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Is the Dollar’s Reign Over?

November 30, 2010 by · Leave a Comment 


The greenback is still the world’s reserve currency of choice. Much of the world is rooting for its dominance, but the Fed wants to bring it down. Here’s what’s at stake.

By Anthony Mirhaydari
MSN Money

It’s become somewhat of a national pastime to worry about the fate of the U.S. dollar. After all, the greenback is down 35% from its 2001 high. And it’s down more than 52% from the all-time high it reached in 1985.

These concerns have found new life recently in the wake of the Federal Reserve’s decision to print an additional $600 billion under the guise of a second round of “quantitative easing” — dubbed QE2 — following last year’s $1.7 trillion money-drop operation designed to kick the economy into gear.

Since Fed Chairman Ben Bernanke first alluded to QE2 back in August, the dollar has lost nearly 7%, posting all-time lows. Investors were driven to move assets away from the dollar out of fear that Bernanke, who has a fanatical focus on fighting deflation, would follow the steps he outlined in a 2002 speech by printing excess money to devalue the dollar and push inflation higher.

The international community was outraged; it has a vested interest in a strong dollar. Leaders at this month’s G-20 meeting in South Korea– a financial conference of the 20 largest economies in the world — railed against the Fed’s move.

The ongoing crisis in the eurozone has helped the dollar regain some ground on other currencies over the last two weeks, but many questions remain. Will the Chinese target our currency in a trade war? Will the euro, backed by the hardcore inflation hawks at the European Central Bank, replace the dollar as the world’s reserve currency of choice? Do we need a radical move, like a return to the gold standard?

More generally, there is a nagging fear that the dollar is losing its place in the world as it comes under attack from enemies at home and abroad. So is the dollar dying? And if it is, is that a problem?

How a strong dollar has helped you

The simple fact is that Americans have benefited greatly from the dollar’s role as the global reserve currency. Such status funnels the world’s savings into the country, keeping interest rates lower than they would be otherwise. One study found that foreign purchases of U.S. Treasury debt — the preferred investment for idle dollars — reduced long-term interest rates by about 1%.

This may not seem like much, but consider this: The Fed’s epic $1.7-trillion money-printing operation last year is believed to have shaved only 0.5% off interest rates. The $600 billion QE2 operation likely will accomplish even less.

These actions subsidized all manner of credit-based spending, both by the government (President George W. Bush’s tax cuts, President Barack Obama’s stimulus package and the accumulation of the $13.7 trillion federal debt were all enabled by overseas savings held in U.S. dollars) and by households (foreign demand for mortgage-backed securities powered the housing boom and bust). So the dominant dollar helped the average citizen enjoy an era of low taxes, cheap credit and heady government spending.

The new reality

The pressure to end this era will only increase as France assumes the chairmanship of the G-20. French President Nicolas Sarkozy wants to have a serious discussion on the future of the international monetary system. He has frequently spoken out against the dollar’s status as the world’s reserve currency and its role in contributing to global credit and trade imbalances — factors that contributed to the 2008 credit crisis.

In Sarkozy’s words, “what was true in 1945 can no longer be true today,” referring to the post-WWII agreements known as Bretton Woods. That system secured the dollar’s role as the linchpin of the global exchange-rate system.

The simple truth, according to Barry Eichengreen, a University of California at Berkeley economist and an expert on the global monetary system, is that our multipolar world — with China and a unified Europe becoming more assertive — will eventually be matched by a multipolar currency system. And in his mind, this would be a better system than we have now.

But the realization of this vision depends on many things and won’t happen overnight. So for now, the dollar’s place is secure. But that means problems as well as benefits for the U.S.

Still the one

The dollar remains the global reserve currency of choice, thanks to the deep and liquid U.S. financial markets, as well as its dominant position in global trade.

One study, which looked at Canadian imports between 2002 and 2009, found that 75% of imports from countries other than the United States are paid for in U.S. dollars. A recent survey by the Bank for International Settlements found that the dollar was used in more than 86% of all foreign exchange transactions worldwide, a small decrease from just over 88% in 2004. Roughly 45% of all international debt securities are denominated in dollars. And of course, the Organization of Petroleum Exporting Countries (OPEC) continues to price its oil in dollars.

