The sliding greenback has been hailed as the quick fix for the ailing U.S. economy, but there is one major problem a weaker currency cannot paper over -- the country's gargantuan current account deficit.
True, a sharp depreciation of the U.S. dollar against the euro, the loonie and other major currencies will go some way to narrowing a deficit sitting at a whopping 5% of gross domestic product.
But there is one currency the U.S. dollar cannot slide against -- the Chinese yuan. Thanks to a peg that has fixed the currency at 8.3:1 to the U.S. dollar since 1994, every time the U.S. dollar goes down the yuan goes down, too. And China has the biggest trade imbalance with the United States.
China ships about US$100-billion more goods to the United States than the U.S. ships to China, up from US$2.8-billion in 1987.
"Just how is a weaker dollar going to correct the current account deficit when the greenback is not going down against the country that is primarily responsible for the balance of payments gap --China?" asked David Rosenberg, chief North American economist at Merrill Lynch in New York.
Economists say one of three things will likely happen: pressure will mount for China to "revalue" or increase the value of its currency; other currencies will have to strengthen even more to lower the U.S. trade deficit; or the world will learn to live with a United States that lives beyond its means.
While much of Asia -- China's main competitors -- have been screaming for China to make its currency more expensive, many analysts say that is a non-starter, at least for the next few years.
"The weakness in the dollar and move in the Chinese currency with it is helping to counter some of the deflationary pressures that were forming ... so that provides an additional boost to growth," said Stephen Hannah, chief economist of Macro-Dev, an economic consultancy in London.
However, a strong Chinese currency might choke off the one area of the world that is growing significantly, and fan the deflationary flames.
Glen Hodgson, deputy chief economist at Export Development Canada, said because of the shift of labour within China from state enterprises to the private economy, the rest of the world is benefiting from lower prices for labour-intensive Chinese manufacturers.
"Why would we want to give that up right now, at a delicate stage in the global recovery, by pushing for an appreciation of the yuan?" he said. "Appreciation will come in due course -- years, not months -- but should really only occur when the shift in Chinese labour has run its course."
If the Chinese currency is not revalued, that could mean other currencies, including the Canadian dollar, will have to strengthen even more to allow U.S. exports to become more attractive.
"If you can't touch China for a few years still, then you're asking the other currencies to bear the brunt of the adjustment," said Stéfane Marion, assistant chief economist at National Bank Financial. "Under circumstances like this, you might reach levels that you weren't expecting to reach on the euro."
Marc Chandler, chief currency strategist for HSBC's American operations in New York, said the U.S. current account and trade deficits are not the big problem many people think they are.
The world has lived with current account imbalances before. Before the First World War, for example, current account imbalances of the major economies averaged 5% of GDP. They are now half that.
"Given the fact that capital flows have multiplied many times over, surely the global economy can finance the U.S. gap between savings and investment of 5% of GDP," Mr. Chandler said. He added the U.S. contribution to global development is buying other people's excess goods.
Mr. Chandler said he agrees with John Snow, the U.S. Treasury Secretary, who has said the world does not suffer from a current account deficit but a growth deficit.
"The best way to resolve the external imbalance is to have stronger world growth, not to have the U.S. lurch into recession just to grow slower than the meagerly expanding Europe and Japan," Mr. Chandler said.
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