-- Neal Kimberley is an FX market analyst for Reuters. The opinions expressed are his own --

Twenty-four years ago, major nations called for depreciation of the dollar to rebalance the global economy. Now, as another effort at rebalancing looms, the dollar will again bear the brunt -- though officials will try to ensure its fall is less dramatic this time.

That's the implication of President Barack Obama's announcement this week that he will push world leaders for a new global "framework" in which the United States would cut its huge trade and budget deficits.

Agreeing on this framework would be politically difficult, since it would require policy changes by many countries -- China, for example, would probably have to rein in its explosive export-led growth.

But as the euro's climb to a new one-year high versus the dollar this morning shows, markets are starting to think the rebalancing process may start as soon as this week's Pittsburgh summit of leaders from the Group of 20 nations.

The Plaza Accord of 1985 called for "orderly appreciation of the main non-dollar currencies against the dollar"; it was followed by central banks' coordinated intervention to ensure that happened.

This time, with the world shakily emerging from a financial crisis, policymakers are likely to try to manage the dollar's drop in a more low-key fashion.

They are unlikely to issue an explicit call for the dollar to fall. In fact, the U.S. Treasury may continue proclaiming its "strong dollar policy" in an attempt to keep the markets calm.

No one in the G20 wants to risk a freefall of the dollar that could disrupt global trade as it recovers from recession. And in contrast to the 1980s, developing nations such as China are now challenging the dollar's long-term role as the world's top reserve currency.

The dollar's premier status helps the United States to obtain foreign capital and in order to keep that access, Washington is likely to encourage central banks around the world to continue holding dollars. This would require slow depreciation of the currency rather than a panicky slide.

So unless policymakers completely lose control of the forex markets -- which cannot entirely be ruled out -- the dollar's slide is likely to be slower and smaller than it was after the Plaza Accord, when the currency sank about 50 percent versus the yen between Sept. 22, 1985 and the end of 1987.

The overall direction of the dollar does not look in doubt, however. Top presidential adviser Lawrence Summers has said he wants a U.S. economy that is "more export-oriented and less consumption-oriented".

A lower dollar is a logical tool to achieve that goal, and letting the currency weaken would probably be faster and easier than most other big policy steps to reshape the U.S. economy, such as tax changes and health reform.

The International Monetary Fund, which is advising G20 nations on economy policy, is hinting heavily at the need for currency realignment.

In a report released this week, it said "current policies and the assumed constellation of exchange rates may not be sufficient for the needed rebalancing of demand."

It added that policy reforms by the world's big economies to restore growth "would be more effective if accompanied by a real effective renminbi appreciation, offset by euro and dollar depreciation".

An international understanding on dollar depreciation may well not be reached in Pittsburgh. A French official said last Friday that Pittsburgh would merely set the stage for future talks on foreign exchange rates.

"At this stage there will not be currency discussions, but the framework that we hope to put in place...is a way of discussing later the question of exchange rates," said the official, who declined to be named.

But giving China and other developing countries more power in the IMF and the World Bank could be part of an informal quid pro quo in which China quietly undertook to resume appreciating the yuan against the dollar.

The rise of the euro as high as $1.4821, breaking the December 2008 peak of $1.4719, is a technical signal that the market thinks the dollar is increasingly vulnerable.

For many traders, the break suggests a good chance of a rise to at least the psychologically important level of $1.50 in coming weeks or months.

The European Central Bank might seek to limit speculation against the dollar by expressing concern about such a move. But the market does not appear to worry that the ECB could actually intervene to support the dollar.

When the European Union's Economic and Monetary Affairs Commissioner Joaquin Almunia said last week that excessive appreciation of the euro could hurt Europe's economy, the euro fell back only marginally and briefly.

The market knows that even at levels just above $1.5000, the euro would remain well below its all-time high against the dollar of $1.6038, hit in July 2008.

And any rise of the euro against the dollar in the current circumstances would probably be seen by policymakers as the result of general dollar weakness, not excessive euro strength. When euro/dollar reached its July 2008 peak, euro/yen hit a similar high; now, euro/yen is a full 35 yen lower.

The Japanese may also be willing to see their currency strengthen. Before new Finance Minister Hirohisa Fujii took office this month, he said a strong yen was generally good as it boosted the purchasing power of Japanese.

Fujii subsequently backed away from that comment, but speculation will remain that after sweeping to power last month, the Democratic Party of Japan may try to shift the country away from its reliance on exports and its opposition to yen strength.

In the context of a G20 drive to rebalance the global economy, this could easily cause the market to think the yen should be trading stronger than 90 to the dollar.

-- Agnes T. Crane is a Reuters columnist. The views expressed are her own --

It looks bad for the dollar, but looks can be deceiving.

