China and Japan must help the U.S. in order to help themselves.
Any time the financial markets become as obsessed
with a single financial vehicle as they currently are with the U.S.
dollar, it's natural to assume that most of the currency's movement is
already behind it.
Indeed, some savants like Steve Leuthold of Leuthold
Asset Management think the greenback has already overshot its intrinsic
value. But that is clearly a minority opinion. Most experts, ranging
from Federal Reserve Board Chairman Alan Greenspan to PIMCO's Bill
Gross to officials in the Bush Administra-tion, believe it has more
room left to fall.
Moreover, the prospect of the vertiginous freefall of the U.S. dollar continuing has left many advisors like El Cajon, Calif.-based Bill Bengen deeply disconcerted. So much so that he is seriously considering reducing clients' positions in American equities and bonds and moving their assets into foreign mutual funds. That would be a major shift for Bengen, who only five years ago was questioning whether his clients needed to have any significant holdings of international equities whatsoever.
Even those advisors whose client portfolios are defensively positioned for a drop in the currency are still getting bombarded with questions from clients about it. "We think the dollar is going to get softer," says Ross Levin of Accredited Investors in Minneapolis.
Yet over the long term, Levin believes a weak dollar would be positive for the U.S. economy since it will make U.S. exports more competitive in international markets. "But the big issue now is the short term and what it says about the policies of our government, our national savings rate and our propensity to take on debt," he adds.
Whatever happens in the markets, Accredited Investors' client portfolios would appear to be ready for the worst. Fully 40% of the typical client's total portfolio sits in international mutual funds and securities, with 30% in international stock funds and 10% in foreign bond vehicles. "We think that next year won't be that good for domestic stocks," Levin says.
Perhaps the biggest reason that many experts think the dollar remains weak is that the Bush administration appears comfortable with it as a means to address some of the imbalances that exist between the U.S. and foreign economies. "When Alan Greenspan says the dollar has to come down for two or three years to address the current account deficit, you listen," says Ken Buntrock, co-manager of the Loomis Sayles Global Bond Fund. "We think there will be dollar weakness for some period of time, perhaps five years."
But Buntrock believes that the softness in the dollar probably is quite manageable, if for no other reason than it is in the best interest of America's biggest creditors, Japan and China, to continue to finance the gaping U.S. current account and federal budget deficits. "As long as China, and particularly Japan, decide to manage their reserves" cautiously, the tenuous market conditions are unlikely to spiral out of control, he says.
"It's in China's interest to continue purchasing U.S. [government securities] because they need the U.S. consumer to export products to," says Joe Taylor, an Asian sovereign debt analyst at Loomis Sayles. "In both Japan and particularly in China, domestic demand is very low."
Asia's two largest economies are driven by external demand, primarily American demand for goods and services, but as a consumer economy takes hold in China over the next decade its citizens will inevitably become bigger spenders and its surpluses should shrink, Taylor believes. This, in turn, could reduce China's appetite to finance U.S. debt.
That's a big reason why many think the imbalances between America and Asia are not sustainable over the long term. The possibility for a crisis is exacerbated by the excess supply of dollars, printed to finance the twin deficits. It is creating a huge amount of liquidity that is sloshing around the global financial system. "There are too many dollars chasing too few good ideas," Buntrock says. "And the U.S. administration has gone out of its way not to defend the dollar."