Perkier Economy Pushes Dollar Back Down the Slide

The U.S. dollar continued its descent Wednesday, probably resuming a slide that began earlier in the decade, as improving economic conditions have prompted investors to seek higher returns in emerging markets and in gold futures.

The decline of the dollar was temporarily reversed last year as the global economy found itself in the grip of the worst downturn since the Great Depression. Despite the nose-diving U.S. economy, nervous investors and central banks looked to greenbacks and U.S. Treasurys as safe havens and loaded up accordingly.

Many economists think the global recession is winding down or is already over, which has encouraged investors to dump dollars to buy stocks and other higher-yielding assets. "As we have stepped away from the abyss people have a healthier appetite for risk," said Marc Chandler, global head of currency strategy at Brown Brothers Harriman.

The Federal Reserve's strategy of keeping a key interest rate near zero to help get the economy back on track has given investors further incentive to search for alternative investments that pay a higher yield. They have poured money into emerging markets, which are expected to rebound quickly. The closely watched MSCI Emerging Markets Index on Tuesday reached highs not seen since before the collapse of Lehman Brothers a year ago.

Even as investors are feeling more emboldened, the falling dollar has increased the popularity of another safe haven -- gold. On Tuesday, gold futures for December delivery hit an 18-month high, topping $1,000 an ounce in trading on the Comex division of the New York Mercantile Exchange, before settling Wednesday down $2.70, at $997.10.

Gold has become attractive as another aspect of the Fed's strategy to jump-start the economy -- creating billions of dollars in new money to buy government debt and mortgage-related securities, also known as quantitative easing -- as well as doubts about the government's ability to get spending under control have stoked fears of inflation down the road.

"The essence of the gold rally is a weaker dollar, but also the prospect of the dollar weakening further linked to concerns over quantitative easing and U.S. deficits," said James Steel, a precious metals analyst for HSBC in New York.

The dollar traded Wednesday at $1.45 to the Euro, compared with around $1.25 in November. The DXY Dollar Index, which compares the dollar with six other currencies, sank to 76.80, its lowest point in nearly a year, before rebounding modestly. A falling dollar has been a boon for U.S. exports by making them cheaper and more competitive. Rising exports helped the U.S. trade deficit shrink to a nine-year low earlier this year.

The Commerce Department is expected to report Thursday that the trade deficit was largely unchanged in July from June, when it was $27 billion. It peaked at $65 billion in July 2008.

While exports have been increasing, so have imports. In July they probably got a boost from the federal government's "Cash for Clunkers" program. The program, which ran in July and August, offered a subsidy to consumers for trading in older cars for new, more fuel-efficient models. Foreign automakers were among its biggest beneficiaries.

A sinking dollar also has drawbacks. It could make it more expensive to service the nation's debt. It erodes the value of foreign investment in the United States, making it less attractive for other nations to lend the United States money at a time when tax receipts are shrinking and government spending has increased to help revive the economy. Investors may demand a higher premium to make up for the dollar's diminished value, which would, in turn, increase borrowing costs.

Creditors to the United States are getting antsy, including China, which lends the United States more than any other nation. In March, Chinese Premier Wen Jiabao said he was concerned about the safety of his country's U.S. investments in light of stepped-up deficit spending. Wen's comments fueled a larger and long-running debate over the dollar's role as the leading reserve currency, a position it has held for more than 50 years. A U.N. panel on Monday bolstered the case for ending the dollar's special status by calling for a new flexible exchange-rate regime. U.S. public debt is expected to rise from 41 percent of gross domestic product at the end of fiscal year 2008 to 60 percent after fiscal year 2010, according to the Congressional Budget Office.

U.N. officials have made similar comments in the past, but the latest comes in advance of a summit of the Group of 20 industrialized and developing nations, meeting in Pittsburgh this month, where the global recession is likely to dominate the agenda. The United Nations blamed the global financial crisis in part on the buildup of U.S. dollars in central bank reserves. The surplus of dollars, some economists argue, combined with inadequate regulation, encouraged excessive risk-taking that contributed to the housing bubble and the subsequent meltdown of the global financial system.

A major shift in the dollar's role as a reserve currency is unlikely to happen anytime soon, economists say, citing a dearth of viable alternatives. And countries, including China, continue to amass dollars and Treasury securities, Chandler said.

There are scenarios that could diminish the dollar's appeal as a reserve currency. The federal government could fail to curb deficit spending. Inflation in the United States could spiral out of control. But experts don't believe those scenarios are probable. "The U.S. would have to really screw up things badly in order for the dollar to lose its reserve currency status," said Menzie David Chinn, an economist at the University of Wisconsin.