NEW YORK, Jan 25: Global investors unsettled by US economic weakness, low rates of return and the threat of a Mideast war have roundly shunned the dollar, which analysts say could prompt a deeper liquidation of US assets.

Paradoxically, some say a cheaper dollar could in the longer-term attract capital flows back into American financial instruments, with a weaker currency making US assets relatively less expensive than they have been in recent years.

On Friday, the dollar fell to a 3-year low against the euro and sterling, probed a 4-year trough against the Swiss franc and neared a 4-month low against the yen as worries over a war with Iraq reached a crescendo.

A chief concern of the investment community has long been the massive US trade deficit, which has helped to widen the nation’s current account deficit to about 5 per cent of US gross domestic product.

The current account deficit is an accounting identity. It always gets financed, but the question is: ‘By whom and at what price?’ said Nic Pifer, a portfolio manager at American Express Asset Management in Minneapolis.

To fund the current account deficit, capital flows into the United States need to run at about $2 billion a day. A research note from Citibank this week put securities inflows at $40 billion for the entire month of October 2002. It noted that those flows had begun to wane as US securities became less attractive.

Over the past two years, as the US Federal Reserve has lowered interest rates to the lowest level in a generation, yields on US bonds have become less attractive than yields in European debt markets. This has led to lower overall capital flows into the United States as investors seek out higher returns in other global markets.

The US is already using a disproportionate amount of global savings, said Pifer. Against a backdrop where real interest rates in the US are quite low, for foreign investors, that obviously gives them some pause.

For years, one of the benefits of a strong dollar was the relatively high returns it provided foreign investors who held US assets. But with the US stock market unable to gain traction and bonds prices appreciating unevenly at best, investors have few reasons to hold the greenback

The decline in the US currency prompted Russia’s central bank to announce on Thursday its intention to cut its foreign currency reserves to improve returns on its holdings, due to the “very low returns” on dollar-denominated assets.

The move led to speculation that other global centers could soon follow suit.

The US dollar has lost that investment aura, said Michael McGuinness, head of North American sales at American Express Bank in New York. It’s a currency that people will issue debt in, but I don’t see the world seeing it as a vehicle to invest in right now, considering how low short-term lending rates are.

The dollar’s slide increases the currency risk for investors in US assets and feeds back into the calculations of foreign investors who might otherwise consider buying US stocks or bonds.

The risk is a self-fulfilling move, where investors start focusing on the United State’s large funding need because of its current account deficit. That leads to concerns over the currency, Pifer said.

But Peter Morici, professor of international business at the University of Maryland and a former chief economist with the International Trade Commission under former President Bill Clinton, says a weaker dollar may eventually serve the dual purpose of reducing the current account deficit while attracting foreign capital.

Morici says the dollar would have to fall as far as 105 yen in order for the United States to reap the benefits of a weaker dollar.

He contends that could happen within three to six months.—Reuters