RIYADH, 29 November 2004 — The big story last week was the demise of the dollar. On Friday, the dollar reached an all-time low of $1.3329 against the euro in a nervous market that is reacting to news and views on the dollar’s prospects. What accounts for the dollar’s stunning drop in recent months, what is in store for the future and what does it mean for oil-producing Saudi Arabia? As of last week, the dollar stands close to an all-time high of $1.323/euro or 59 percent above its all-time low of $0.83 in Oct. 2000.
The euro is up 3.4 percent against the dollar in the past four weeks, 7.8 percent above its two-month ago level, and 12.6 percent above its 2004 low of 1.175 reached last April. This year the dollar rose against the euro until April and then started its slide. Interestingly, this is also the period from when oil prices took off in earnest. Against the yen, the dollar stands near its four-and-a half-year low at 102.6 yens per dollar. It started the year at 107.3 yen and rose to a peak of 114.2 in mid- May before the current slide began.
The dollar has lost 4.6 percent against the yen in the past four weeks, and 7.4 percent over the past two months. The trend has been similar against other major currencies. Most analysts agree that the key underlying economic factors behind the dollar’s decline are the twin deficits of the US — in its international trade and its government budget. However, politics is also playing a part.
According to the latest data, the US current account showed a deficit of $166 billion in the 2nd quarter 2004 compared to its year-ago same quarter level of $134 billion. In the full year 2003, the US ran a current account deficit of $531 billion, and in the 12 months ending on June 2004, the deficit stood at $572 billion.
In other words, the US was importing $572 billion more of goods and services from abroad than it was exporting. It pays for this extra imports with dollars, thus pumping up the supply of dollars in the global forex markets. However, foreign countries, especially, Asian exporting countries which end up with the bulk of these dollars mop up a large part of these excess dollars off the forex markets by buying US treasuries.
In the 12 months ending on June 2004, foreign purchases of US government securities totaled $336 billion (still leaving $236 billion of excess dollars in global forex markets to be mopped up by other factors). This excess supply of dollars — which will continue as long as the US continues to run up current account deficits — is the essential factor behind the dollar’s decline. The decline in foreign purchases of US treasuries of late has prompted the current slide and questions anew about the dollar’s value.
Government overspending is a primary reason for the huge current account deficit. In 2003, the US federal government budget deficit was $375 billion; the number is projected to balloon to $521 billion this year and to $363 billion in 2005. Clearly, these are unsettling numbers for the dollar going forward.
(Khan H. Zahid is chief economist and vice president at Riyad Bank. He is based in Riyadh.)