But the biggest reason for the dollar’s dominance, and the main reason up-and-coming nations like China won’t wage war against it, is because of the massive buildup of dollars in cash reserves around the world. According to Societe Generale estimates, the developing world has amassed nearly $6 trillion in reserves, with the advanced economies accounting for an additional $3 trillion. A majority of this is held in dollars.

According to the International Monetary Fund, the dollar’s share of official foreign exchange holdings through the beginning of the year stood at 61% — compared with 66% in 2002-2003. But if you go back and compare to the early 1990s, the dollar’s share has actually risen.

Nations like China, Brazil and Germany have another big reason to support a strong dollar: it keeps their exports cheaper than those of their U.S. counterparts. Much of the reason the European debt crisis subsided over the summer was because a devalued euro boosted the fortunes of German exporters.

So the chance of a disorderly plunge in the dollar is very remote, because the major economic powers have an interest in protecting it. In fact, the most likely path forward is a continued, if short term, increase in the greenback’s value based on rising concerns about European debt and efforts to fight inflation in China.

Fear factor

I wrote about the subject this time last year under similar circumstances, just before Dubai got into trouble for lending too much money against boom-era real estate projects in the Persian Gulf. ”Soon after, the world’s attention focused on Europe’s PIIGS — Portugal, Italy, Ireland, Greece and Spain — which were similarly vulnerable after years of credit-fueled overinvestment and government largesse.”

At the time, when the dollar like now was trading near all-time lows, I said that “during the next calamity, we will be reminded of just how secure the dollar is. There will be no place to hide except real cash, and the world’s investors will frantically buy dollars to unwind their risky positions.”

The dollar subsequently gained more than 12% as the eurozone crisis and May 6 “flash crash” on Wall Street incited a rush into dollar-denominated safe haven assets. A repeat looks very likely now.

With Ireland joining Greece in the European Union bailout club — and with all eyes now on Portugal and Spain — the dollar should gain ground against a weakened euro in the months to come. The worry is that deep and painful austerity measures being forced on bailout recipients could result in political turmoil and exits from the eurozone, which will destabilize the euro. There are also concerns that Germany, tiring of funding its spendthrift neighbors, could restore the deutschemark and leave the euro. Adding to the chorus of concerns are efforts to fight QE2-induced inflationary pressures in places like China, South Korea and Australia.

But these are short-term issues.

Over the long term, the current foreign-exchange apparatus is unwieldy. America is simply unable to generate the volume of currency and debt instruments demanded by a fast-growing global economy (something known by economists as the “Triffin dilemma”). Further, the natural rebalancing of the U.S. economy away from debt-fueled, import-driven consumption and toward savings and exports will require a less prominent role for the dollar. Here’s why:

Fun while it lasted

A French politician once said that the United States enjoys an “exorbitant privilege” in its ability to print and distribute the world’s reserve currency. We can, at essentially no cost, print paper money with which to buy natural resources from Brazil, high tech goods from Japan and manufactured wares from China. No other country can do this like we can.

But this privilege has encouraged excessive risk-taking, excessive debt and under-saving, and has also fueled the housing bubble by keeping credit too cheap. Further, it has emaciated our manufacturing sector by making imports too cheap and exports too expensive. All of this must change if America is to return to the path of sustainable economic growth.

There are two ways out of this: Either the U.S. dollar must depreciate by about 25%, according to Socieite Generale estimates, which would be enough to close the current account deficit, or the savings rate must rise to 7.5% from 5.3% now. A mix of the two, say a 10% drop in the dollar and a 6.5% savings rate, would accomplish the same goal.

So it is in our collective interest to have a weaker dollar. Ben Bernanke himself alluded to this problem of current account imbalances being fueled by the dollar-based monetary system in a Nov. 19 speech. In his words, the current system “has a structural flaw” in that it isn’t flexible enough. As of last year, the currencies of 54 countries were pegged to the dollar.

The chatter on Wall Street is that the real goal of QE2 wasn’t to lower borrowing costs to businesses and consumers, but to force the dollar lower and get the process of economic rebalancing started. The end game, according to Eichengreen, is a world where the dollar plays a much smaller role.

