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The story that the dollar has to be devalued to "fix" America's current account deficit keeps recurring. Now that George Bush has four more years, the kneejerk assumption is that continued taxation cuts and deficit finance will drive the dollar down.
There are some faults in the argument. First, the dollar's deficit is not that serious. In relation to GDP, America is only seventh worst among the OECD countries. In focussing on the sheer size of the American deficit, commentators rather tend to overlook the even greater relative size of the American economy!
Second, the dollar is still indisputably the world's preferred money. Much offshore banking is in dollars. The world apparently runs a deficit with itself, which is impossible, and the logical explanation is that some of the world's money simply does not get counted. The uncounted money is, of course, largely dollars. This alone may account for about half the apparent deficit.
Third, the Eurozone is heading for trouble. German manufacturing has turned down sharply. The Netherlands and Italy are showing signs of a renewed downturn. Sooner or later, currencies must reflect this.
The reality is that the US, like Britain, has lived through an easy credit boom which has yet to unwind. It is likely that the unwinding will start soon, and therefore that the next US presidential election will be about who takes the blame. The point was well argued in The Times last week. Once economic slowdown starts, then the supply of dollars will cease to grow so fast. Unless other major countries experience the same reduction in credit expansion, the price of the dollar will rise.
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