IMF: Large Trade Gap Puts U.S. Dollar At Risk Of Sharp Decline

By BridgeNews The International Monetary Fund (IMF) warned Aug. 14 that the large U.S. current account deficit could prompt a sharp decline in the value of the U.S. dollar, especially if U.S. productivity performance "proves disappointing." In its annual assessment of the U.S. economy, the IMF also indicated the Fed has room to lower interest rates further, if the economy remains weak. In a summary of the IMF discussion of U.S economic conditions, the IMF said the large current account deficit does not appear sustainable "over the longer term." A sudden "correction" in the current account deficit could hurt the U.S. economy as well as the world economy, the IMF said. IMF directors stressed that "disciplined" economic policies, including a continuation of budget surpluses, "would help to facilitate an orderly adjustment in the dollar and the current account deficit." The IMF warnings about the threat to the dollar posed by the large U.S. current account deficit are nothing new. Economists have expressed concern about the potential for a dollar plunge for years as a result of the current account deficit, which has widened sharply in recent years to more than 4.5% of GDP in 2000. However, the dollar has continued to climb this year, despite sharply lower interest rates in the United States and a sharp slowdown in U.S. economic growth. Generally, lower interest rates tend to lower a country's currency. The IMF warning of a sharp dollar decline comes at a time when there has been mounting pressure from manufacturers on the Bush administration to back away from its rhetorical support for a "strong" U.S. dollar. Also, in a sign that sentiment may be changing in the investment community, Goldman Sachs Chief Economist William Dudley recently urged the U.S. to scrap the "strong dollar" policy. Treasury Secretary Paul O'Neill has rebuffed such entreaties. In its assessment, the IMF expressed concern that the continued strength of the dollar and slower economic growth would lead to greater calls for trade restrictions. It cited as an example the U.S. decision this spring to investigate whether steel imports into the United States were being unfairly subsidized. Regarding the U.S. economy, the IMF said most of its executive directors expected inflation pressures to remain "quiescent." That gives the Fed room to cut interest rates if economic weakness persists, it added. The IMF said it was unclear whether the economy would remain weak or pick up soon, saying prospects depend on how confidence affects business and consumer spending. Regarding U.S. budget policy, the IMF said the recent tax cuts have been appropriate and timely. But the IMF also indicated some misgivings about the size of the multi-year tax-cutting program now signed into law, saying the total cost of the cut is likely to be "higher than current estimates suggest, unless offsetting actions are taken." It said there is a "significant risk" that spending targets could be breached. The IMF also hinted the United States should hold open the possibility of delaying implementation of the planned tax cuts. "Given the uncertainties about the final costs of the tax cut, the ability to contain discretionary spending, and the accuracy of fiscal forecasts, directors recommended that spending increases and multi year tax cuts should be implemented flexibly so as to ensure that there will be sufficient resources over the medium term to finance these measures," the IMF said.

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