Downward pressure on the U.S. dollar is coming from all directions. This has resulted in a net outflow in foreign purchases of U.S. securities, China’s sales of U.S. treasuries and uncertainty about the health of U.S. financial institutions in the aftermath of the credit crisis.

In both August and September, net foreign purchases of U.S. securities were negative. As a result, National Bank Financial Ltd. of Montreal points out that the 12-month net inflows were no longer sufficient to cover the U.S. current account deficit, which was US$800 billion in June. In September, net inflows were only US$568 million.

However, it’s China’s sales of U.S. treasuries that are particularly ominous. China was a net seller in four of the six months of April through September, unloading a total of US$18.5 billion during the period. China could sell a lot more, as U.S. treasuries are the main component of its US$1.3 trillion in foreign reserves.

Analysts have long been concerned that China and the other Asian central banks, which hold most of the U.S. treasuries, would diversify the currency exposure in their foreign reserves. This makes sense, but has its downside as the downward pressure on the US$ that results from the sales lowers the value of their remaining U.S. securities.

China has the largest foreign reserves, but the combined total for Japan, Taiwan, Korea and India is even larger, at US$1.7 trillion. Then there’s Russia, at US$416 billion. Canada’s foreign reserves are only US$41 billion.

The Canadian dollar has risen more than most currencies against the US$ since the beginning of 2002, and the domestic impact is even greater because we trade so much with the U.S. The loonie was up 53% on a trade-weighted basis, vs 40% for the Australian dollar; 31% for a basket of European currencies, including the euro, the British pound and the Swiss franc; and 16% for the Norwegian krone.

Australia and Norway are both big resources producers, so their currencies, like the C$, are mainly driven by resources prices, particularly oil. Neither, though, trade nearly as much with the U.S., so the impact on the drop in the US$ is not as big a factor for them.

If slower U.S. growth dampens demand for resources sufficiently during the current economic slowdown, these currencies could come down. Some economists expect this, with Bank of Montreal and TD Bank Financial Group, both based in Toronto, expecting the C$ to fall back to around the US95¢ range by the end of 2008.

But others think the demand for resources will stay high enough to keep the C$ around par or higher. Toronto-based CIBC World Markets Inc. predicts the exchange rate will be around US$1.05 by the end of 2008.

The loss in competitiveness from the rise in the C$ is felt by many Canadian companies. But this is masked in terms of growth for Canada’s economy as a whole because resources companies and the provinces in which they are produced continue to do very well. IE