Currency's Dive Points to Further Pain

By Anthony Faiola, Peter Whoriskey and Renae Merle
Washington Post Staff Writers
Tuesday, September 23, 2008; A01

The dollar took its steepest one-day drop in years as the financial crisis eroded the nation's basic measure of value, helping to drive U.S. stocks sharply lower and the dollar-based prices of oil and gold sharply higher.

The convergence of negative sentiment came as investors focused on the uncertainties in the Bush administration's emergency plan for a massive bailout of the financial system, outlined this weekend. Indications yesterday that the administration would need more time to iron out a compromise with Congress raised questions about what the plan will ultimately look like, even as investors tried to assess how and whether it would work.

New concerns also emerged over the toll the crisis will take on the U.S. economy, with many analysts saying the slowdown could worsen, perhaps costing more jobs and hurting consumers.

The government's plan to spend up to $700 billion to take troubled assets off the books of ailing firms and billions more to guarantee money-market mutual funds will force the Treasury to add to the already massive national debt. It may have to raise that money by selling more Treasury bills and perhaps even printing more dollars. That, economists said, could trigger higher inflation and drag down the economy further.

The dollar yesterday plunged 2.2 percent against the euro -- its biggest one-day fall since January 2001. Some analysts predicted that if the dollar continues its dramatic tumble, the Bush administration would seek the assistance of foreign central banks to prop it up.

The steep drop was partly behind Monday's surge in the price of oil -- denominated in the U.S. currency -- its biggest one-day jump ever in dollar terms. The price of the benchmark crude oil catapulted to $120.92 a barrel on the New York Mercantile Exchange, a $16.37 increase. At one point, the price was up $25.55.

"This is a revaluation of the U.S.," said C. Fred Bergsten, director of the Peterson Institute for International Economics and a top Treasury Department official during the Carter administration. "Growth is going to be slower, the budget deficit higher, but mostly, the whole U.S. financial system has been thrown into question. People around the world are looking at this and saying, 'Holy Toledo.' "

The realization that the United States may find itself in worsening financial straits with or without a bailout sparked a sell-off on Wall Street. The Dow Jones industrial average fell 372.75 points, or 3.27 percent, to close at 11,016. That wiped away Friday's nearly 400-point rally that accompanied the initial unveiling of the Bush administration plan. The technology-heavy Nasdaq composite index fell 94.92, or 4.2 percent, to close at 2179. The Standard and Poor's 500-stock index was down 47.99, or 3.8 percent, to close at 1207.

The size of the bailout, analysts said, has focused attention on just how much debt the United States can handle without being forced to raise taxes or make sharp cutbacks in government spending. Peter Schiff, president of Euro Pacific Capital, said the fear of inflation provoked by the $700 billion plan -- without figuring out a way to pay for it -- was behind the market's dramatic movement.

"Where's the tax increase to fund this bailout? Where is the cut in programs? The government's not doing either -- they're just going to print money," he said. "And if you think inflation is the answer, take a trip to Zimbabwe and see how it's working for them."

He added that the new rules imposed on short selling, short-term bets that a stock's price will go down, caused a flow of money into commodities besides oil, including gold. "You can't short stocks anymore, right? So if you want to bet against the market, you need to buy commodities: gold, oil," he said.

As the market gyrations left many investors wondering what would happen next, major credit-rating agencies issued statements rejecting the notion that the AAA rating of the U.S. government might be immediate danger. Yet analysts acknowledged it was a valid question.

"This is arguably a critical question given that the U.S. Treasury's Aaa rating acts as the cornerstone of risk pricing in the global financial system," said Pierre Cailleteau, managing director of the sovereign risk unit at Moody's Investors Service and author of a report issued yesterday on the U.S. credit rating.

A loss of that status would probably mean that the United States would have to pay more to those investors, including foreign governments, that hold U.S. bonds. But the report said, "Moody's continues to view the foundations of the U.S. government rating as unshaken."

Similarly, John Chambers, a managing director at Standard and Poor's, said he viewed the United States as stable. Although some have drawn parallels between the current financial woes and those in Japan, which lost its AAA credit rating in 2001, Chambers said the United States has far greater ability to meet its obligations.

He noted that before Japan lost its AAA rating, its general government debt was more than 100 percent of its gross domestic product. By contrast, even figuring in "every last nickel" of the proposed U.S. bailouts, general government debt in the United States falls below 60 percent of gross domestic product, he said.

One key question for investors and multilateral lenders is how the U.S. bailout plan will treat foreign investors in troubled mortgage-backed securities. "A substantial amount of these securities are held by non-U.S investors," said John Lipsky, first deputy managing director of the International Monetary Fund. "Obviously, the disposition of the U.S. [toward these investors] will be important to determining future attitudes about investing in the U.S. versus elsewhere."

Foreign governments and multilateral lenders have been offering advice to the U.S. government as it moved in recent weeks to take over some financial institutions while allowing others to fail. The IMF has been subtly calling on the United States to take a broader approach to the financial crisis, and officials there applauded the administration's efforts in recent days to launch a more comprehensive plan to address core issues.

"Obviously, these events have been striking and potentially very troublesome, but the remedial actions being taken, if done right, will help to restore any confidence that might have been lost," Lipsky said.

As investors await final details of the financial rescue plan, some analysts noted that it will not address some of the economy's fundamental weaknesses, including poor housing prices and growing unemployment figures.

"With talk of the government buying assets at steep discounts and of an emphasis on taxpayer protection, the benefits to bank and thrift capital levels may be less than the market anticipates," Paul J. Miller Jr., an analyst with Friedman, Billings, Ramsey, said in a research note yesterday. "At this point, we just do not know. While the plan will most likely help, banks and thrifts still need to raise capital."

It is also unclear whether the $700 billion will be enough. Will banks be forced to open their books to their public, and how will their bad debt be evaluated? "It's not clear who is going to be allowed to participate," said Joseph Brusuelas, chief U.S. economist at Merk Investments. "How much will each individual bank be allowed to dump on the public?"