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Monday, Jan 03, 2005

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Imbalances in the global economy

By Heather Stewart

Decline in the dollar means the challenge is how to ward off a global financial crisis.

WHEN PRESIDENT George W. Bush is inaugurated later this month, he will have reason to be grateful that a leader's success at stewarding his country's economy is no longer measured by the strength of its currency. Since he first came to power four years ago, the dollar has already lost more than 10 per cent of its value, with the latest frenzied sell-off taking place since he was re-elected in November. The greenback has further to fall; but it is only the most visible symbol of the creaking imbalances in the global economy that will challenge policymakers throughout 2005.

Mr. Bush's re-election seemed suddenly to focus the foreign exchange markets on America's vast current account deficit, which is fast approaching six per cent of GDP.

The dollar's fall, which is already threatening growth in the eurozone and Japan, has re-ignited a long-running debate about the relationship between the world's great powers in a globalised economy. The G-8 club of rich nations, which includes Canada and Italy but not China, looks anachronistic — but it remains the major forum for global leaders to discuss currency moves.

Already, eurozone Ministers have admitted that the appreciation in the single currency against the dollar is likely to dampen growth prospects in the 12 member-countries; and some have put the blame squarely on the U.S., calling for Washington to rein in its budget deficits to put a floor under the greenback. These tensions are only likely to increase as the dollar decline continues, and at home eurozone Finance Ministers face a row about their tax and spending rules, the Stability and Growth Pact.

The pact, which puts a limit on budget deficits, has been broken repeatedly by several eurozone members, including France and Germany. Agreeing on a new version of it, while a stronger euro puts the brakes on an already anaemic recovery, is one of the major challenges in the months ahead.

One reason eurozone policymakers were initially sanguine about the surge in the euro against the dollar is that it was helping to insulate them against rising oil prices.

Although prices have declined sharply from their peak above $50 a barrel, analysts believe they will remain a drag on economic growth in 2005. OPEC, the oil producers' cartel, certainly seems keen on keeping prices above $40 a barrel.

Mr. Brown has already expressed his irritation at OPEC's move, and a January production cut would exacerbate tensions between oil producers, and gas-guzzling consumers already struggling to cope with the falling dollar. Throw in political risk in Iraq, Russia and Saudi Arabia, and the recipe for a tight oil market — and a resultant slowdown in global growth — is in place.

Both the downward shift in the dollar and the move to a climate of high oil prices will test the mettle of policymakers, but 2005 is also meant to be the year when the members of the World Trade Organisation agree to rewrite the rules of global trade. The so-called "Doha round" of global trade talks is due to conclude by the end of December.

Doha is meant to be a "development round", reshaping the global economy to offer a level playing field to the world's poorest countries. Talks in Cancun, Mexico, collapsed in acrimony in 2003 after developing countries demanded that the U.S. and the European Union dismantle their lavish farm subsidies in exchange for better access to their markets.

Fresh negotiations in Geneva last summer resurrected the talks but largely by postponing the most controversial issues.

A successful conclusion of Doha could be more important than any other event in 2005; but for the next few months it will be overshadowed by the gyrations of the foreign exchange markets and the price of oil.

The challenge for global leaders will be to make sure they do not let short-term tensions take over. —

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