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Columns

Time is now for intervention to prop dollar: James Saft

(James Saft is a Reuters columnist. The opinions expressed are his own)

LONDON (Reuters) - The time may have come for sustained coordinated intervention by governments to support the wilting U.S. dollar.

The dollar has taken another leg downward on fear surrounding the bailout of Fannie Mae and Freddie Mac and the perilous state of banking in the United States, briefly breaching $1.60 against the euro and now down almost 7 percent this year against a trade-weighted basket of currencies .DXY.

Intervention by the U.S. Federal Reserve, undertaken in concert with the European Central Bank and other global economic powers, could be an inflexion point for the dollar after its 6 year fall.

And with the falling dollar playing a substantial role in rising oil prices, official action to back the currency could provide relief for consumers and ease the pressure from inflation, both in the United States and globally.

It would also be a very useful and timely insurance policy against any run on the dollar should global holders of U.S. debt take fright at what may be a massive bill, and proportionally huge supply of new U.S. debt, to backstop Fannie and Freddie and sort out problems in U.S. real estate and banking.

“This is a situation crying out for intervention and leadership,” said Nick Parsons, head of market strategy at nabCapital in London.

“The benefit to (U.S.) exporters has been more than outweighed by the costs to consumers of a weak dollar.”

The falling dollar is a problem -- and not just for the United States -- because it is associated with the rising cost of energy, which in turn feeds inflation and chokes off consumption.

Fed Chairman Bernanke acknowledged both the problem and the link with oil in June, when in highly unusual comments he said he was “attentive” to the inflationary impact of a sinking dollar, combining this with tough talk about inflation that led investors to bet U.S. rates were heading upward.

A study by the Fed said that about a third of the rise in the price of oil between 2003 and 2007 was caused by a falling dollar.

Bernanke on Wednesday told Congress there “may be conditions in which markets are disorderly where some temporary action may be justified.”

Treasury Secretary Hank Paulson has been doing his bit too, saying time after time that a strong dollar, set by free markets, is in the best interests of the United States and the world.

Problem is that markets have called Bernanke’s bluff and now realize that, with finance in an abject state, he’s in no position to raise rates to support the dollar and choke off inflation.

As for Paulson, the market long ago concluded that the strong dollar mantra is a meaningless piety, though he did say in June he’d never take intervention “off the table.”

Bernanke on Wednesday told Congress there “may be conditions in which markets are disorderly where some temporary action may be justified.” A pattern of intervention comments from both sides of the Atlantic is probably a precondition for actual intervention.

STARS COMING INTO ALIGNMENT?

Talking the Europeans into it would not prove too hard. The European economy is suffering under the burden of a strong currency, with industrial output falling by the most in 16 years in May. And though a falling euro would import inflation, this must be set off against the prospect of lower energy prices and the relief they would bring.

For the United States, the biggest obstacles are probably ideological. The Bush administration has long argued that the value of the dollar should be set in the free and unfettered market, though where exactly a free market can be found I am increasingly unclear.

The serial bailouts, first of Bear Stearns and now Fannie Mae and Freddie Mac, have robbed that argument of much of its moral and intellectual authority, though probably not all of its emotional appeal.

Intervening to drive the dollar up would have costs; it would be unpopular with exporters, one of the few parts of the economy that is doing well. The benefits for consumers could be both big and easy to sell in an election year, however.

The United States must also be weighing the possibility that international support for its debt fades as the crisis in its financial sector worsens.

The cost of buying insurance against a default by the United States has risen markedly, to a still tiny 18-20 basis points from its usual two or less.

With neither the costs or the scope of the emerging bailout known, it is possible that foreign investors begin to impose a markedly higher risk on U.S. government assets. Remember too that the recapitalization of the U.S. financial system depends in part on attracting a fair amount of new risk capital from overseas, and investors may decide that buying into a very weak industry in a weak currency is not attractive.

No one can argue that intervention will change the very poor fundamentals in the United States. Savings still have to rise, housing prices still have to fall and standards of living will fall for a time.

But intervention can provide some relief.

No one wants to start from here, but here is where we find ourselves.

-- At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. email: saft@thomsonreuters.com --

Editing by Ruth Pitchford

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