Jeffrey Garten: The Dollar's Scary Decline

Actually there are considerable advantages to a dollar decline. US debt in dollars will be paid off in less valuable dollars. This is what worries countries such as China that hold a lot of US currency. Exporters also benefit since their goods are cheaper in the global market. But for the average working person it means that prices of imported goods will increase as well as goods manufactured in the US that use foreign imported inputs. However, the points Garten makes are for the most part sound and no doubt many would agree with him. This is from the Daily Beast.


The Dollar's Scary Decline
Jeffrey E. Garten on the dollar’s coming decline—and the terrible ripple effects ahead.

Most analyses of the president's State-of-the-Union speech Wednesday night have dwelled on its potential impact on his electoral fortunes in 2010 and 2012 in the face of widespread angst in the country and political gridlock in Washington. But among the longer-term consequences of our political meltdown is something that could overshadow the fate of the stimulus, financial reforms, the wars in Iraq and Afghanistan, and the next presidential election itself: the slow but inexorable decline of the U.S. dollar. For over 60 years, the greenback has been the world's key currency, underwriting a good deal of American prosperity and influence in the world. Over the next decade, it will decisively lose its exalted status.

A permanently weaker dollar means that military commitments and foreign assistance will become much more expensive in real terms.
The dollar will be depreciating for a number of reasons. Foremost is our soaring budget deficit, well over $1 trillion annually; our ballooning national debt, which increased last year by a third to reach $7.6 trillion; and the inability of the political system to deal with the problem, which will only get much worse as 75 million baby boomers become eligible for Social Security and Medicare. On Wednesday night the president talked of freezing some domestic spending, but given how dramatically budget outlays have expanded these past few years, his initiative was at best symbolic. Mr. Obama said he would create a presidential commission to examine policy alternatives, but the recommendations will not bind the Congress. A day before, Congress refused to create a commission with teeth, the Republicans saying it was a stalking horse for higher taxes, the Democrats saying that the commission would aim to cut social programs.

The problem with a continuation of this farce, which has been going on in some form for years, is that our debt repayments will eventually be debilitating, causing us later this decade to borrow nearly a trillion dollars a year just to pay interest. We could of course throw ourselves into severe austerity to honor our debts, slashing spending and raising taxes to levels as yet not even being discussed by our politicians. But a politically easier way would be to devalue the dollar—perhaps by allowing more inflation—so we can pay our creditors in currency that is less valuable than it was when the debt contract was made. It is hard to believe there is any other outcome for our gutless political system than to choose the second way out.

Another reason why Washington will push the dollar south is that a weaker greenback will stimulate sales abroad by making them cheaper in world markets. In his Wednesday night address, the president pledged to double exports over the next five years, a massively ambitious goal. Unfortunately, the U.S. has little choice but to try, because the big surges in consumer demand are no longer in America but in countries like China, India and Brazil.

Beyond what the U.S. will do to depreciate the currency, some of our biggest creditors will also be looking to reduce their holdings of dollars—dumping them on markets and further eroding their value—because they will not want to hold a deteriorating asset. China, the single largest lender, has already been vocal about its concerns, but so has Pimco, America's largest fund specializing in bonds. The problem is that we need these lenders not only to keep up their lending but to vastly expand it.

Why does all this matter? A permanently weaker dollar means that military commitments and foreign assistance will become much more expensive in real terms. Everything we import from abroad—from oil, to food, to autos—will have a higher price tag, as foreign suppliers demand more dollars to compensate for its decline vis-a-vis their currencies. Since imports are so woven into the fabric of our economy, that, in turn, could unleash serious inflation. On the other hand, we could see a massive wave of foreign acquisitions in the U.S. as foreign companies, some government owned, will be able to purchase American companies and real estate at bargain basement prices.

You can debate all you want about the advantages and disadvantages of a declining dollar. But the question is no longer whether it will happen but rather when, and how. Thus, it pays to prepare. A change from a dollar-centric world to something else could create financial instability everywhere. To prevent that from happening, the U.S. should be working on designing a new rule-based global monetary system, in which the dollar plays a strong role alongside the euro and eventually the Chinese RMB, plus a new currency issued by the International Monetary Fund. Many American companies will do well to expand their operations overseas, where their earnings in foreign currencies can make them stronger and more profitable. Investors will need to diversify their assets internationally to a much greater extent than most have.

I'd much prefer to be predicting a strong dollar, one befitting a great nation on the rise. Right now, however, that seems like a hallucination.

Jeffrey E. Garten is the Juan Trippe professor of international trade and finance at the Yale School of Management.

For more of The Daily Beast, become a fan on Facebook and follow us on Twitter.

