Hot on the trail of the trailing US dollar.

The US dollar has been declining for two years. Against the world's major currencies, it has fallen by an average of 25% over this period, substantially reversing the strong rise of the late 1990s. Large and growing trade imbalances, disappointing growth relative to other global regions, and the sharp decline in US interest rates orchestrated by the Fed all have played a role in the dollar's fall.

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In a world of prospective single-digit returns, double-digit currency moves clearly matter -- for offensive reasons when looking for opportunities to enhance investment returns across borders, and defensively in understanding how investments could be affected by sizable swings in exchange rates. Investors should consider the potential effects of an eventual bottoming or turnaround in the dollar later this year, especially against the euro.

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With many Asian countries either pegging their currencies to the dollar or actively resisting upward pressure through intervention, the dollar's recent decline has disproportionately played out against European currencies. The euro is up 40% against the dollar over the last two years and over 50% since its low in late 2000. It has now more than fully recovered its initial losses in 1999 and 2000.

Euro-zone officials are now pressing the US administration and its G-7 partners to slow the dollar's decline and to shift more of the burden to Asia. They see a further sharp rise in the euro as a key risk to the European recovery, which is still young and potentially fragile.

The dollar's overall correction may have somewhat further to run, but the pattern may shift toward Asia. While one more leg of euro strength against the dollar is still likely, we may be in the late innings of the dollar's adjustment against the major European currencies.

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Other scenarios are also possible. One is a disorderly decline or dollar crash in which foreign investors lose faith in the United States and withdraw support in favor of the euro, the yen, or some combination of alternatives. New growth disappointments in the US, compounded by election-year rhetoric on trade protection, could be a catalyst. So far, the decline in the dollar has been orderly and not disruptive to other financial markets, but there is no guarantee this will continue.

Another possibility is a meaningful rebound in the dollar. In this scenario, confidence grows in the sustainability of a strong US recovery that extends into 2005. The Fed validates this confidence by beginning to raise interest rates, foreign investment sweeps back into the US equity markets, and the dollar rallies.

Regardless of which scenario unfolds, investors would do well to prepare themselves for further foreign exchange movements in the coming year.

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This is an article by Timothy Stewart entitled "Dollar Decline: Game Over or Seventh-Inning Stretch?" dated March 19, 2004. For important information and disclosures regarding Morgan Stanley, please see www.morganstanley.com/ourviews or contact 1-800-962-1343. This article is for readers in the United States, does not provide individually tailored investment advice and has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. It was based on public information, and Morgan Stanley makes no representation that it is accurate or complete. Estimates of future performance are based on assumptions that may not be realized. Investments and services are offered through Morgan Stanley & Co. Incorporated, member SIPC. Morgan Stanley and One Client At A Time are service marks of Morgan Stanley. [C] 2004 Morgan Stanley.

Timothy Stewart, Chief Currency Strategist