Friday, November 05, 2004

Whither the Dollar?

The conventional wisdom seems to be that the dollar is headed down. The case is made pretty clearly here in the Economist.

The U.S. current account deficit will reach about $600B this year, or about 6% of U.S. GDP. Most of this is financed by Asian central bank purchases of Treasury debt. How long will China and Japan continue to finance our profligacy? Certainly they have strategic reasons to keep their currencies cheap relative to the dollar. But someday (soon?) they'll begin to diversify their foreign reserves into Euros. When that happens, we can expect a run on the dollar and a significant increase in interest rates to keep dollar-denominated Treasuries attractive to our creditors.

How to hedge this risk? If you have any good ideas, let me know! Bonds denominated in Euros or NZ dollars or Norwegian Crowns are one option, but they've already had a big run up in recent years. (The dollar is down 14% in trade-weighted terms since 2002.)

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