For inquiries, please contact The Daily Beast at editorial@thedailybeast.com.

The Dollar Doldrums.

Although there does not seem to be any new unit yet central banks are diversifying into other existing currencies and no doubt a lot are buying gold as well. Gold is reaching new highs recently and shows no sign of going below the one thousand dollar mark in US funds. This is from Bloomberg. Or own Canadian dollar will soon be at par with the US and the New Zealand and Australian dollar are strong as well.

Dollar Reaches Breaking Point as Banks Shift Reserves
By Ye Xie and Anchalee Worrachate
Oct. 12 (Bloomberg) -- Central banks flush with record reserves areincreasingly snubbing dollars in favor of euros and yen, further pressuringthe greenback after its biggest two- quarter rout in almost two decades.Policy makers boosted foreign currency holdings by $413 billion lastquarter, the most since at least 2003, to $7.3 trillion, according to datacompiled by Bloomberg. Nations reporting currency breakdowns put 63 percentof the new cash into euros and yen in April, May and June, the latestBarclays Capital data show. That’s the highest percentage in any quarterwith more than an $80 billion increase.World leaders are acting on threats to dump the dollar while the Obamaadministration shows a willingness to tolerate a weaker currency in aneffort to boost exports and the economy as long as it doesn’t drive away thenation’s creditors. The diversification signals that the currency won’trebound anytime soon after losing 10.3 percent on a trade-weighted basis thepast six months, the biggest drop since 1991.“Global central banks are getting more serious about diversification,whereas in the past they used to just talk about it,” said Steven Englander,a former Federal Reserve researcher who is now the chief U.S. currencystrategist at Barclays in New York. “It looks like they are really backingaway from the dollar.”Sliding ShareThe dollar’s 37 percent share of new reserves fell from about a 63 percentaverage since 1999. Englander concluded in a report that the trend“accelerated” in the third quarter. He said in an interview that “for thenext couple of months, the forces are still in place” for continueddiversification.America’s currency has been under siege as the Treasury sells a recordamount of debt to finance a budget deficit that totaled $1.4 trillion infiscal 2009 ended Sept. 30.Intercontinental Exchange Inc.’s Dollar Index, which tracks the currency’sperformance against the euro, yen, pound, Canadian dollar, Swiss franc andSwedish krona, fell to 75.77 last week, the lowest level since August 2008and down from the high this year of 89.624 on March 4. The index, at 76.104today, is within six points of its record low reached in March 2008.Foreign companies and officials are starting to say their economies aregetting hurt because of the dollar’s weakness.Toyota’s ‘Pain’Yukitoshi Funo, executive vice president of Toyota City, Japan-based ToyotaMotor Corp., the nation’s biggest automaker, called the yen’s strength“painful.” Fabrice Bregier, chief operating officer of Toulouse,France-based Airbus SAS, the world’s largest commercial planemaker, said onOct. 8 the euro’s 11 percent rise since April was “challenging.”The economies of both Japan and Europe depend on exports that get moreexpensive whenever the greenback slumps. European Central Bank PresidentJean-Claude Trichet said in Venice on Oct. 8 that U.S. policy makers’preference for a strong dollar is “extremely important in the presentcircumstances.”“Major reserve-currency issuing countries should take into account andbalance the implications of their monetary policies for both their owneconomies and the world economy with a view to upholding stability ofinternational financial markets,” China President Hu Jintao told the Groupof 20 leaders in Pittsburgh on Sept. 25, according to an English translationof his prepared remarks. China is America’s largest creditor.Dollar’s WeightingDeveloping countries have likely sold about $30 billion for euros, yen andother currencies each month since March, according to strategists at Bank ofAmerica-Merrill Lynch.That helped reduce the dollar’s weight at central banks that report currencyholdings to 62.8 percent as of June 30, the lowest on record, the latestInternational Monetary Fund data show. The quarter’s 2.2 percentage pointdecline was the biggest since falling 2.5 percentage points to 69.1 percentin the period ended June 30, 2002.“The diversification out of the dollar will accelerate,” said FabrizioFiorini, a money manager who helps oversee $12 billion at Aletti GestielleSGR SpA in Milan. “People are buying the euro not because they want thatcurrency, but because they want to get rid of the dollar. In the long run,the U.S. will not be the same powerful country that it once was.”Central banks’ moves away from the dollar are a temporary trend that willreverse once the Fed starts raising interest rates from near zero, accordingto Christoph Kind, who helps manage $20 billion as head of asset allocationat Frankfurt Trust in Germany.