Behind the Sinking Dollar: America's Image as a "Rogue Nation?"

The message from the foreign exchange markets since November 3, 2004, seems to be simply this: The free ride for the "rogue nation" is over.

No more guns and butter, or wads of foreign cash for a nation deeply enmeshed in the Middle East, heavily indebted at home — and seemingly disengaged (some might say) from the rest of the world.

The sinking dollar could be a sign that the world is no longer willing to underwrite the designs of U.S. foreign policy. To a large degree, a rebound in the U.S. dollar could hinge on a revamped U.S. foreign policy.

The day after the presidential election, many foreigners cast their own ballot by selling the U.S. dollar — a sell-off that has only gathered momentum in the month since Mr. Bush was reelected.

Since election night, the dollar has dropped by 4% against the euro, 2.6% against the yen, 4.3% against the British pound — and even 4.3% against the Brazilian real. The U.S. NAFTA partners, meanwhile, have seen a dollar decline of 2.4% against the Mexican peso and 2.6% against the Canadian dollar.

The dollar sell-off — in other words — has been broad based, with the U.S. dollar sliding 3.7% on a trade-weighted basis since November 2, 2004 alone.

The dollar's swoon has been blamed on America's debtor status, manifested in a current account deficit approaching 6% of GDP and a federal budget deficit of well over $400 billion — greater than the output of most nations.

To be sure, the United States does spend more than it saves — and consumes more than produces. It seems that foreigners have grown weary of underwriting the spendthrift American way of life.

But that said, I think that apathy towards the greenback reflects something more than foreign angst over America's abysmal savings rate — which, incidentally, fell to its second-lowest level on record in October 2004.

After all, the U.S. savings deficit has been part of the global financial landscape for years. That is why I believe that something else is in play in the dollar's current slide.

In my opinion, the dollar's decline mirrors America's plunging approval rating with the rest of the world. Concerns over the U.S.-led war in Iraq, the Kyoto agreement, the U.S. relationships with international institutions and its allies, U.S. visa restrictions and burdensome custom procedures all could have converged to taint America's global image.

They cast the United States as a "rogue nation," or an outsider that prefers to take matters into its own hands.

It seems as if U.S. popularity with the rest of the world has never been lower. Little wonder, then, that the U.S. dollar is as unloved as it is today.

The election appears to have been the tipping point — or selling point — for foreigners. Going forward, we believe that some parts of the world may anticipate a more forceful path when it comes to U.S. foreign policy.

In that context, consider the recent announcement by the Pentagon of rising U.S. troop levels in Iraq prior to the country's January 2005 election, which could put continued pressure on the dollar — and keep the markets on edge.

Rarely has U.S. foreign policy influenced the global financial markets and weighed on the U.S. dollar as it does today.

In the November/December 2004 issue of Foreign Affairs, Robert Tucker and David Hendrickson forcibly make the argument "that the United States has a serious legitimacy problem" with the world.

I believe it does. More worrisome, the authors correctly note that it takes time to restore one's reputation and legitimacy. In other words, America's tarnished global image could weigh on U.S. dollars for some time to come.

The sooner America's image is restored, the better the prospects for the U.S. dollar. My hunch, though, is that this may take time — leaving the dollar vulnerable to more downside pressures.

Adapted from a December 3, 2004, Banc of America Capital Management research report.