Its sharp decline in the last week has pushed the euro to its highest level in a year and reignited fears that there's only one place for the dollar to go, and that's down.

Rhetoric from influential investors like Warren Buffett as well as big foreign buyers of U.S. debt like China and Russia has fed that sense of doom.

Then there's the yen-like role of the dollar as the funding currency, which is casting a pall over the buck since the longer the Fed keeps a lid on interest rates, the longer the pressure stays on the currency.

Yet the dollar is still the No. 1 currency stashed in reserves around the world, by a long shot. International Monetary Fund data showed the dollar accounting for 65 percent of total allocated reserves in the first quarter.

That means there's only so far you can push the currency before the self-interest of the world's savers kicks in to support the buck.

First a little perspective. The dollar's decline this year mirrors the rise in risky assets like U.S. junk-rated corporate debt that have returned to valuations seen before Lehman Brother's implosion. Just as credit markets shut down and money poured into safe-haven U.S. Treasuries, the dollar soared as currency investors viewed it as a place to hunker down until the storm passes.

It may still be cloudy, but investors have been confident enough to venture back into riskier territory like emerging markets, which are booming.

That's meant less money for U.S. assets. Recent data from the U.S. Treasury confirmed as much when it showed net foreign capital outflows of $97.5 billion in July, up from the exit of $56.8 billion in the previous month.

The Fed's zero-bound interest rate policy has also turned the dollar into a funding currency, where investors borrow in the low yielding dollar and invest in nations that offer juicier returns.

"The dollar is selling off because we have low interest rates. That's a macro fact," said Marc Chandler, global head of currency strategy at Brown Brothers Harriman.

Yet, unlike the Japanese yen, which also served as a funding currency earlier this decade, the dollar, or rather dollar-denominated assets, continues to be sought after by nations with big reserves like China and Japan.

Brown Bothers Harriman notes that China snapped up $21.5 billion of such assets in July while Japan added $19.25 billion. Russia and Brazil, which are also sitting on stockpiles of reserves, trimmed their holdings by a relatively small amount.

This is significant. Earlier this year, China and Russia spooked currency markets when they began talking about the need for an alternative to the dollar for the world's currency reserves.

Such an alternative would help savers like China better protect the value of their assets should the dollar fall out of favor, as it is now. Yet it could take years if not decades to implement.

That means the dollar is still the only game in town, rightly or wrongly, which should provide some comfort to those fearing the worst -- a dollar in freefall without a net.

Latvia needs more support from the European Union if it is to preserve its currency peg to the euro and avert a chain reaction of devaluations and bankruptcies around the Baltic and beyond.

The Latvian government and central bank are taking extreme measures to maintain a currency board linking the lat with the single European currency, hoping to steer the former Soviet republic into the safe haven of the euro zone in 2012.

But the price in wage and pension cuts for ordinary Latvians has risen to normally intolerable levels, and the prospect of entering the promised land of monetary stability looks ever more remote as the EU sticks to its strict rules on euro entry.

Furthermore, Latvia’s prospects of economic recovery after a staggering 20 percent forecast contraction of output this year look poor with an overvalued currency. The boom years of consumer spending based on cheap euro credit are well and truly over.

To secure the disbursement of 1.2 billion euros in emergency International Monetary Fund and EU loans, parliament in Riga is expected to approve a revised budget on Tuesday cutting pensions by 10 percent and public sector wages by a further 20 percent on top of the 20 percent reduction already implemented.

Devaluing the lat, as emerging market economists recommend, would trigger a wave of bankruptcies because 80 percent of private borrowing is in euros. Euro zone entry would recede since the country would have to restart from scratch in the EU’s Exchange Rate Mechanism (ERM) with higher inflation and a bigger budget deficit. A new currency peg might prove hard to defend, while a floating lat would likely overshoot on the downside.

More seriously for the EU, a Latvian devaluation would cause big losses at Swedish banks, heavily exposed to the Baltic states, and put immediate pressure on the currency pegs of neighbours Estonia and Lithuania, and perhaps of Bulgaria. It could also make the main central European economies such as Poland and the Czech Republic more wary of entering the ERM.

There is some suspicion that Germany, the EU’s central economy, may want to slow down euro zone enlargement to preserve stability for existing members and perpetuate its orthodox influence over European Central Bank decision-making. But the EU has a strategic interest in holding the line in Latvia against currency turmoil.

To achieve this, it needs to give Riga both more generous financial assistance and a clearer perspective for euro zone membership. Yet so far the European Commission and the ECB have seemed semi-detached, at the risk of sending Latvians the message that Europe doesn’t care too much.

The Commission has left the loan negotiations to the IMF. The ECB has lent Sweden 3 billion euros to guard against its banks’ Baltic exposure. ECB President Jean-Claude Trichet disclosed in an aside on June 4 that the ECB had a repurchase agreement with the Latvian central bank, but he did not say if or when it had been used and whether the European institution accepted assets in lats as collateral.

