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Economic Forecasts

U.S. as Safe Haven: How Long Can It Last?

Despite all its economic problems, America continues to be a favorite for currency traders and foreign investors of all kinds.

Consider this: The U.S. economy is anemic; unemployment remains stubbornly high; exports are disappointing; the budget deficit is mounting; and the credit rating agencies have downgraded U.S. debt. Moreover, policymakers are deadlocked over what to do. There are fears that new budget-tightening could push the economy back into recession.

SEE ALSO: Investing in Volatile Markets

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Yet the dollar is holding its own on the foreign exchange markets, and foreigners are stepping up their investment, buying U.S. companies, acquiring real estate and continuing to buy U.S. Treasury notes. Even the Chinese, who have officially expressed reservations about the performance of the U.S. economy, are in on the buying spree.

The reason is plain: It's the safe haven phenomenon. As uncertain as the picture looks here in the U.S., it's still better than the alternatives. America's economy may seem anemic, but Europe is in serious trouble, Asia is weakening, and the emerging market economies, from China and Brazil to Russia and India, are visibly slowing.

Although the U.S. budget deficit is worrisome, America's debt problem is nowhere near as bad as that of Europe, which is scrambling to stave off serious threats of default by Greece, Spain, Italy, Portugal and Ireland. And though several big U.S. banks have been downgraded, they're far better off than many European, Russian and Asian banks.

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Moreover, last year's doomsday prediction that the combination of swelling deficits and easy monetary policy would lead to soaring inflation, rapidly rising interest rates and a plummeting dollar never proved true. Instead, inflation and interest rates have remained low, while the dollar has edged down only slightly.

As a result, America has remained the safe haven -- and preferred investment -- for investors all over the globe. According to a recent Barclays poll, investors worldwide "see U.S. prospects as relatively strong." Almost 80% of credit investors view America as the best bet. So do more than half of stock market investors.

And while Americans may consider the real estate market here a dicey investment, the combination of lower home prices and a weakening of the dollar against some currencies has spawned a deluge of property buying by Chinese, Europeans, Canadians and Latin Americans, reports the National Association of Realtors.

To be sure, there are some early signs that such optimism may not continue indefinitely. Although the U.S. is still regarded as a safe haven in this time of turmoil, foreign purchases of U.S. Treasury securities plus foreign direct investment in the U.S. slowed during the first quarter.

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Also, though the dollar hasn't plunged in the face of the slump in China or the Federal Reserve's decision to continue its low-interest-rate policies -- and it isn't likely to face any serious pressure in the next few months -- it has declined somewhat against some currencies. Moreover, with so many dealers on vacation during June, July and August, the currency markets are traditionally thinner and more volatile during the summer months.

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Larry Greenberg, a former New York Federal Reserve Bank currency strategist who publishes a blog called Currency Thoughts, argues that, given the situation in Europe, the dollar should now be even stronger against the euro than it is. "It's happening gradually," he says.

The biggest threat that the safe haven phenomenon faces is the possibility that Congress and the administration won't agree on what to do about two giant fiscal dilemmas looming right after the elections: the pending expiration of the Bush-era tax cuts and huge automatic spending cuts under last summer's congressional budget deal.

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Few investors are likely to panic if lawmakers don't agree on any more than a stopgap resolution between November and January. But if Washington allows those cuts to take effect as scheduled early next year, the move may well blunt the still-fragile U.S. recovery, sending the dollar sliding and making investors more wary about prospects here.

What impact a souring of the current investment picture would have depends on why the deterioration took place. If the dollar weakened a bit because Europe dug itself out of the euro crisis -- as may happen if last week's ministerial bailout plan works -- it wouldn't hurt the U.S.: American exports would be more competitive, and Europeans would have more to spend on them.

But if foreigners were to cut back sharply on their purchases of Treasury notes, companies and real estate, it would boost U.S. interest rates and impede the recovery. Either way, the investment boom -- and the safe haven factor -- remains America's to lose.

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