‘Flush’ With Dollars“The world is currently flush with the U.S. dollar, which is available at nocost,” Kind said. “If there’s a turnaround in U.S. monetary policy, therewill be a change of perception about the dollar as a reserve currency. Thediversification has more to do with reduction of concentration risks ratherthan a dim view of the U.S. or its currency.”The median forecast in a Bloomberg survey of 54 economists is for the Fed tolift its target rate for overnight loans between banks to 1.25 percent bythe end of 2010. The European Central Bank will boost its benchmark a halfpercentage point to 1.5 percent, a separate poll shows.America’s economy will grow 2.4 percent in 2010, compared with 0.95 percentin the euro-zone, and 1 percent in Japan, median predictions show. Japan isseen keeping its rate at 0.1 percent through 2010.Central bank diversification is helping push the relative worth of the euroand the yen above what differences in interest rates, cost of living andother data indicate they should be. The euro is 16 percent more expensivethan its fair value of $1.22, according to economic models used by CreditSuisse Group AG. Morgan Stanley says the yen is 10 percent overvalued.Reminders of 1995Sentiment toward the dollar reminds John Taylor, chairman of New York-basedFX Concepts Inc., the world’s largest currency hedge fund, of the mid-1990s.That’s when the greenback tumbled to a post-World War II low of 79.75against the yen on April 19, 1995, on concern that the Fed wasn’t raisingrates fast enough to contain inflation. Like now, speculation about centralbank diversification and the demise of the dollar’s primacy rose.The currency then gained 26 percent versus the yen and 25 percent againstthe deutsche mark in the following two years as technology innovationincreased U.S. productivity and attracted foreign capital.“People didn’t like the dollar in 1995,” said Taylor, whose firm has $9billion under management. “That was very stupid and turned out to be wrong.Now, we are getting to the point that people’s attitude toward the dollarbecomes ridiculously negative.”Dollar ForecastsThe median estimate of more than 40 economists and strategists is for thedollar to end the year little changed at $1.47 per euro, and appreciate to92 yen, from 89.97 today.Englander at London-based Barclays, the world’s third- largestforeign-exchange trader, predicts the U.S. currency will weaken 3.3 percentagainst the euro to $1.52 in three months. He advised in March, when thedollar peaked this year, to sell the currency. Standard Chartered, the mostaccurate dollar-euro forecaster in Bloomberg surveys for the six quartersthat ended June 30, sees the greenback declining to $1.55 by year-end.The dollar’s reduced share of new reserves is also a reflection of U.S.assets’ lagging performance as the country struggles to recover from theworst recession since World War II.Lagging BehindSince Jan. 1, 61 of 82 country equity indexes tracked by Bloomberg haveoutperformed the Standard & Poor’s 500 Index of U.S. stocks, which hasgained 18.6 percent. That compares with 70.6 percent for Brazil’s BovespaStock Index and 49.4 percent for Hong Kong’s Hang Seng Index.Treasuries have lost 2.4 percent, after reinvested interest, versus a returnof 27.4 percent in emerging economies’ dollar- denominated bonds, MerrillLynch & Co. indexes show.The growth of global reserves is accelerating, with Taiwan’s and South Korea’s,the fifth- and sixth-largest in the world, rising 2.1 percent to $332.2billion and 3.6 percent to $254.3 billion in September, the fastest sinceMay. The four biggest pools of reserves are held by China, Japan, Russia andIndia.China, which controlled $2.1 trillion in foreign reserves as of June 30 andowns $800 billion of U.S. debt, is among the countries that don’t reportallocations.“Unless you think China does things significantly differently from others,”the anti-dollar trend is unmistakable, Englander said.Follow the MoneyEnglander’s conclusions are based on IMF data from central banks that reporttheir currency allocations, which account for 63 percent of total globalreserves. Barclays adjusted the IMF data for changes in exchange rates afterthe reserves were amassed to get an accurate snapshot of allocations at thetime they were acquired.Investors can make money by following central banks’ moves, according toBarclays, which created a trading model that flashes signals to buy or sellthe dollar based on global reserve shifts and other variables. Each tradetriggered by the system has average returns of more than 1 percent.Bill Gross, who runs the $186 billion Pimco Total Return Fund, the world’slargest bond fund, said in June that dollar investors should diversifybefore central banks do the same on concern that the U.S.’s budget deficitwill deepen.“The world is changing, and the dollar is losing its status,” said AlettiGestielle’s Fiorini. “If you have a 5- year or 10-year view about thedollar, it should be for a weaker currency.”

