Debt and the dollar

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“How are you, comrade Bush?” When Hugo Chãvez, Venezuela’s left-wing leader, cheers from the sidelines, the US government must be acting radically. The financial rescue plan is still being hammered out on Capitol Hill, but early estimates put next year’s fiscal deficit at about $1,000bn; a doubling of this year’s, to perhaps 7 per cent of GDP. Adding in the need to roll over existing borrowing, the Treasury will have to raise about $1,500bn in 2009.

Yet the implications for the dollar are not all bad, if only because prospects are little better elsewhere. Indeed, when the last financial lifeboat – the Resolution Trust Corporation – began to buy bad assets in 1989, economic growth, house prices and equity markets did not bottom out for another 12-18 months. The dollar, however, traded sideways. Heightened counterparty risk has pushed funding costs up, so the US is no longer a source of cheap capital for carry trades. As commodity markets weaken, so will currencies of countries reliant on exports of resources. And the housing busts and slowing economic growth in the UK and Eurozone suggest little likelihood of further appreciation of their currencies. The fall in the dollar during the past week may be only a pause in its nascent recovery.

With this bleak backdrop, the Treasury should find a healthy market for government bonds among jittery investors. Allocations of government bonds to public pension portfolios are near two-decade lows. Households, which may rediscover saving, have less than 0.7 per cent of their financial assets in government bonds. To return that share to the 1993 peak of more than 4 per cent would require individuals alone to buy more than $1,000bn of bonds, Merrill Lynch calculates. As inflation fears fade, Treasuries may be the last boom left.

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