Bank bailout means dollar uncertainty

The U.S. dollar could be in for a rocky ride in coming days as investors lurch from hope that the worst of the financial crisis is over to fear about the long-term impact that hundreds of billions of dollars in new debt will have on U.S. government finances, analysts say.

The $700 billion U.S. government bailout plan to prop up the creaking banking system by buying banks' bad debts could renew confidence in the U.S. economy and fuel greenback gains.

But it could also spark fears that the package may cost too much, drive up inflation, swell the already bloated U.S. deficit and hurt the ailing economy, analysts said.

At this point, no one is really sure which way things will go. And for the dollar, that means uncertainty — never a good thing for any currency.

"The dollar is being undermined by a lack of clarity," said London-based Bank of America currency strategist David Powell.

Should it make it through the U.S. Congress, the bailout package "would be overall positive for the dollar in the sense that it reduces the chances of a full-blown banking crisis. It eliminates the worst downside risks," Powell said.

But possible delays in Congress, where leaders are haggling over details of the massive rescue with the administration of President George W. Bush, are adding to the uncertainty.

Another question clouding the dollar's future is how the U.S. Treasury will value the toxic assets poisoning banks' balance sheets.

The emergency legislation would give the government broad power to buy up devalued assets from troubled financial firms in a bid to unlock the flow of credit and stabilize badly shaken markets in the United States and around the globe.

By purchasing the debt, the government would make pricing easier and more uniform among institutions. That could clear up huge uncertainty in the market for subprime mortgages. But the clarity could bring bad news to some, if the prices are lower than the ones they used for the bad debt remaining on their books.

Key for the dollar's future is what the bailout will do to the U.S. budget deficit, since large deficits can undermine a country's currency. The plan gives the Treasury secretary broad authority to buy up to $700 billion in troubled assets from financial institutions, and to raise the $10.6 trillion statutory limit on the national debt to $11.3 trillion.

The Bush administration is already forecasting that the federal deficit will hit a record $482 billion next year. Analysts say the bailout costs mean a $1 trillion annual deficit is not out of the question.

Over the past week, traders have erased recent gains by the dollar against the euro. Between July 15 and Sept. 11, the dollar rose 12.5 percent compared to the euro, but since then has slipped back 5.3 percent.

On Monday, the dollar fell 2.3 percent against the 15-nation euro and sank against other major currencies as oil prices soared and uncertainty over the government's bailout plan propelled flight from the buck.

The euro steadied somewhat Tuesday against the dollar as investors bet "that hopefully the worst of the banking crisis is behind us," Powell said. At 4:15 p.m. (1415GMT), the dollar was trading down 0.5 percent versus the euro at $1.4707.

The euro steadied somewhat Tuesday against the dollar as investors bet "that hopefully the worst of the banking crisis is behind us," Powell said.

The dollar's recent weakness is a result of "concern over whether foreign investors will keep buying dollars," said Geoffrey Yu, a London-based currency strategist for Swiss Bank UBS AG. "There are also worries about how the plan will work, and even whether it will get through Congress."

Yu said that traders' initial reactions to the plan had been to dump dollars. But he added that the sell-off has been "somewhat exaggerated" because the U.S. Treasury is not expected to flood money markets with the new debt all at once and because the U.S. government does not intend to finance the plan by simply printing more dollars, which would hurt the currency's worth.

But if the plan dies in Congress, "all bets are off," he said. In the meantime, "volatility will dominate."

Despite the plan's huge size in nominal terms, the U.S. economy is large enough to absorb it, said BNP Paribas' London-based global head of foreign exchange strategy, Hans Redeker. Redeker estimates the plan would raise U.S. debt as a percentage of GDP to 48 percent from 38 percent now. "That's still lower than what you see in Europe," Redeker said.

Italy's debt is 96 percent of GDP, Belgium's is 86 percent and France's is 53 percent, according to 2007 data from the Organization for Economic Cooperation and Development.

"Relative to GDP, the Swedish and Asian crises were much bigger," Redeker said. He noted that the U.S. deficit was also high in the early 1980s, which corresponded to a period of dollar strength. "During the buildup phase of deficits, the currency strengthens as you must offer higher yields to attract foreign investment," Redeker said.

But eventually there will come a reckoning for the dollar, Redeker added: "It's a couple years from now, when the bill must be paid, that it will be a problem."

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	More anxiety on Wall St.: Stocks dive, oil soars	Associated Press	Mon Sep 22	24
	US, examining a bailout, has boosted debt before	Associated Press	Tue Sep 23	1