THE US Treasury’s $700 billion (£380 billion) plan to bail out the banks could undermine the dollar, economists warn.

The plan, details of which were unveiled yesterday, will seek congressional approval to raise the total amount the US government can borrow from $10.6 trillion to $11.3 trillion.

It also gives Hank Paulson, the US Treasury secretary, immunity from legal challenge under the plan. The US Treasury will buy mortgage-related securities “from any financial institution having its headquarters in the United States”, draft legislation said. Securities issued before September 17 will be eligible for inclusion.

Word of the proposals created a mood of euphoria in financial markets on Friday. But analysts warned of the risks.

Tim Bond of Barclays Capital, while conceding that the rescue was necessary to avoid the risk of depression, said: “The volume of fresh government borrowing and the fast expansion of the Fed’s balance sheet are both negatives for the dollar, carrying a potential risk of increased inflation.”

Other economists also think that the dollar could be undermined. Kenneth Rogoff, former chief economist at the International Monetary Fund and now a professor at Harvard, said: “It is hard to believe that the dollar will continue to stand its ground as the crisis continues to deepen.”

Critics have long warned that a consequence of the debt bubble would require governments to take debt onto their books and “monetise” it, resulting in higher inflation.

Market reaction in the coming days and weeks will depend on the performance of the American economy and the actions of other countries.

“The eipcentre of the crisis has been the US but we do need to see global responses to these issues,” said Gerard Lyons, head of research at Standard Chartered. He expects more evidence of US economic weakness in coming months.

President George Bush said yesterday the rescue was necessary to prevent financial contagion damaging the wider economy. He said the government had intended to deal with the crisis “one issue at time”.

But the financial “house of cards” was much bigger, he said, “so when one card started to go, we were worried about the whole deck coming down”.

Failure to approve a big rescue package would put “hundreds of billions of dollars at risk”, he added. “The problem would spread to the average citizen. This is Wall Street plus Main Street and I’m worried about Main Street.”

Senator Charles Schumer, chairman of Congress’s joint economic committee, said: “It includes no visible protection for taxpayers or homeowners. We look forward to talking to the Treasury to see what, if anything, they have in mind in these two areas.”

Political critics warned that the deal went too far.

“The free market for all intents and purposes is dead in America,” said Republican Senator Jim Bunning of Kentucky. The proposal would “take away the free market and institute socialism in America”, he said.

Explore Economics

• Pre-Budget Report 2008

• Budget 2009

• World Economic Forum

• The Times MPC

Times Recommends

• C&G axed - 1,660 jobs to be lost
• UK house prices rise 1.1% as buyers return
• Mixed reaction to US banks repaying bailouts