The Slow Death of the US dollar

This comes from aribisto. . This is a good companion analyses to the Dwyer article that I posted earlier and provides more data and also explores further the reasons why the dollar might decline even more and be replaced in some areas. However, I think it would be premature to predict the demise of the US dollar any time soon.

Dr. Aref Assaf



The Slow Death of the US Dollar

December 03, 2007 10:11 AM



"The dollar is falling" was the cry of Iran's President at a recent OPEC meeting. Many OPEC members are now publically expressing their grave concerns about the dramatic decline of the value of the U.S. dollar. In fact, some members are publically calling for depegging from the dollar, the


use of other currencies in which to sell their oil. For OPEC, the issue is the substantial decrease in the value of their huge financial reserves which are denominated in U.S. currency. There is also the recognition that huge investments in foreign companies in the U.S. do not create local wealth; and with the weakening of the American dollar, the value of such investments is rapidly eroding.

While free market economists have their theories about the fall of the dollar, I would argue that the unprecedented rise in the Euro's value to the U.S. dollar is another facet of the Bush administration’s failed Iraq Policy. Bush’s unilateral and antagonistic policies may have perhaps irrecoverably debased the dollar as the world’s currency. If OPEC were to decide to accept the Euro for its oil, then American economic hegemony would be irreversibly challenged. “If one day the world’s largest oil producers demanded euros (sic) for their barrels, it would be the financial equivalent of a nuclear strike”. Bill O’ Grady, A.G. Edwards

Iraq, which has the second largest oil reserve in the world after Saudi Arabia, has been a major US concern since the start of the Bush administration, and indeed earlier. Iraq’s total reserves could be 200 billion barrels or even more, and all of it can be easily and cheaply extracted. Because the US is the world's largest consumer of oil and its appetite is growing because of its standards of consumption, it needs control over the oilfields of the Middle East.

The U.S.'s policy, however, is not premised on controlling oil for its domestic consumption. More importantly, it wants to also deny this control to the other world economic powers - the European Union, China, Japan. Driven by both strategic imperatives and reasons related to energy security, the US wants to ensure that Europe's access to oil will be routed through American-controlled pipelines.

Indeed, broadly speaking, the war in Iraq was directed as much against major powers in Europe as Iraq, a fact to which the "old Europe" of Chirac and Schroeder were quite alert. As in the case of Caspian oil, the US wants to deny Iraq’s oil to China as well, which has a quickly increasing need for imported crude. Since America perceives China as its potential rival in establishing a secure and dynamic global system under its own control, this is quite a significant reason for the Bush administration’s persistence to keep China out of the oil regions of Eurasia.

There were many motives related to the Iraqi oil justifying the Bush administration's military intervention in Iraq. But the biggest one seems to be about the currency used to trade oil: the role of preserving the dollar as the world’s reserve currency.

The United States' status as the unrivaled global superpower has rested on two unchallengeable pillars. First, the overwhelming US military superiority over all other rivals; second, the control of global economic markets with the dominant role of the US dollar as reserve currency. Reserve currencies are held by governments and institutions outside the country of issue and are used to finance international economic transactions, including trade and the payment of debts. Reserve currency status is not just an international status symbol. It brings international seignior age, benefits for ‘home’ financial institutions, relaxation of the ‘external constraint’ on macroeconomic policy, a greater role for the issuer in international institutions, and the wider geopolitical consequences of exercising currency hegemony.

However, this all changed in 1971 when president Richard Nixon took the dollar off the gold standard that has been agreed to at the Bretton Woods Conference in 1944. Thus, the dollar has been an irredeemable currency, no longer defined or measured in terms of gold. This removed the restraints on printing new dollars. The dollar has become the world’s dominant currency and the core reserve asset of central banks all over the world. It has replaced gold as an international currency. Central banks around the world have built up large reserves of dollars. Those dollars flow back into the US banking system in the form of investments in US dollar-denominated assets.

The dollar hegemony is key to the future of American global dominance, in many respects as significant if not more so, than the overwhelming military strength. And the petrodollar has been at the heart of the dollar hegemony since the early 1970s. Almost two-thirds of the world's currency reserves are kept in dollars, because oil importers pay in dollars and oil exporters keep their reserves in the currency they are paid in. The entire global oil trade is conducted in dollars. This means that everyone needs to keep dollars. This effectively provides the American economy with an interest-free loan, as these dollars can be invested back into the U.S.A. with zero currency risk. This money is not inactive; it is invested in dollar securities like US Treasury notes, stocks, mutual funds, and bonds. The US dollar's current strength is supported by OPEC’s requirement that all OPEC oil sales be denominated in dollars. This was secured by an agreement between the US administration and Saudi Arabia, the largest OPEC oil producer. This had been determined in June 1974 by Secretary of State Henry Kissinger, establishing the US-Saudi Arabian Joint Commission on Economic Cooperation. In 1975 OPEC officially agreed to sell its oil only in dollars.