The EU is a community of law. Treaty rules for joining the single currency cannot simply be torn up in a crisis to admit countries in distress. But once the Latvian parliament adopts the drastic budget cuts, the EU should use this week’s summit to send a political signal to markets that it will do what it takes to keep the Baltic states on track for the euro zone.

To underpin this commitment to avert contagion, the ECB should flesh out its intention to support Latvia with liquidity, accepting assets denominated in lats as collateral. The Commission should propose to member states using more of the EU’s emergency balance of payments facility to support Latvia.

Both moves might set risky precedents if other, bigger economies get into trouble. But if the EU wants to prevent a currency meltdown with wider consequences, that is the political price.
(Editing by David Evans)

– Margaret Doyle is a Reuters columnist. The opinions expressed are her own –

LONDON, April 9 (Reuters) - Ireland’s budget is painful, but insufficient.
Brian Lenihan, the finance minister, is taking an additional 3.25 billion euros out of the economy each year, largely in higher taxes. But that will simply trim the budget deficit to 10.75 percent of national income. The 3 percent eurozone target is a distant dream.

Ireland’s position looks uncomfortably like Latvia’s, only delayed by a few months. It is on the second round of public spending cuts since the International Monetary Fund rescued it last autumn.

Like Latvia, Ireland enjoyed galloping growth. In the decade to 2006, an economic strategy that focused on attracting foreign direct investment, with a super-low corporate tax rate of 12.5 percent, helped generate an additional 1 million jobs, net immigration and higher incomes.

The growth was accompanied by a construction and property boom that saw house prices triple in a decade. The fuel was cheap money following the one-size-fits-all interest rate which came with the adoption of the single currency in 1999.

Thanks to the higher inflation that accompanied the boom, the real interest rate was negative: householders were effectively paid to borrow.

Now this process has gone painfully into reverse. Costs have risen rapidly, while Ireland’s main trading partner, Britain, has seen its currency fall heavily against the euro over the past year.

Irish companies must accept lower margins to safeguard long-term supply relationships, and earnings will suffer. Falling tax revenues make the hole in the public finances bigger.

DEVALUATION OR INFLATION
The traditional ways out are devaluation or inflation, or a mixture of the two, but membership of the euro prevents the first, and makes the second dangerous to corporate competitiveness.

Latvia - not a formal member of the euro, but pledged to peg to it - has chosen to deflate to fit the monetary straitjacket, and going through this painful hot wash cycle has so far shrunk its national income by around 10 percent.

Ireland has no choice but to do the same. National income is forecast to drop by 8 percent this year, and unemployment is soaring. Hence Lenihan’s draconian income tax increases, which include an income levy of 6 percent for those earning above 175,000 euros ($232,000) and a doubling of a health tax to 5 percent for higher earners.

In this budget he has increased taxes by more than he has cut spending, but he will have to borrow a leaf from the Latvians’ book. The tiny Baltic state slashed public sector pay by 15 percent after its IMF bailout last year, and another 20 percent reduction is on the cards. It is also cutting jobs.

Ireland allowed public sector pay to balloon in a “benchmarking” process, the price for social harmony during the go-go years.

Now private sector pay is falling, even for those workers who are not being laid off by struggling companies. Private sector employees have expensive and uncertain pensions, while those in the state sector enjoy the certainty of payments linked to their salary.

The government recognised this in last emergency budget, introducing a pension levy averaging 7 percent of pay on public sector workers.

POLITICAL PAY
Lenihan has made a start by taking a scythe to politicians’ pay and perks. But the exercise has simply shown how far out of line Ireland’s political pay had become.

Brian Cowen, Ireland’s Taoiseach (prime minister), for example, earns more than either Germany’s Angela Merkel or France’s Nicolas Sarkozy. He is stopping the practice of paying ministerial pensions to those still serving as members of parliament.

For all the pain of euro membership, there is no chance that Ireland will get out. For starters, there is no procedure for countries to leave the euro. In fact, Ireland is likely to huddle even closer to the European Union, and especially to Germany, the EU paymasters.

Lenihan likes to claim membership of the euro as a bulwark against the storms in international financial markets. It is true those Central European countries with floating exchange rates, especially Hungary and Poland, have endured their own pain.

Thanks to hopes of rapid euro convergence and easy credit (much from Western European banks), many borrowed in euros or Swiss francs to invest in local property. With the forint and zloty well down against the euro, those repayments are proving painfully expensive.

Not all investors are convinced that the euro is forever. The yield on 10-year Irish government bonds has ballooned to more than 200 basis points (2 percentage points) over the equivalent German 10-year debt.

