IS THE U.S. DOLLAR IN SERIOUS TROUBLE?

From the International Herald Tribune:

Finance ministers and central bankers have long fretted that at some point, the rest of the world would lose its willingness to finance the United States' proclivity to consume far more than it produces - and that a potentially disastrous free-fall in the dollar's value would result.

But for longer than most economists would have been willing to predict a decade ago, the world has been a willing partner in American excess - until a new and home-grown financial crisis this summer rattled confidence in the country, the world's largest economy.

On Thursday, the dollar briefly fell to another low against the euro of $1.3927, as a slow decline that has been under way for months picked up steam this past week.

"This is all pointing to a greatly increased risk of a fast unwinding of the U.S. current account deficit and a serious decline of the dollar," said Kenneth Rogoff, a former chief economist at the International Monetary Fund and an expert on exchange rates. "We could finally see the big kahuna hit."

So long as Americans buy more than they earn from exports - and they did, creating a current account deficit of $850 billion last year - the rest of the world financed the binge by bringing dollars into the United States for investment in stocks, bonds, real estate or other assets, thereby preserving demand for the dollar.

While most economists just a few months ago would have dismissed the prospect of a dollar collapse outright, they now are debating the possibility that something on par with the dollar debacle of the 1970s might just happen again.

When a currency collapses, the central bank can push up interest rates to attract needed investment, but strangle the economy in the process. Alternatively, it can let the currency fall and watch prices of imports - and eventually competing domestic goods - rise sharply.

Double-digit inflation resulted in the 1970s and only a global recession brought it to an end.

The European Central Bank put off an interest rate increase it had planned for September, but is still inclined to tighten credit at least one more time by the end of this year. By contrast, the U.S. Federal Reserve has hinted at a rate cut at its meeting next Tuesday - a step that would diminish the appeal of dollar-denominated assets, almost certainly sending the dollar lower.

Pressed to make an educated guess, most economists opt for calm, believing the dollar is unlikely to go into a tailspin even as they mark up the odds of one.

The major holders of dollars - notably the Chinese, with their $1.3 trillion in currency reserves - have little incentive to see the dollar weaken, and their support provides the dollar with a bulwark of strength. And since investors need to stay diversified, and U.S. markets are deep and liquid, abandoning the dollar wholesale is hardly a realistic option.

"Rather than a precipitous decline, we are probably be looking at a move steadily lower," said Simon Derrick, chief currency strategist at Bank of New York in London.