In the summer of 1999, many authoritative figures predicted that the US dollar would depreciate against the euro. They pointed to the growing current account deficit of the United States and the overheated economy of Wall Street as the reasons behind this view. The underlying theory was that non-US investors would withdraw their funds from US stock and bond markets and invest them in countries with stronger economic conditions, leading to a significant decrease in the value of the dollar. This concern had been persistent since the early 1980s when the US current account recorded a record high of 3.5% of GDP.
Foreign investors’ appetite for American assets remained strong, similar to the 1980s, despite the disappearance of the fiscal deficit in the 1990s. While the growth rate of foreign holdings of US bonds may have slowed down, the influx of substantial funds into the US stock market was sufficient to offset this slowdown. In times of market turbulence, non-US investors tended to seek safer investments in US Treasury bonds rather than euro zone or British stocks, as the latter were more likely to be adversely affected. This pattern was observed during the crisis of November 1998 and the stock panic triggered by false statements made by Federal Reserve Chairman Alan Greenspan in December 1996. In both instances, the net purchases of foreign Treasury bonds increased significantly, nearly tripling to $44 billion in the former case and growing more than tenfold to $25 billion in the latter.
Over the past two decades, the asset market method has replaced the balance of payments method in analyzing the behavior of the US dollar. Although improvements in economic fundamentals within the euro zone can support the recovery of the euro, relying solely on fundamentals may not be enough. Other market dynamics need consideration.