Falling dollar, limited external adjustment

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The recent drop in the dollar gives a misleading impression of the extent to which trade and current account imbalances will be alleviated. Relative to its peak levels in 2001--2, the dollar has dropped only moderately against the currencies of countries with which it runs major current account deficits. Many US trading partners face severe deflation/domestic demand problems of their own, which they are unwilling to exacerbate with currency weakness.

Consequently, there is a risk of

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