Dollar May Drop to Record Low as Bush Seen Increasing Deficits

Nov. 8 (Bloomberg) -- The dollar may fall to its lowest ever against the euro for a second consecutive week after President George W. Bush signaled he will expand policies that produced record deficits and a 21 percent decline in the currency since he took office in 2001, according to a Bloomberg News survey.

Sixty percent of the traders, strategists and investors questioned on Nov. 5 from Tokyo to New York advised selling the dollar against the euro. Participants also said the U.S. currency will likely drop versus the yen, British pound, Swiss franc and Australian dollar.

"A second-term for Bush doesn't bode well for the dollar," said Samarjit Shankar, director of global foreign-exchange strategy at Mellon Financial Corp. in Boston, which manages $625 billion. "There's no way of convincing the market additional spending on the war can be paid for if you have a lower tax base. It's a fundamental mismatch between spending and revenue."

Bush, who won a second term on Nov. 2, presided over a record fiscal and current-account deficit at a time when appetite for U.S. securities among foreign investors is diminished. The president, who campaigned on making permanent his $1.85 trillion in tax cuts and prosecuting the war in Iraq, said he will spend political capital "earned" during the campaign.

"So many people just want to hammer the dollar," said Ashley Davies, a currency strategist in Singapore at UBS AG, the largest trader in the foreign-exchange market. "An endorsement of the last four years means more of the same. The underlying trend for the dollar is down."

'Benign Neglect'

The U.S. currency fell 1.3 percent last week against the euro to 1.2961 at 5 p.m. on Nov. 5. It fell as low as $1.2972, an all- time low. Compared with the yen, the dollar shed 0.3 percent. The dollar has fallen for four consecutive weeks against the euro and six versus the yen.

Measured by the Fed's Trade-Weighted Major Currency Dollar Index, the dollar has shed 21 percent since Bush took office in January 2001. The decline is the most since Ronald Reagan's second term, when the dollar lost 35 percent.

In a second term, the Bush administration will let the dollar weaken, keeping its policy of "benign neglect" of the currency, said Ryan Faulkner, a currency strategist in London at Lehman Brothers Holdings Inc. Officials may be temped to spur a prolonged decline in an effort to boost exports and narrow the current account, he said.

"If there is a policy shift it would be in terms of them talking about the dollar more frequently," said Faulkner, a former Federal Reserve employee. "Look for any type of commentary, especially from Treasury, about the level of the current account and whether it is sustainable."

'Sell More Stuff'

Lehman, the most accurate forecaster of exchange rates in a third quarter Bloomberg survey of 50 companies, predicts the dollar will drop to $1.32 in 12 months and 99 yen. The current account is a measure of trade, services, tourism and investments.

The shortfall in the current account widened to a record $166.2 billion in the second quarter. The gap is equivalent to 5.7 percent of gross domestic product, up from 5.1 percent in the first quarter, meaning the U.S. economy needs to attract about $1.8 billion a day to maintain the value of the dollar, based on Bloomberg calculations. Third quarter figures are scheduled to be published next month.

A weaker dollar "certainly would make U.S. goods more competitive and help with the trade deficit," said Susan Phillips, dean of the business school at George Washington University and a former Fed Governor. "It will help businesses sell more stuff, make more money and pay more taxes, which will help narrow the budget deficit."

Trade Deficit

The trade deficit, the amount by which the country's imports exceed its exports, probably held at $54 billion in September, according to the median forecast of economists surveyed by Bloomberg in advance of a government report on Nov. 10. The gap was a record $55 billion in June.

"We do not comment on day-to-day market fluctuations," said U.S. Treasury spokesman Rob Nichols. "That said, there is no change to our dollar policy." Treasury Secretary John Snow said on Oct. 27 the U.S. favors a "strong dollar, but we feel a currency's value ought to be set in open, competitive markets."

The dollar fell to a record low against the euro on Nov. 5 even after a surge in U.S. employment fueled expectations the Fed will raise its benchmark interest rate two more times this year to 2.25 percent from the current 1.75 percent. The currency initially rallied after the Labor Department said employers added 337,000 workers in October, almost twice as many as forecast.

'Bulls Hoping'

The jobs report "does give the Fed enough ammunition to go twice before the end of the year," said Mellon's Shankar, and "keeps the dollar bulls hoping the economy is chugging along."

"You are going to have a tussle between the current pace of economic activity and the growing deficits," he said.

Futures traders increased their bets to a record that the euro will gain against the dollar, figures from the Washington- based Commodity Futures Trading Commission on Friday show.

The difference in the number of wagers by hedge funds and other large speculators on an advance in the euro compared with those on a drop -- so-called net longs -- was 53,465 on Nov. 2, compared with 45,531 a week earlier. The net long position was the biggest since Bloomberg began keeping records in 1999.

After the employment report, "the dollar's gain just offered better opportunities to get in and sell," said David Mann, a currency strategist in London at Standard Chartered Plc. "We're likely to see new highs in the euro."

'Green Light'

European policy makers are encouraging the dollar's slide by indicating they are not opposed to the euro's appreciation, said Chris Melendez, president of currency hedge fund Tempest Asset Management in Newport Beach, California.

German Chancellor Gerhard Schroeder said on Nov. 5 the euro's climb is "not yet dramatic." His remarks followed European Central Bank President Jean Claude Trichet's failure a day earlier to protest the euro's four-week euro advance. Schroeder spoke at a press conference after a summit of European Union leaders in Brussels.

European officials have "given the green light to buy euros," said Melendez. "It is the ECB who sets policy and it is clear that they and the finance ministers are happy with a strong euro."

The U.S. budget deficit swelled to $412.6 billion in the fiscal year ended Sept. 30, as war in Iraq and security costs contributed to the third straight annual shortfall under Bush. Those deficits, which require the Treasury to issue more debt, reversed four consecutive surpluses from 1998 to 2001. The White House predicts a $331 billion deficit in fiscal 2005.

Bush is pledging to make his tax cuts permanent as global investors reduce the pace at which they accumulate U.S. assets. International added to their holdings of U.S. assets in August at the slowest pace since October 2003, the Treasury Department said on Oct. 18. The net increase in holdings of Treasury notes was about a quarter of march's $60.8 billion, which was the highest level so far this year.

"I don't get the impression Bush will implement anything to reduce the budget deficit," said Lawrie Dryden, head of currency and asset allocation in Sydney at State Street Global Advisors, which manages about $29 billion. "There is nothing to make us want to be long dollars."

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