The US currency has had a number of reasons to rise over the past few days. Friday the markets were reassured about the greenback’s prospects by Fed Chairman Alan Greenspan who said that the US huge trade deficit can be reduced by market forces and a drop in the budget deficit. The optimism somewhat waned after Bloomberg columnist John Berry dampened the hopes saying the market "should have listened more closely" to Greenspan’s caveats and his statement that the U.S. trade gap "isn’t likely to shrink anytime soon". This claim will endure an acid test on Thursday when US trade data are due to be released.

Monday President George W. Bush submitted his plan on trimming the federal budget deficit to 3.0% of the GDP in fiscal 2006 from a record 3.5% in 2005. The budget deficit is expected to shrink to 1.5% of the GDP in 2009. The administration counts on robust economic growth to meet the projections. Discretionary budget spending will fall 1% in absolute terms after cuts in as many as 150 programs, mainly educational initiatives and agricultural subsidies. There is still doubt, however, as to whether the Congress will prove willing to follow the President’s initiatives as the past record shows that Congressmen might balk at the cuts, irritable over the sustained military expenditures for military actions in Iraq and Afghanistan.

Other factors may come into play in the long run lending support to the greenback. J.P.Morgan identified in its research report released Wednesday dollar repatriation flows expected after the passage of the American Jobs Creation Act of 2004 as "gorilla in the shadows” that may boost the greenback. J.P.Morgan analysts now expect US companies to repatriate $77 billion worth of earnings to the US this year.

But perhaps the most intriguing story of the forex market is the possibility of the yuan revaluation. US currency was propped by the comments by Chinese central bank Governor Zhou Xiaochuan in the G-7 meeting that demonstrated that the efforts of the European nations to push China to share with them the burden of the dollar weakness have yielded little fruit so far. China has already agreed to the revaluation over the long run, but has not set a definite timeframe as Chinese authorities claim the country needs to implement large-scale reforms in the banking sector before abandoning the 8-year peg of renminbi to the dollar. At the moment the yuan is tied to the greenback at the rate of 8.27 yuan for $1 and a 0.3% band, while analysts assess the real exchange rate would quickly reach 5 yuan for $1 if the yuan is allowed to float. Other Asian nations including Japan that has a looser peg to the US currency could also be expected to allow their currencies to appreciate following China’s example.

China is reluctant to loosen the peg for several reasons. First, the artificially low yuan keeps the cost of the Chinese exports low allowing China to flood the whole world with its products. Second, the Chinese central bank, like other Asian central banks, has been helping the US deficit by buying US Treasuries. China had currency reserves totalling $611 billion at the end of 2004. Now the Asian nations have seen their reserves shrink as the dollar keeps sliding. 10% dollar depreciation would trigger a loss of $60 billion in the Chinese bank reserves. Third, a higher yuan would attract more speculative capital in the country, spurring a new circuit of uncontrolled explosive growth, a development that is seen by the Chinese leadership as very unwelcome. The nation is already struggling with a capital inflow provoked by the projected yuan appreciation, even though no definite moves are expected within an 18-month period.

Key players in the forex market point to the fact that the US is actually benefiting from the weak dollar. The lower value of its exports helps the economy to expand and to lower the current account gap. The decline, however, cannot go on interminably without affecting the economic situation adversely. The US economy has so far successfully survived the rising cost of the imported raw materials, but the further drop in the dollar is likely to reduce the financial asset prices affecting the wealth of US households and institutions. Rapid asset depreciation would squeeze the liquidity of the financial institutions, and an inevitable rise in interest rates could damage investment. Thus, a significant drop in the US currency could turn expansion into a recession. The question is how much decline the Bush administration is willing to accept without risking to lose the steam of economic growth. Recent actions on cutting budget expenditures seem to confirm the opinion that the US leaders are finally trying to bring down the looming deficit.