The Demise of the Dollar?
The United States Dollar has fallen to its lowest levels in fifteen years against a basket of six currencies. Things are so bleak that the Indian rupee is beginning to look like a viable reserve currency, a 'hard' currency. As a matter of fact, that's not a bad idea, but more on that topic later.
With the world's central bankers, including former Federal Reserve chairmen, trash-talking the US Dollar, it seems as if its days are numbered. With special friends of the United States like the Saudis indicating they might unpeg their currency from the dollar, it seems almost a done deal.
Wait, there's more. Kuwait became the first emirate to actually unlink it's currency from the USD in June, and Venezuela, the largest oil exporter in the Western Hemisphere said it would do the same yesterday for its investment accounts. Iran has abandoned the petrodollar entirely.The US Dollar flirted with Canadian loonie parity, and the euro, that strange animal, is at $1.40. The Indian rupee is close to the Rs 40/$ level, having broken through the psychological mark yesterday.
Were the US Dollar to lose its status as the 'world's reserve currency', it would be the largest financial shift since the end of World War II, and the subsequent agreements that established this position. The strength of the dollar was backed both by the relative size of the United States economy and by a collective willingness of export-oriented nations to fund American prosperity. It was also in effect, an 'oil-backed' currency, with oil revenues mostly counted in dollars the world over, even by putative enemies such as Iran. The US Government issued the greenback on the basis of fiat and extended its debt. US National debt today stands at over $9 trillion, approximately 6.5% of US GDP. It's near its federally mandated limit. 44% of the public debt is held by foreign entities, including central banks, with Japan and China at the top of the list.
Were the US government to pay down the national debt, it would contract the money supply, leading to US deflation. On the international front, however,which is the topic of this article, the decline of the US Dollar leads to a drop in value of foreign exchange reserves in USD terms, and impacts exports. While the strong dollar paid for US prosperity, and concomitantly, the prosperity of exporting nations, a falling dollar could lead to higher inflation both in the US and globally.
Alternatives to the US Dollar might seem obvious, such as the euro, but the strength of the euro relative to the dollar masks weakness in a number of European economies, ranging from Italy to Germany. Further, there have been significant property bubbles in most economies, from the United Kingdom to China and India. Iran mandated that its oil exports to Japan be paid in yen earlier this year, and the yen might appear a promising option, but the multi-year slump in the Japanese economy has left it fragile and prone to export-related shocks. The Nikkei is a volatile index, by any measure. China's size and growth seem to be able to accommodate global capital flows, but the Dragon is itself trying to push away foreign capital inflows so at not stoke already high inflation.
Inflation concerns are global. Beijing imposed a price freeze on all government-controlled prices recently in an attempt to stem anger over inflation, Saudi advisers said ``It's not necessary that there will be a de-pegging of the riyal from the U.S. dollar, not in the near future,...``The issue is that we have an abundance of liquidity in the economy.'' The latest wave has come from the $25 billion+ purchases of stakes in the NASDAQ and LSE by various emirates, including Dubai and Abu Dhabi.
USD-INR historical chart
India has not held back in its quest for financial domination, strange as that term might feel to those of us weaned on economics of scarcity and limitations. Apart from the much-publicized buyouts of a few foreign firms by Indian corporations, India has indicated a willingness to flex its naval muscle in pursuit of oil diplomacy. Venezuela has been a key business target, and India has also courted Cuba. China has not stood still, signing deals such as the $10 billion agreement with Caracas and numerous Africa-centric deals - many of which overlap with ONGC interests. India is in talks with Israel to induct defence systems such as the Barak missile, and the eponymously-named Israeli defence minister, Ehud Barak has planned a visit to India in October to discuss the same.
All of the following is speculative and open to dispute, yet one can look at various ways the current global economic crisis might play out.
To begin with, various salves and quickfixes might be applied by central bankers to defer the slide, and induce optimism in the global financial markets, perhaps by boosting the largely irrelevant stock markets through sweet-talking the banks. Liquidity concerns might ease, given the massive infusions of cash by the central banks, but this could lead to a renewed threat of hyper-inflation. If the Federal Reserve raises interest rates to attract foreign buyers, the US economy will almost certainly enter into a deep recession. Gold is already at historically high levels, and any additional economic shock might make it the default standard. The United States and other countries might choose to announce a return to the gold standard in this case.
The dollar's slide seems irreversible, and beyond a not-too-far point, numerous other currencies emerge as better-yielding zones to park oil and other global revenues. While this is not the place to debunk the already weak myth of a global clash of civilizations, the long term emergence of alternative economic zones is likely. One could be the Euro/Amero area, initially separated, but merging into a larger Western macro-economic zone. Another might evolve out of the Shanghai Cooperative Organization, with the rouble and yuan embracing each other, after a similar phase of antagonism. A third, as-yet unknown currency bloc could emerge out of the Islamic oil crescent, with the facade of religion and blending with the SCO to be at least as strong as the Euro/Amero zone.
That leaves the Indian sub-continent. A global economic shock might make the emergence of a subcontinental Confederacy almost necessary, and the Indian rupee itself becomes a tempting intermediate hard currency at levels of Rs 25/30 to the dollar, IMHO. Already, a global triangulated USD/INR/Yen carry trade has evolved in recent times. India might choose to continue its pretense of a non-aligned zone, but it must choose soon enough, and the options are to identify itself either regionally or with the Anglophone world, or perhaps, follow an imperialistic path.
Oil diplomacy can easily enough be replaced by gunboat diplomacy, and were the looming war clouds to materialize, it could accelerate events, with each economic zone being forced to take sides in a fight few really want, and leading to factional divisions even between friends.
The Demise of the Dollar?
- » Published on September 21, 2007
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