Risk seen in letting the dollar fall too far

By Nick Olivari and Vivianne Rodrigues - Analysis

NEW YORK (Reuters) - The dollar's relentless decline may increase the dangers facing the U.S. economy, with the potential for risk-averse investors to stop funding the U.S. current account deficit.

The initial trigger for the dollar's slide in recent years had been the large deficits in spending and trade, analysts said, but as long as they were funded by investment flows into U.S. dollar-denominated assets few were worried about the long term.

But with a slowing economy and increasing concerns about the stability of the U.S. financial system amid widening losses on credit defaults, dollar-denominated securities are becoming less attractive to investors, reducing the demand for dollars to fund such investments.

"That's one of the main concerns: that the sell-off in the dollar reaches the point where foreign investors would start selling most of their positions, and then we would really have funding problems," said Omer Esiner, a market analyst at Ruesch International in Washington, D.C.

Soaring U.S. deficits are cited by academic economists as a root cause of deepening problems in the economy because they reflect the propensity of U.S. consumers to spend rather than save and to borrow endlessly from abroad to finance spending.

The current account deficit narrowed to $172.9 billion (86.1 billion pounds) in the fourth quarter from a revised $117.4 billion in the third quarter, the Commerce Department said on Monday. The current account, which includes goods, services and income flows, is the broadest measure of U.S. trade with the rest of the world.

The New York Board of Trade's U.S. dollar index, which measures the dollar against a basket of currencies, fell 8.4 percent in 2007, for a second year of declines after losing 8.2 percent in 2006.

The dollar index is down 6.2 percent in 2008 despite strong gains on Tuesday after the Fed cut interest rates by 75 basis points.