There are ways to manage this dollar crisis

Governments cannot resist underlying forces, but they can influence the speed of change
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The Independent Online

It is more than a little crass of the Chancellor, Gordon Brown, to go on, as he was again doing yesterday, about all the wonderful things for world poverty and indebtedness that the UK is proposing as next year's president of the G8 while continuing to ignore the one thing that is really getting the group of industrial nations worried - and that is the collapsing dollar.

It is more than a little crass of the Chancellor, Gordon Brown, to go on, as he was again doing yesterday, about all the wonderful things for world poverty and indebtedness that the UK is proposing as next year's president of the G8 while continuing to ignore the one thing that is really getting the group of industrial nations worried - and that is the collapsing dollar.

Of course, it's much more attractive for politicians to go on about feel-good issues of poverty, debt and welfare. But, as Vincent Cable, the Lib Dem economics spokesman, pointed out yesterday, Britain's primary job as president of the G8 is to chair its discussions. And the most immediate item on the agenda is the dollar, which has plunged nearly 5 per cent against the euro in the last month, and some 15 per cent overall since its peak two years ago. To pretend that it doesn't matter, or that it's something we can do nothing about it is, at best, insouciant and, at worst, grossly irresponsible. It's a lack of understanding of how markets behave which resulted in Gordon Brown's disastrous decision four years ago to sell off a substantial quantity of our gold reserves at ridiculously depressed prices.

Part of the problem, of course, is that, in today's world, finance ministers hate having to think about markets. They are unpredictable. And in many ways the globalisation of markets and the establishment of independent central banks has allowed politicians to stand aside from crises, enabling the system to take in its stride even such crises as the bursting of the high-tech share bubble three years ago and the rapid rise in oil prices this year.

Maybe the same will prove true of the dollar today. We've been here before, after all. At one point under Mrs Thatcher, the pound seemed to be heading for parity with the dollar and then climbed back up again when she finally decided to intervene to prop it up. The dollar itself fell by at least as much as it has this time in the Eighties. Given the disaster of trying to keep sterling, for example, in the European Monetary System under John Major, you can understand the reluctance of officials or their political masters to intervene again to stop a currency run.

There are also good underlying reasons why the dollar should be devalued at the moment. The US is running a huge, and increasing, trade deficit. To date, that has been largely financed by the rest of the world taking advantage of the country's high growth rates to invest in its businesses, and so soak up the dollars. But at some stage, that was bound to come to an an end, and, once it had, the dollar was bound to plunge in ratio to the underlying trade imbalance. On that score, you could argue, as many do, that the dollar has still not fallen nearly far enough. Even quite conservative economists are quoting a final devaluation of some 30 per cent - in other words, twice the fall so far, putting the pound at more than $2, and the euro at $1.50.

That is fine for the US, which can see its deficit rectified by the market, and other countries who have been happily enjoying the fruits of America's import binge being made a lot less competitive with US companies. But it is not so fine for the rest of the world, especially the Europeans who have found the euro and, to a less extent, the pound the main target of market revaluation. It is also extremely painful for countries who price their commodity exports in dollars (and this includes far more than the oil exporters) or the countries, especially in Asia, who keep large reserves in dollars. And it is these latter countries who are financing the equally burgeoning budget deficit of the US.

That is why this currency crisis is worrying so many countries at the moment, and not just in the G8. Second guessing the markets is a mug's game. But the fear is that this retreat could easily become a rout if countries now decide to sell off dollar reserves for fear of it falling still lower, and if investors round the world cease to invest in the US for the same reason. To date, the world's economy has been largely kept moving by US growth and imports. A sudden halt to this, as the US is forced to adjust its budget as well as its trade, on a world where Europe and Asia's economic recoveries are still fragile could be disastrous.

Given time, of course, markets and underlying economic structures can adjust. Given sudden jerks, as happened with the 1973/4 oil price increases, and the results are dire. What we are witnessing today is one part of a long-term adjustment away from US world dominance, through the dollar as through military might. But what we are also witnessing is the way that markets, in responding to those changes, can also pre-empt them, causing chaos in the process.

Governments cannot, Canute-like, resist underlying forces, but they can influence the speed and timing of adjustments. Just as Gordon Brown lost us all money by announcing gold sales at the bottom of the market and being surprised when the markets responded by treating it as a fire sale, so he could influence the markets in the opposite direction if he organised the G8 countries in their first meeting of the new year to undertake co-ordinated intervention in the currency markets. It will be the poor of the world, after all, who will most suffer from economic crisis in the industrialised nations.

a.hamilton@independent.co.uk

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