While the European Central Bank and the Bank of England are expected to raise their current benchmark interest rates (3.75% and 5.25% respectively) soon, it is widely believed that the Federal Reserve will lower its rate (5.25%) by August. According to some analysts, if the current economic trend continues, the euro could rise to $1.40 by summer, which would mean the sharpest fall ever in exchange rates for the dollar.

Now one may ask: why are we making all this fuss over the exchange rate problem of one currency? Why is it so important to monitor the movement of the dollar in the foreign exchange market? Well, the importance of the exchange rate of the dollar against other currencies is due to three factors: the dollar is the currency of the world's number one economy, and since the end of World War II it has become the only major currency in which most of world's financial transactions are conducted.

The other important point about the US currency is that most of the foreign exchange reserves of central banks are held in dollars. No wonder that the dollar's relative strength or decline affects trade balances, capital flows, growth rates, and even the relative sizes of the economies.

Actually, the price of a foreign currency is largely determined by the forces of demand and supply, hence the importance of having a surplus or a deficit on the current account.

Persistent current account deficit of a country creates pressure on its currency. The current account deficit of United States now stands at close to 7% of the GDP ( it was 5% in 2003), which can be considered as high by any standard, and is financed by borrowing from the rest of the world. The US needs $3 billion dollars every working day to finance its current account deficit.

Actually, it is quite normal for a specific country to have small deficits for a short period of time. What is dangerous is having high imbalances over a long period. Unfortunately, the US has been suffering from high imbalances for a long time, which means that it has a chronic savings shortfall.

As long as America suffers from budget and current account deficits, the dollar will continue to fall in the foreign exchange market.

Now the question is: If the dollar is declining, why does the world lend money to United States? In simple terms, it can be described as a confidence trick. First of all, the sheer size of the economy inspires confidence. And second, since the US is the only remaining super-power, the lenders believe that it will somehow manage to get out of its financial difficulties and will not default.

Asian countries like China and Japan export a lot of merchandise to the US, and, as a result, accumulate a lot of dollars. Then they help finance American deficits by buying treasury bonds, federal agency bonds and private-sector debts.

If they do not, the dollar will weaken further, which will lower the value of their dollar reserves (more than one and a half trillion dollars). It has become a vicious cycle.

These loans have kept prices and interest rates relatively low in the US, and financed Bush's tax cuts and his so called war-on-terror. But, at the same time, this practice has placed the US in a vulnerable position by allowing these countries to have significant economic leverage, which can be used to force the US to make political concessions.

This situation may, in the long run, have other political consequences for the US. At the end of World War II, Britain's devastated economy, together with a plunging pound and a massive post-war debt, forced the dissolution of the empire.

As far as economic consequences are concerned, if the Asian central banks decided to diversify into other currencies or spend more at home, it will have an adverse effect on American living standards.

There are indications that the central banks are already switching to this policy slowly. A quick change in allocations can have devastating effects on the American economy. If the oil exporters decided to price their crude in euros, with a declining dollar, the financial burden of United States will grow further because it continues to be the world's biggest oil consumer.

Of course, the United States holds a trump card. Asia's reckless willingness to place most of its savings in one basket by buying American debt has also placed it in a vulnerable position.

Although it may neither be strictly legal nor fair, the US may decide to change the rules and link the use of these reserves to specific additional purchases of US goods and services as it did in 1971 by tearing up the Bretton Woods system and ending the convertibility of dollars into gold. Whether such an action would make the global economic system more stable or less is another story.

On the other hand, it is true that a weak dollar makes American products cheaper. Therefore, it should benefit its export market, and will give a much needed boost to the economy.

Since it would make imports from other countries more expensive, it should also help its balance of payments on current account by putting a brake on the profligate consumerism of its people. But is it wise to depend entirely on a weak dollar policy alone to cure all of America's ills? No, as the treasury secretary acknowledged recently: "We have got a low savings rate, and it is a problem in the US. We can do more, and we can do more on deficits."

This, indeed, is a good start. In the words of Nobel laureate Joseph Stiglitz: "Nothing significant can be done about global imbalances unless the United States attacks its own problems." So, for the sake of greater financial stability in the world, including the US, it must take urgent measures to bring its dangerous deficits under control.

The writer is a columnist for the Daily Star.