Like Greece, Spain and Portugal, Ireland’s credit rating has been downgraded, from AAA, but the prices are anticipating further downgrades as the credit squeeze worsens.

As with the Balts, previous hubris about their flexibility and dynamism has gone now that “old Europe” may be called upon to stand behind Ireland’s debt.
Lenihan signalled that the Irish people would be much more likely to accept the Lisbon treaty now that its “false sense of invincibility” had been shattered.

Even so, it was notable that Lenihan did not do the one thing that the Germans would have liked above all in the budget. Among all the tax rises, he did not touch the 12.5 percent corporate tax rate.

That is very unpopular with Germany, which sees it as unfair tax competition. But Ireland can see that retaining a competitive edge will be the cornerstone of its attempts to re-establish economic independence.
($1=.7553 Euro)

(Editing by Richard Hubbard)

Paul Taylor is a Reuters columnist. The opinions expressed are his own.

The financial crisis has rallied support for euro adoption in many European countries outside the currency bloc, yet in Britain the discussion is so far confined to a few voices among the policy elite.

The politics of the issue remain as fraught as ever, and Britons appear no more willing to lose monetary sovereignty in a recession than they were in the boom years.

For most of the last decade, as the flexible, finance-driven British economy was roaring ahead of its sluggish continental cousins, the economic and political case for joining the single European currency was hard to make.

A Eurosceptical tabloid press helped scare former Prime Minister Tony Blair out of his initial intention to lead Britain into the euro. The 2003 Iraq war drained the political capital he would have needed to win public support.

But now that Britain faces the deepest recession of any major economy next year, arguments for keeping the pound have become harder to defend.

“The crisis has taken the hubris out of the debate. It’s now possible to mention the euro again in British politics without getting a complete ‘No’,” said Lord Wallace of Saltire, European affairs spokesman of the pro-EU Liberal Democrats.

The City of London financial district has been humbled by bank crashes, government bail-outs and a vicious credit squeeze. The housing market is collapsing and the pound has fallen 21 percent against a basket of currencies in 15 months.

“PRAGMATIC SELF-INTEREST”

The establishment think-tank Chatham House was first to call for a rethink in a September report entitled: “A British agenda for Europe; designing our own future.”

A panel of policy wonks stopped short of urging London to join the currency but said: “The extension of euro membership to the vast majority of EU member states in future years will mean Britain is excluded in practice from deeper intra-EU economic consultation and coordination, including in areas of significant national interest such as financial market regulation.”

While London should not join just to avoid losing influence in Europe, “under future national or global economic conditions, the government may need to appeal to the pragmatic self-interest of the British electorate over giving up the pound”, it said.

Denmark, which voted against the euro in 2000, is feeling the political and economic cost of having opted out and weighing a referendum on joining. If it does, Sweden may well follow.

Central European governments led by Poland were quick to conclude they could no longer afford to question the merits of euro adoption, and are now racing to meet the criteria for joining the currency bloc as soon as possible.

The euro zone may not be perfect, but it’s warmer inside.

Will Hutton, director of the left-leaning Work Foundation, argued this month that Britain now resembles a gigantic hedge fund and sterling’s sharp fall could turn into a rout.

“Suddenly membership of the euro — politically toxic — is beginning to look a very attractive escape route,” he wrote in the Observer newspaper.

Joining the euro at the current devalued exchange rate would make British exports competitive, enable reindustrialisation and underwrite the City’s huge borrowing needs, Hutton argued.

COMPETITIVE DEVALUATION

Opponents of euro membership say a floating currency has enabled Britain to avoid painful adjustments in wage costs by depreciation, first when sterling was ejected from the European Exchange Rate Mechanism in 1992 and again this year.

“What is the point of enduring the years of economic weakness needed to achieve the 15 per cent improvement in competitiveness against the euro zone secured, painlessly, in the past year?” economic columnist Martin Wolf asked in the Financial Times.

Yet the idea that Britain can get away with a competitive devaluation every 15 years to wipe the slate clean from the excesses of its bubble economy sits uncomfortably with traditional notions of fiscal rectitude.

It also suggests that British membership might be more of a threat to the stability of the euro zone than joining the euro would be to Britain’s monetary sovereignty.

Prime Minister Gordon Brown, who faces a general election within 18 months, has sought to avoid a public debate on the euro. As finance minister for a decade, he had a hand in blocking Blair’s ambition for euro membership by devising five economic tests that were never met to his satisfaction.

Opposition foreign affairs spokesman William Hague said in an interview that the national sovereignty argument against the single currency remained stronger than any short-term expediency case for joining in a crisis.

Things may have to get still worse before the British conclude they would be better sharing monetary sovereignty with France and Germany than risking the fate of Iceland or Hungary.