There is no single alternative to the dollar

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Despite billions of dollars of central bank intervention in the past few days and action last week by the Germans on interest rates, the dollar continues to hit new lows against the yen and continues bouncing close to its all-time floor against the mark. The question facing investors is whether the dollar has merely caught a cold or whether it is terminally sick.

On a trip to London yesterday, David Hale, economist at the Chicago-based investment house Kemper Financial Services, argued that the dollar's recent fall against the yen and the mark does not represent a profound sea-change. With the dollar largely stable in trade-weighted terms, its weakness against the hard currencies is instead a cyclical phenomenon. The dollar will turn.

The Fed's loosening of policy in the early 1990s meant that the US led the global economic recovery. Now the Fed is marking time to see whether its doubling of rates since the start of 1993 is sufficient to glide the economy into a model soft landing. If it touches down on schedule, that will automatically release resources for a shift to net exports, cut the current account deficit and restore investors' faith in the dollar. If the economy turns out to be growing more strongly, as Mr Hale suspects, then the Fed will tighten policy and that will do the trick - only later.

A quite different perspective was provided earlier this week by analysts at James Capel. Keith Skeoch and David Bloom argued that structural problems in the US economy imply the dollar is in "long-term decline". Put simply, the US saves too little, the government borrows too much, and as a result the US has become increasingly dependent on foreign capital inflows. In just 10 years, the US has accumulated foreign debts of over $500bn. As a result, they expect further depreciation to around 70 yen and DM1.20 over the next five years - a prediction that at current rates of decline will be achieved a lot sooner.

Some who deal in even longer-term horizons do not see the dollar ever returning to more than DM1.50. It is apparently the case historically that currencies never return to former glories once an empire is past the peak of its military power, as the US almost certainly is.

What is at stake in all this - and here there is agreement - is the dollar's status as the pre-eminent reserve currency. For all its vicissitudes, the dollar still represents 55 per cent of the world's foreign exchange reserves, down from about 70 per cent at the beginning of the 1980s. The result is that the US can continue to fund its balance of payments deficit by pumping out dollars. James Capel argues that the dollar's role as a reserve currency is now "in terminal decline". It has lost its appeal as a safe haven. And with rumours that central banks in the Far East wish to offload excess dollar holdings, the dollar's day may draw to an end with a bang rather than a whimper.

But what would happen to those excess holdings if, for example, they were switched into yen? David Hale believes they would simply add still further to the Bank of Japan's record foreign exchange reserves as it sought to fend off still further appreciation. The dollar will stagger on because there is no alternative, he contends. Neither Germany nor Japan wants to assume the responsibility of a reserve currency.

The argument over the fate of the dollar reflects the new position of the US in the world. It is no longer the economic colossus of its heyday; but there remains no one single opposite pole of influence. It may have lost the greatness it once achieved, but Japan and Germany are still reluctant to have greatness thrust upon them. As in the Mikado, its death may be a lingering one.