the current account of the balance of payments. A common feature of most of these recessions is the disappearance of the current account deficit. In other words, when recoveries begin, US demand for global capital is, generally, rather low. Recoveries have, typically, been funded through domestic, rather than foreign, savings.

This latest economic downturn presents a very different picture. The current account deficit is still very large. If there is a decent pickup in US economic growth — as, indeed, many economists are forecasting — there will be a further expansion of the current account deficit. The demand for foreign funds will rise even further. In effect, overseas investors will be asked for more money even though their earlier forays into the US have ultimately led to losses, not gains.

Will they continue to be willing providers of funds for the US? There must be serious doubts. Looking at the US first quarter GDP numbers, the strength came from inventories, consumption, housing and government spending. None of these categories is the kind of thing that’s going to get foreign investors excited.

The one thing that would be helpful for international confidence — a strong recovery in capital spending — manifestly failed to materialize. Companies appear to be suffering the consequences of over-investment in the second half of the 1990s and are finding it increasingly difficult to spot new, profitable, investment opportunities. And, if this is true of companies, the same is also likely to apply to foreign investors looking to benefit from investing in the US. Their formerly gung-ho desire to fill their portfolios with US assets is in danger of being dramatically revised.

If foreign investors are less willing to support the US economy, there are only two or three possible solutions. The first is a period of significant weakness in US growth, perhaps constrained by the lack of profitability and, on the consumer’s part, a recognition that strong capital gains are now a thing of the past. By limiting the pace of domestic growth, this would reduce the demand for funds from overseas and, hence, shrink the current account deficit.

The second is a sustained decline in the value of US equities and bonds relative to those elsewhere in the world, a process that would reduce America’s liabilities with foreign investors (in effect, by making foreign investors worse off).

The third is a sustained dollar decline as foreign investors in droves pull their money out of the US economy, hitting European and Japanese competitiveness in the process. None of these remedies is very palatable. Whichever way you look at it, America’s soft landing is likely to be followed by a very bumpy recovery that will persistently threaten to go into reverse. (The Independent)

***

(Stephen King is managing director of economics at HSBC.)