Dollar sunk by imbalance of payments

People have been complaining about a weak euro for eighteen months, and now there's a lot of excitement just because it goes up 1%."

So commented a senior European monetary official who wished to remain anonymous. But despite this official's dismissiveness, there are a number of straws in the wind. They all indicate that perhaps, at last, the financial markets are beginning to worry about those "imbalances" in the world economy that have weighed on the G7 finance ministers and central bank governors - and especially the Bank for International Settlements in Basle, for several years.

The US Treasury secretary, Paul O'Neill, yesterday did his bit to erode confidence in the greenback yesterday, when he said he doubted the effectiveness of government intervention on foreign exchange markets. Currency traders took this to mean there would be no intervention to protect the dollar, which has lost 3.4% against the euro and 3.6% against the yen during April.

The main concern has been the potential instability of an international economy in which the US is regarded as "consumer of last resort", piling up balance of payments deficits (the gap between receipts and payments) at the rate of over $1bn a day. Various explanations - the underlying strength of the US economy; its faster growth rate; the attractiveness of returns on investment in the US - have been trotted out to justify the dollar's strength.

Others - the infancy of European monetary union; slower European growth rates; "structural rigidities" in European economies - have been adduced to explain why the euro was weak and would remain weak. During the past few months some of these senior analysts have produced sporadic reports questioning the sustainability of the US payments deficit.

In the past 10 days or so the daily market reports have begun to reflect the concerns not just of the analysts, but of the traders too. Intriguingly these latest concerns have appeared at a time when traders might be expected to look for additional reasons to complain about the euro - such as the political upheaval in France. It can hardly be claimed that National Front leader Jean-Marie Le Pen was trying to prop up the euro during his nasty campaign.

But the markets suddenly seem to have become more concerned about the dollar and the sustainability of an ever growing US payments deficit than about the euro. Result? That 1% rise in the euro - above the 90 US cents barrier - about which my anonymous monetary official was so dismissive.

And all this despite the reported rapid recovery of the US economy in the first quarter. But that recovery was heavily dependent on the statistical quirk by which a lower pace of de-stocking (or inventory reduction) serves as a positive contribution to gross domestic product.

It is becoming increasingly apparent, even to some previous "bulls" of the US economy, that US industry has been badly hit by the reaction to the earlier investment bubble, and that the basis of this year's recovery is more fragile than supposed. This, plus growing concern about what seems to have been an endemic tendency to overstate profits during the boom, has also shaken financial markets,

What is more, analysts are finally beginning to make the link between rising protectionist tendencies in the US and the detrimental impact of the overvalued dollar on profits.

Those of us who have warned for several years about the trend of the US payments deficit have sounded as if we were crying wolf. But in the fairy story the wolf eventually came.

William Keegan is the Observer's economics correspondent.