Sunday, March 9, 2008

Decline of the American dollar

Fiscal policies over the years take toll on the greenback

The days when the greenback ruled with absolute supremacy and simultaneously commanded the unparalleled confidence of chiefs of international and domestic financial institutions along with the man in the street in the remotest parts of the planet are over. The American dollar is no more “The Currency” that can be relied on for value, as was evident by a recent CNN news clip showing an antique store in New York preferring Euro over the local currency.

Since World War II, when the American dollar started replacing gold as a means of transaction on the international level, the dollar has taken some hard knocks in recent years.

With the launch of the Euro nearly a decade ago, much was written in the pro-dollar media and EMU, as the Eurozone is called, and it was compared with the “EMU,” a bird that cannot fly. But then, compared to the launch and subsequent drop as the nascent currency took baby steps, the Euro has come of age and has crossed the threshold One Euro=USD 1.5 plus. And the dollar has also lost against the other leading currencies, like the Japanese Yen and British Pound.

With the way things are going, one must understand why and when the American dollar got to that place on the pedestal. Only then does it become clear what is happening now. As mentioned earlier, a walk down memory lane shows that till World War II the exchange rates of major currencies were reflected in terms of the price of gold in the respective countries, but with the manipulation of costs of other goods then, gold was a growing discomfort among trading partners across the globe, and the dollar came as a suitable solution.

World War II ended with the emergence of the United States as the dominant military and economic powerhouse, and as countries gathered to this epiccentre for military and financial support, the dollar emerged as the financial powerpoint of the financial world.

With the issuing of US government securities there was an added charm of earning interest over dollar deposits.But to the discerning eye, there was a Catch-22 situation that stayed afloat all these decades - and still is. The use and abuse of the technical term “Balance of Payments” was so rampant by the US that one shudders to look at the figures over the years. The United States consumed more than it produced, financing the payments with printed paper and all had been well till 1971 arrived.

The US devalued the “International Currency” unilaterally. Internationally-held dollar reserves overnight lost value and that was quite a hard knock for some of the poor countries of the world.Five years later, in 1976, came the Jamaican Agreement that gave the financial world a floating exchange rate system where the markets started playing a lead role.

But again, it was not a free float and, instead, government intervention in the form of buying and selling determines the final results at the end of the day.With the arrival of the Euro in the world F/X (foreign exchange) market scene, things started changing.

And let us not forget that the Euro has replaced 15 European currencies, and some of them, like the German mark, French franc and Italian lira were backed by strong economic and industrial giants of the world.

With the Euro surging not only in value but also as a dependable currency, the world commodity markets, especially relating to oil, will start contemplating a switch to the Euro to protect themselves against instability or the falling dollar.

The US administration will definitely want to sabotage such a move by hook or crook as its financial survival depends on the role of dollar as a legitimate international currency. Now, a look at what is really going on behind the scene.

US statistic reports have repeatedly shown the American C/A (current account) deficit has expanded continuously with billions in fiscal deficit.With China shifting some of its foreign reserves into Euro, there is already a warning ringing for the United States as more countries shift to Euro; more falls in the dollar will result.

Add to those factors the role played by the locomotive economies of Asia including China and India growing by leaps and bounds in the current years. But the financial mechanism needed to keep the dollar at a price that will sustain the US C/A deficit without putting pressure on its import/export ratio, which in turn enhances or erodes the lifestyle of its citizens, will not garner support internationally over a long-term period and US will have to pay the price at some point.