Who’s afraid of the big, bad deficit?

Nearly everyone appears to agree: The large U.S. current account deficit is undermining the value of the dollar in the foreign exchange market. Sure enough, the dollar has been in a major bear market. The Euro bottomed against the dollar below $0.8250 in fall 2000 and reached a record high at the end of last year above $1.3650. The dollar has been declining against the Japanese yen since peaking in 2002 near 135 yen, and earlier this year traded below 102 yen, albeit briefly.

And yet there is good reason to be suspicious of what passes for conventional wisdom. For example, the Hungarian forint was one of the strongest currencies against the dollar last year, even though that country’s current account deficit was around 9 percent of gross domestic product (GDP). By comparison, the U.S. current account deficit was closer to 6.0 percent of GDP.

Or consider the Australian dollar. It appreciated nearly 4 percent against the U.S. dollar, despite its current account deficit being slightly larger than the U.S.’s as a percentage of GDP.

Moreover, for active market participants, it is difficult to build a trading strategy around the U.S. current account position. The Euro rose about 7.5 percent in 2004, but in the first six weeks of 2005 it surrendered 4.3 percent.

The dollar lost 4.5 percent against the yen in 2004 and recouped more than half in the first six weeks of this year. The volatility in the currency market is such that nothing substitutes for disciplined risk management.