Global Policy Forum

By Eric Pfanner

The dollar tumbled to a historic low against the euro on Tuesday after a report of a sharp drop in foreigners' appetite for U.S. investments raised alarms about possible fragility in the U.S. economic recovery. The plunge in the dollar, which lifted the euro by more than 2 cents on the day to $1.1954, the highest level since its introduction in 1999, was given added momentum by fears of rising protectionist sentiment in the United States, analysts said.

International investors' purchases of U.S. stocks and bonds dwindled in September to less than one-tenth the level of the previous month, the Treasury Department said. Because the United States imports far more goods and services than it sends abroad, the economy is highly dependent on funding inflows from abroad, and the size of the decline surprised traders on both sides of the Atlantic. "That was a bit of a shocker, actually," said Tony Norfield, a currency strategist at ABN AMRO, one of the biggest currency dealers. "Given the financing requirements of the U.S. economy, they can't afford that kind of a number."

Until September, the United States had generally been attracting enough foreign inflows to finance the roughly $500 billion-a-year shortfall in its current account, the broadest measure of trade in goods and services. Analysts said the big drop in September may have been caused by one-time factors, including a meeting then of the Group of 7 industrialized countries where leaders endorsed "flexibility" in exchange rates, which was seen by the financial markets as a warning to Asian central banks to slow their efforts to bolster the dollar. Nonetheless, the drop in foreign purchases of U.S. securities was far larger than expected, and it came against a backdrop of concern over the U.S. economy and the dollar, which has fallen 15 percent against the euro this year and 11 percent against the yen.

Adding to those concerns Tuesday was an announcement from the Bush administration that it planned to limit U.S. imports of Chinese clothing by setting a quota. The move comes as Washington is already embroiled in a dispute with the European Union, Japan and other trading partners over tariffs on steel imports that have been deemed illegal by the World Trade Organization. The surge in imports from China has broadened the U.S. current-account gap; it has become a sensitive issue for Bush as an election year approaches and is blamed by some U.S. manufacturers for job losses in America.

But analysts say America's Asian trade partners, including China, have been providing an important underpinning for the U.S. economic recovery, which picked up speed in the third quarter, by purchasing U.S. securities in huge volumes. Foreign purchases of U.S. stocks and bonds, which totaled $49.9 billion in August, fell sharply to $4.19 billion in September, the Treasury Department said Tuesday. "America is more dependent on the rest of the world for financing than at any time in the last 50 years," said David Bowers, chief global strategist at Merrill Lynch. "People might not be aware of how fragile this recovery is, how dependent on Asian financing." Bowers said a Merrill Lynch survey of global fund managers showed that a majority of large investors now think a solid, strong global economic recovery is for real. But with the plunge in the dollar Tuesday, doubts about the sustainability of the U.S. economy, the engine of global growth, could be renewed, analysts said. While the dollar's move was most pronounced against the euro, which eclipsed a previous high of $1.1933 that it had set in May, the U.S. currency also fell against the yen, to ¥108.065 from ¥108.920.

Appearing before British business leaders on a visit that coincided with President George W. Bush's trip to London this week, the U.S. Treasury secretary, John Snow, had reassuring words about the U.S. economy. But analysts say Snow has sent clear signals to financial markets this year that Washington is not opposed to a gradual weakening of the dollar. Such a gentle downward drift would make U.S. exports more competitive abroad, improving the prospects of U.S. manufacturers at a time when many voters are still worried about a weak job market.

Analysts are worried, however, that if the dollar falls too quickly, it could prove destabilizing to the global economy. If foreign investment inflows dry up, it could also lead drive up interest rates in the United States through higher bond yields, hurting the U.S. recovery prospects. So far, that has not happened. And analysts warned against reading too much into one month's data on investment flows. Because the drop was so big, it surprised the markets, perhaps exaggerating the one-day movement in the currency markets.

If the flows reversed in October, which analysts say is possible, the dollar could still rebound, particularly because the U.S. economy is growing considerably faster than the euro zone or Japan. In other trading, the dollar fell to 1.2946 Swiss francs from 1.3236 francs. The pound rose to $1.7017 from $1.6927.

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