Investor/An insider's guide to the market: Concerns over the impact of the falling dollar on US and global economies have moved centre stage following comments by Alan Greenspan, chairman of the Federal Reserve, regarding the unsustainability of the US foreign trade deficit.

Mr Greenspan warned that the US current account deficit is growing so big that, at some point, foreign investors will lose their appetite for holding dollars and dollar-denominated assets such as US stocks and bonds.

The size of the US's trade deficit is enormous at $531 billion (€408 billion) for fiscal year 2003. The deficit is still growing and rose past $313 billion for the first half of 2004. The current account deficit, which includes investment flows, now equates to an all-time record high of 6 per cent of US GDP.

The rise in the trade deficit has gone hand-in-hand with the move in the fiscal balance into deficit over the past four years. For fiscal year 2004, the federal budget deficit is estimated at $413 billion driven by military spending and tax cuts.

While the deficits are not directly linked, they are tightly connected. The huge borrowing requirement of the US government has lowered the savings ratio, which in turn helps fuel higher consumer demand thus sucking in more imported goods.

Many market analysts have long taken the view that a large decline in the foreign exchange value of the dollar is the only way to halt the runaway trade deficit. Against the euro, the dollar has been falling for more than two years and recently breached the €/$ 1.30 barrier.

The problem is that the large fall in the dollar value against the euro has had very little impact on the US/Europe trade position. Europe continues to run a trade surplus with the US despite the appreciation of the euro. This must be partly due to the fact that, in its early days, the euro was undervalued and part of the recent appreciation reflected a correction to more normal levels.

The slow pace of recovery in the euro-zone economy is also making it difficult for the Americans to cut their trade deficit. European consumers have been very slow to increase spending and, therefore, increased imports of US goods have not followed improved US competitiveness.

The US argues that the solution is for Europeans to do more to stimulate their sagging economies resulting in higher US imports. However, the European Central Bank has maintained a cautious stance in view of its overriding goal of price stability.

The Europeans argue that the US could do more to solve the trade deficit problem if it reduced excessive government borrowing.

This argument between the US and Europe misses the key issue - the main source of the US trade deficit lies in the economies of China and other Asian powers, including Korea, Taiwan and Malaysia. These countries have closely tied their currencies to the dollar and are now greatly undervalued versus the dollar.

China is the dynamo of the Asian region and it has pegged the yuan to the dollar since 1993. By maintaining a competitive exchange rate, Chinese exports to the US mushroomed over the past decade in response to the seemingly insatiable demand of the US consumer. Now, however, the Chinese are under increasing pressure, from the US and Europe, to revalue the yuan. Until this happens, the euro will continue to bear the brunt of the weakening dollar, which will increase the risk of an economic slowdown in Europe.

Last weekend at a G20 meeting of bankers and finance ministers, the Chinese hinted that the yuan peg to the dollar might be reviewed. No one expects a change in the short term but moves towards relaxing the peg could occur over the next year.

Any policy change that led to a revaluation of Asian currencies would be welcomed in the US and Europe. In fact, the sighs of relief amongst European central bankers could well be greater. This is because in the absence of a revaluation move in Asia the euro could continue to appreciate for the foreseeable future.

Euro-zone growth in the third quarter was slow and there are fears that further euro strength could seriously weaken Europe's economy going into 2005. As a consequence, euro-zone interest rates are not now expected to rise until well into 2005 and some commentators believe that a downward move is possible if growth continues to disappoint.

So far, the fast-growing Irish economy has been able to comfortably absorb any loss of competitiveness caused by the strong euro. Any dampening impact on exports from further euro strength will probably be offset by a deferral in euro-zone interest rate increases.

Furthermore, the strong currency will act to keep a lid on inflationary pressures. For the Irish equity market, this combination of rapid domestic growth, a strong currency and low interest rates provides a very positive backdrop going into 2005.