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Friday, February 25, 2005

Warning from the markets (S. Korea to diversify away from the US Dollar)

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This is from the International Herald, N.Y. Times

Excerpt: Enter South Korea. On Monday, its central bank reported that it intended to diversify into other currencies and away from dollar-based assets. And why not? It holds about $69 billion in U.S. Treasury securities, or 4 percent of the total foreign Treasury holdings. Such dollar-based investments lose value as the dollar weakens, leading to losses that any cautious banker would want to avoid. But as the Korean comment ping-ponged around the world, all hell broke loose, with currency traders selling dollars for fear that the central banks of Japan and China, which hold immense dollar reserves - a combined $900 billion, or 46 percent of foreign Treasury holdings - might follow suit.

That would be the United States' worst economic nightmare. If it appeared that the flow of investment from abroad was not enough to cover the nation's gargantuan deficits, interest rates would soar, the dollar would plunge, and the economy would stall.

Tuesday's sell-off of dollars did not precipitate a meltdown. But it sure gave a taste of one. The dollar suffered its worst single-day decline in two months against the yen and the euro. Stock markets in New York, London, Paris and Frankfurt, Germany, dropped, and gold and oil prices, which tend to go up when the dollar goes down, spiked.

Luckily, the markets calmed down Wednesday, as Asian central banks said they did not intend to shun dollars. While such damage control is welcome, it's no fix. Tuesday's market episode has its roots in American structural imbalances that will be corrected only by new policies, not more of the same tax-cut-and-weak-dollar deficit-bloating ploys. If George W. Bush were half the capitalist he claims he is, he would listen to what the markets are telling him.

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