The Dollar's Problems Are Bigger Than Saddam - TheStreet

The Dollar's Problems Are Bigger Than Saddam

Economists see the currency weakening because of structural problems.
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The failure of Saddam Hussein's capture to move currency markets is an ominous sign for the U.S. dollar.

After a brief jolt higher, the dollar pulled back Monday as investors realized that geopolitical issues are secondary considerations and that only a major structural shift in the U.S. economy would halt the greenback's slide.

"It's good news and I think it will help consumer sentiment but what's been

pressuring the dollar is the big current account deficit," said Lara Rhame, an economist at Brown Brothers Harriman. "People who are looking at day-to-day events are really missing the forest for the trees."

The Iraqi dictator was apprehended in the Tikrit region by coalition forces on Saturday, prompting a short-lived rise in the U.S. stock market and the dollar. Momentum quickly faded, and by Monday afternoon stocks had weakened and the dollar was sitting at another record low against the euro.

While Hussein's capture is symbolically meaningful, analysts say the practical implications aren't nearly as significant.

"The capture of Saddam Hussein is not going to get rid of the twin deficits in the U.S.," said Ashraf Laidi, chief currency analyst at MG Financial Group. "It's not going to make unattractively low interest rates become attractive and it's not going to alter the fundamental picture of the dollar."

The U.S. trade deficit widened to $41.8 billion in October from $41.3 billion in September, as imports soared to a record level. The deficit, which is set to widen further, currently amounts to about 5% of gross domestic product.

The big concern for currency traders is that the trade gap will prompt foreigners to take money out of U.S. assets. The U.S. needs to attract about $1.5 billion each day from overseas investors to finance the trade deficit. By purchasing bonds and making direct investments here, foreigners allow the U.S. government and U.S. companies to import far more than they export.

Recent data from the Treasury Department show that the foreign appetite for U.S. stocks and bonds remains strong. Foreign purchases of U.S. assets soared 560% to $27.6 billion in October, up from a five-year low of $4.2 billion in September. Overseas investment slowed in September after the Group of Seven industrialized nations said China and Japan should let market forces determine their exchange rates.

"I don't think there's a big panic about how the deficit is going to be financed, but the tension is always there," Laidi said.

Foreigners have been plowing money into the U.S. because the economy appears to be growing nicely and because Asian countries have been attempting to stem the rise in their own currencies. If either of these forces were to change, however, some pundits say the trade gap could become a much more serious concern. "When any imbalance becomes substantial, it makes people nervous about what will happen when it corrects," said Rhame.

Besides the structural issues, analysts are skeptical about how much the geopolitical situation has really changed now that Hussein is in custody. On Monday, a suicide bomber killed eight policemen on Baghdad's northern outskirts, and President Bush has warned U.S. troops that "further sacrifice" might be necessary.

"Saddam's capture does little to solve the extraordinary challenges that confront the United States," said Marvin Zonis, a political economist at the University of Chicago.

Controlling the violence and rebuilding Iraq's shattered economy will continue to be a major problem for the U.S, he said. The occupation of Iraq is expected to cost hundreds of billions of dollars over the next 10 years and is expected to place a huge strain on the budget deficit and on the dollar.

Standard & Poor's analyst David Wyss said he expects the greenback to decline further "as the last five years of overvaluation is succeeded by undervaluation." He also noted that "on a longer-term historical basis, the dollar is not that weak -- it has just come down from a very high level."

These comments echoed remarks by U.S Treasury Secretary John Snow, who told

Bloomberg

that on a trade-weighted basis, the dollar is higher than it's been for most of the last 25 years. He also said he isn't concerned about the dollar's depreciation because "this whole adjustment process has been orderly."

On Monday, the euro rose against the dollar to $1.2309 from $1.2290 late Friday. The dollar was also weaker against the yen, trading at ¿107.59, down from ¿107.74 in the prior session.

"Sentiment towards all risky assets is bound to improve on this news," said Ian Williams, head of strategy and research at Robert W. Baird. But "the factors undermining the dollar's longer-term prospects have not gone away."