Without dollar fall, U.S. will repeat crisis: Connolly

NEW YORK (Reuters) - The United States may face a series of asset price bubbles and a rerun of the financial crisis unless it lets the dollar fall “at least” another 25 percent, economist Bernard Connolly said on Tuesday.

Because fierce international resistance will likely prevent such a large dollar devaluation, Connolly told Reuters the Federal Reserve may instead have to extend indefinitely its artificial support of a struggling U.S. economy by purchasing another $2 trillion in U.S. Treasuries and federal housing agency debt.

Some investors have started to watch Connolly’s forecasts. In February, he accurately predicted the Fed would have to buy Treasuries to boost the money supply and reduce borrowing costs for companies and households.

The Fed began buying $300 billion in longer-dated debt in March, a program expected to wind up this month, and will buy up to $1.425 trillion in agency and mortgage-backed debt.

“A dollar devaluation is needed of at least 25 percent from here, but resistance will be so great that this is not feasible,” said Connolly, managing director of UK-based Connolly Global Macro Advisors.

Without substantial dollar depreciation or a resurgent private sector, “the Fed will have to buy another $2 trillion in debt, including Treasuries and agency debt” to reflate the economy, running up dangerous asset bubbles in the process.

The dollar has lost about 7 percent against a basket of major currencies this year .DXY and is down about 26 percent since 2003. The euro is about 11 cents from an all-time high.

Some economists say it must fall further to redress global imbalances built up between debtor countries such as the United States and large exporters such as China, Japan and Germany.

But that would meet stiff resistance from governments around the world, who would be forced to reorient growth toward investment and consumption and away from exports.

In recent weeks, policy-makers and government officials in China, France, Canada, Brazil and elsewhere have complained about a weak dollar or taken measures to keep their own currencies from getting too strong and undermining exports.

Connolly was formerly an economist at Banque AIG, a unit of U.S. insurance firm American International Group Inc AIG.N that was saved from collapse last year by a U.S. government bailout.

In the late 1980s and early 1990s, he worked for the European Commission analyzing the European monetary system in the run up to the introduction of the euro currency.


World stock markets and oil prices have rallied this year and gold soared to a record high. The MSCI index of world stock markets .MIWD00000PUS hit a fresh 13-month high on Tuesday.

But Connolly said there is “a real disconnect between the rebound of risky assets and the real economy, and added that “financial markets are working their way up to ... a renewed bubble, which will burst again.”

Signs of stronger global growth have led financial markets to call for less stimulus, with increasing numbers of players saying the Fed should start unwinding its special programs.

Some Fed officials have said interest rates may have to rise even if the U.S. unemployment rate -- now at 9.8 percent -- is still rising, though Fed Chairman Ben Bernanke has suggested rates are likely to stay at record lows near zero for some time yet.

Connolly said a straw poll of participants at a private investors’ conference in New York, where he spoke on Tuesday, showed some three-quarters thought higher rates would come too late and cause inflation.

“I think, if anything, the risk is the other way round -- not necessarily via a rate rise, but by the Fed being forced to validate a market tightening,” he said.

He added that the idea “that we have to raise interest rates to defend the dollar is complete and utter nonsense.”

Reporting by Steven C. Johnson and John Parry; Editing by Jan Paschal