America today practically borrows from the entire world without keeping reserves of any other currency. Because the dollar is the de facto global reserve currency, the US currency accounts for approximately two-thirds of all official exchange reserves. America does not have to compete with other currencies in interest rates; even at low interest rates, capital flies to the dollar. The more dollars there are circulating outside the US, the more the rest of the world has had to provide the US with goods and services in exchange for these dollars. The fact that the world uses the currency in this way means that the US is importing vast quantities of goods and services virtually for free. The US has a luxury of having its debts denominated in its own currency. This is the position the US has enjoyed for 30 years. It means that the US has been afforded a huge subsidy from everyone else in the world. The United States economy is, therefore, intimately tied to the dollar's role as reserve currency. The dominant position of the US dollar in world markets is not only a matter of pure economics, but also “deeply rooted in the geopolitical role of the United States.”

Until the advent of the Euro in late 1999 there was no potential challenge to this dollar hegemony in world trade. The coming of the Euro has threatened the dominant role of the US dollar as reserve currency. Some European leaders have even said that the Euro's main aim is to put Europe on an equal monetary footing with the United States - ending the dollar's 'hegemony,' in the word of former President Jacques Chirac of France.

In just a few years, the Euro has emerged as a real alternative to challenge the dollar. It has established itself as the second-most important currency in the world’s financial markets. Just before the introduction of the Euro, the outstanding amount of bonds and notes denominated in the legacy currencies of the Euro accounted for barely 28% of world issues, compared to 45 % for dollar-denominated bonds and notes. By mid-2007, the gap became much smaller: the share of issues in dollars had fallen to 32 %, while the Euro’s share had increased to 51 %. And even more spectacular development took place on the money market. At the end of 1998, money market instruments denominated in the Euro’s predecessor currencies accounted for just over 17% of world issues, compared to 58 % for dollar denominated instruments. By mid-2007, the share of issues in dollars had fallen to 19%, while the share of Euro issues had climbed to almost 61%. The Euro today accounts for over one quarter of the global market.

Iraq was the first OPEC country, in November 2000, to convert its reserves from dollars to Euros. This was the first time an OPEC country dared violate the dollar price rule. Iraq also converted $10 billion of its currency reserves to Euros. Since then the value of the Euro has increased, and the dollar has begun to decline. Libya has been urging for some time that oil be priced in Euros rather than dollars. Iran, Venezuela, and other countries have begun to denominate their petroleum trade in Euros. In 2002 the majority of reserve funds in Iran's central bank had been shifted to Euros. Some in Saudi Arabia have called for switching to the Euro as “a more effective punishment [than an oil embargo] for the United States, Israel’s principal source of financial and political support”. Russian President Vladimir Putin has threatened to price its oil in Euros as well. Since the oil trade is a central factor underpinning the dollar's hegemony, all these are potentially very significant threats to the strength of US economy in particular, and the US global hegemony in general.

With a significant part of the petroleum trade using the Euro instead of dollars; many countries would have to keep a part of their reserves in Euros. The dollar would then have to compete with the Euro for global capital. Not only would Europe not need dollars anymore, but Japan (which imports more than 80% of its oil from the Middle East) would have to convert most of its dollar assets to Euros. The US, too, being the world’s largest oil importer would have to get hold of Euro reserves. This would be disastrous for the American attempts at monetary management. Not only they would lose a large part of their annual subsidy of effectively free goods and services, but the switch to Euro reserves from dollar reserves would bring down the value of the US currency. Even a modest shift out of dollars, or a change in the flow, would create significant changes. If the Euro becomes a bigger reserve currency [i.e. if the US were to share its reserve currency status with the Euro] it is also likely to mean that either the US buys more Euros or the Europeans reduce their dollar holdings and buy Euros.

That is why there is a clear and definite oil (and petrodollar) connection in the recent military conflict in Iraq. This financial dimension is a power game of the highest geopolitical significance. The future of the dollar/ Euro competition to be the global reserve currency is far from a minor issue of interest only to banks or currency traders. A hidden war between the dollar and the new Euro currency for global hegemony corresponds to two different perceptions of the global order: Pax Americana, or the American Century model of global hegemony on one hand; and to balance the overwhelming dominance of the U.S. in world affairs on the other.

Consequently, the war in Iraq is a war whose purpose is much bigger than fortunes of Halliburton or Exxon: it's a long term and a strategic objective being fought to maintain America's position on top of the world.