In August of 1971, as the burgeoning US budget and trade deficits threatened to initiate a run on the United States' gold reserves, the Nixon Administration announced that the dollar was no longer convertible into the precious metal. For the first time in its history, the US currency would float, effectively ending 25 years of fixed exchange rates. As the global economy braced itself for the inevitable steep decline in the value of the dollar, Treasury Secretary John Connally famously stated: “The dollar is our currency, but it is your problem”.

The plight of the US currency is once again dominating the headlines, but this time its seems to be everybody's problem. Despite a recent rally, the US currency fell to a record low against the euro last year, not far from its all time equivalent low of .69 set against the deutsche mark ten years ago. Some are now speculating that this the next likely target for the market and on Monday the dollar also made a new five-year low against the Yen. The consensus for the dollar this year, not surprisingly, remains overwhelmingly bearish.

For one thing, the weaker dollar has not seemed to diminish the US consumer's appetite for foreign goods. According to the latest trade data, the deficit unexpectedly widened to a record $60.3B in November, at the same time that the savings rate fell to just 0.3 percent of disposable income. Similarly, the “strong dollar policy' has no teeth with a yawning $412B federal budget deficit, especially in the face of the escalating costs of the war and costly new policy initiatives being pushed by the new Bush Administration. This is fuelling speculation that the US will not be able to attract enough foreign investment to make up these capital short falls. Therefore there only seems to be one way for the dollar to go and that is lower.

Ten years ago, there was also much gnashing of teeth as the dollar fell to record lows. Pundits warned of the default risk in Treasury bonds and the impending massive liquidation of dollar reserves by foreign central banks. Gold prices soared. Sound familiar?

This is not an attempt to make light of a very serious subject. The dollar is in trouble and that skiing vacation in the French Alps is not going to get cheap again any time soon. Nevertheless, the apparent profligacy of the American consumer underscores the disparities in growth in the still US-centric global economy. That looks unlikely to change any time soon.

The European economy, hamstrung by double-digit unemployment, may only grow by half the consensus estimates for the US this year. Europe's recovery is still too heavily dependent on exports and in December, the President of the European Central Bank, Jean-Claude Trichet, described the dollar's sharp decline as “brutal”. In Japan the threat of deflation still looms large and the government there faces a huge debt problem of its own. The US currency's woes are more one of dollar weakness more than anything else. It seems unlikely therefore that the dollar is likely to lose its status as the main store of wealth in the global economy.

The huge twin deficits cast long shadows to be sure, however there are signs that the worst may be over in terms of the dollar's decline. In Washington, there are rumblings within President Bush's own party concerning some of his ambitious and costly policy initiatives like the privatisation of Social Security. The re-affirmation of the “strong dollar policy” by the Administration itself suggests that the White House may now be prepared to accede in adopting measures to reign in the budget deficit.

Much of the dollar's weakness is also because of the commonly held notion that the trade deficit is unsustainable. Sooner or later, or so the thinking goes, the market will demand a higher premium, especially as the weak currency begins to fuel inflation. That clearly has not happened, although the bond market is more a phenomenon of the “carry trade” by yield starved investors more than anything else. At any rate, given rising interest rate environment and the high level of US household indebtedness, there is a strong case to be made that the trade deficit this year may undergo a natural level of attrition. It is difficult to see it getting much worse at this stage in the cycle.

The hawkish tone of the Federal Reserve's latest statements also leaves one with little doubt of their intention to continue tightening monetary policy this year. As long as the US economy does not suffer an unlikely inflation shock, which would spook the markets in believing the Fed was behind the curve, positive interest rate differentials should also be supportive for the dollar. For one thing, higher US interest rates make it more expensive to short the dollar and despite the lag, there is a strong correlation between the dollar Index and the Fed Funds rate.

The final supportive measure is of course a potential revaluation of the Renminbi. Yesterday, the head of China's central bank, Zhou Xiaochuan re-affirmed the government's commitment towards a gradual move to “full convertibility” of China's under-valued currency. That would head off any trade protectionist measures by the US, which would certainly undermine any potential recovery in the dollar this year. It may be time to look at the dollar again instead of selling it.