Multipolar world

In his forthcoming book, “Exorbitant Privilege,” Eichengreen provides an excellent review of the dollar’s rise to power and previews its fall from grace. Once upon a time, when Japan and Europe were in ruins following World War II, he believes it made sense for the dollar to dominate international monetary and financial affairs. But now, in an increasing multipolar world with power centers in Europe, Asia and South America, such a raison d’être no longer applies.

The future, according to Eichengreen, will likely be made up of an informal system in which the major currencies share regional reserve currency roles: the yuan and the yen in Asia, the euro in Europe and the dollar in the West. He admits there’s work to be done before this can become reality. Europe needs to clean house and China needs reform. And the United States, in order to secure its position, needs a credible medium-term plan to tackle its fiscal problems and reduce its debt burden.

The current tensions over global imbalances stem mainly from the fact that our WWII-era global currency system is no longer suitable for today’s globalized economy. And that means that for all our sakes, the dollar must lose its crown as the king of currencies — despite the pain that may entail, and the blow to American pride.

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Misplaced gold found by highway patrol

November 30, 2010 by · Leave a Comment 

Pakistan's National Highways & Motorway Police N-5 Central patrol officers have successfully returned a substantial amount of gold to its rightful owner.
The Business Recorder reports how highway patrol officers discovered 300,000 rupees' worth (£2,250) of gold in a lost bag.
The news feeds on this site are independently provided by Adfero Limited © and do not represent the views or opinions of the World Gold Council.

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Rare coins to go on show in Pune

November 30, 2010 by · Leave a Comment 

An exhibition of rare coins is due to get underway in Pune this week, reports DNA India.
From December 3rd, Coinex – Pune commences with two rare examples from the coronation ceremony of Maratha warrior Chhatrapati Shivaji among those going on display.
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Traditional Krugerrand kicks off Salvation Army season in Aurora

November 30, 2010 by · Leave a Comment 

Each year, one-ounce gold Krugerrand coins are donated to the Salvation Army, reports the Chicago Tribune.
The traditional donation appears in collection kettles each season – and nobody knows who puts it there.
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Gold hunters ‘must know where to shoot’

November 30, 2010 by · Leave a Comment 

The old adage that "X marks the spot" may not be so far from the truth in terms of gold-hunting.
According to one Floridian treasure hunter, metal detectors are only half of the solution to finding dubloons and trinkets beneath the sand or hidden at the water's edge.
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Quenching the thirst for gold in Kalgoorlie

November 30, 2010 by · Leave a Comment 

Sydney Morning Herald columnist Max Anderson wrote this week of his trip to Kalgoorlie after the local newspaper, the Kalgoorlie Miner, reported the discovery of a 23.26 kg gold nugget there.
He travelled by train, in the hope of capturing some of the spirit of 1917, when east-coasters journeyed to Australia's own Wild West on the trail of a hidden fortune.
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Recycled gold ‘main supply’ for Bangladesh

November 30, 2010 by · Leave a Comment 

Bangladesh's jewellery industry relies primarily on recycled gold to provide the bullion needed to create new items, reports the Daily Star.
According to the publication, the main source of the precious metal in the country is drawn from previous creations which are melted down and returned to a usable raw state.
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Gold coin donated to charity Christmas appeal

November 30, 2010 by · Leave a Comment 

A rare coin expert launched a charity drive by placing a gold coin into a Salvation Army Red Kettle during a meeting for Bell Ringers.
Orange County's Record Live reports how Michael Fuljenz donated a one-ounce American Eagle valued at $1,400 (£900) to the cause.
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Rare gold antiques to feature in New York display

November 30, 2010 by · Leave a Comment 

A collection of antiques featuring rare gold pieces from the Far East are to go on display in New York next spring.
The Early Chinese Metalwork in Gold and Silver and Works of Art of the Ming and Qing Dynasties exhibit will showcase items dating from the Tang period (618-907 AD), Art Daily reports.
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‘Give gold coins’ as wedding gifts

November 30, 2010 by · Leave a Comment 

Gold has been described as the best wedding gift by one newlywed, who said it allows couples the chance to purchase things in their own taste.
Speaking to the Times of India, Sarthak Gupta explained how she believes coins made from the precious metal will often be better received by people than traditional western presents such as items for the home.
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