A Crisis Candidates Don't Want to Talk About
By Maggie Mahar
A recent Bloomberg News story highlights a moment in a video for the movie ``American Gangster,'' where hip-hop maestro Jay-Z thumbs through a wad of 500-euro notes on a night of cruising the concrete canyons of New York City. Of course he can’t spend Euros in Manhattan, but the scene says something about the value of today’s greenback.
The Bloomberg piece on the dollar's decline begins by reminding us just how cavalier the U.S. was in 1971 when President Richard Nixon, in a stopgap move to cope with the inflationary financing of the Vietnam War, announced that the dollar would no longer be backed by gold: ``It may be our currency, but it's your problem'' was Treasury Secretary John Connally's taunt when the U.S. unhooked the dollar from the gold standard in 1971, unilaterally rewriting the rules of world business in America's favor.
Now Bloomberg notes, “the world is taunting back. Almost four decades after the U.S. tore up the monetary arrangements that governed the post-World War II international economy, the dollar's fall from grace amounts to a tectonic shift in the global hierarchy. This time, the U.S. currency is on the losing side.
“After declining in five of the last six years, the weakest dollar in the era of floating currencies reflects a period of diminished U.S. political and economic hegemony. Whoever wins the White House next year will confront two unpopular choices: Accept the fall in U.S. clout and the rise of new rivals, or rein in record public and consumer debt that the rest of the world no longer wants to bankroll.”
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Put simply, a new administration faces two choices: Accept the fact that the U.S. dollar is a declining currency, which means accepting the reality that all imports, including oil , will become more and more expensive. Or, raise interest rates---which will make the dollar more attractive to foreign investors who buy our Treasuries. But higher rates also will make it that much harder both for U.S. consumers and for the government to pay off the heap of debt that has been keeping this country afloat.
Stepping back and surveying what has happened both at home and abroad in recent years, some observers doubt that the dollar will ever recover: “For the first time,” Bloomberg reports, “economists are raising the once-improbable specter that the dollar's monopoly as the world's dominant reserve currency is under threat. "'Part of the depreciation is permanent,’ Harvard University professor Kenneth Froot, who has been a consultant to the Fed, told Bloomberg: `There is no doubt that the dollar must sink against periphery currencies to reflect their increase in competitiveness and productivity.’''
Meanwhile, for years, we have depended on foreigners to buy our dollars (by investing in Treasuries) in order to finance our trade deficits and a national debt of more than $9 trillion. When other countries use their surpluses to buy Treasuries, they are lending us money at a very low rate. If they buy a 10-year U.S. Treasury Bond, we pay them just 4.5 percent. Yet we need them to keep on buying those bonds: the U.S. still requires $2.1 billion a day of other people's money.
But now even our allies are beginning to feel less confidence in the dollar as the world’s reserve currency, and many are beginning to move away from the greenback.Consider what is happening in the Middle East: “Kuwait, freed by the U.S. from Saddam Hussein's army in 1991, unhinged its currency from the dollar in May, and pressure is building for Gulf Arab neighbors to follow suit.” Bloomberg notes. “Qatar's prime minister, Sheikh Hamad bin Jasim bin Jaber al-Thani, complained Nov. 11 that the dollar's drop is cutting oil and gas income, leaving less to invest abroad. The United Arab Emirates may drop the dirham's peg to the dollar, analysts said.” Even “The central bank in Iraq, last month said it, too, wants to diversify reserves away from mostly dollars. “
As for countries that are less fond of us: Just five days ago, Iran and Venezuela proposed discussing an end to the practice of pricing crude in dollars at an Organization of Petroleum Exporting Countries summit in Riyadh, Saudi Arabia. Bloomberg reported that Saudi officials rejected the suggestion.
The Iranians were not happy. "'They get our oil and give us a worthless piece of paper,' complained. Iranian President Mahmoud Ahmadinejad on Nov 18 in Riyadh. 'The dollar has no economic value.’'' That day the dollar touched down at $1.4814 per Euro—a low for the dollar since the Euro was started in 1999.
Meanwhile, cash-rich countries like China—which has piled up the world’s largest stash of foreign currencies-- are looking for investments that pay more than the current 4.25 percent return on 10-year Treasury Bonds. “A warning by Cheng Siwei, vice chairman of the National People's Congress, that China will invest its $1.4 trillion in stronger currencies triggered a recent stampede out of the dollar,” Bloomberg notes, quoting economists at UBS AG who say that China doesn’t have to dump dollars to depress the greenback. Accumulating dollars at a slower pace will have the same effect.
Finally, Bloomberg cites economists at Merrill Lynch & Co. estimating that as much as $1.2 trillion in dollar holdings will shift to other currencies in the next five years. ``The global reserve system is fraying; it's falling apart,'' Nobel-laureate economist Joseph Stiglitz told a Bloomberg seminar last month in Tokyo. ``The change in mindset about the use of the dollar in reserves and the movement of the dollar out of reserves will continue to exert downward pressure.''
The flight away from the dollar is feeding on itself. This is a crisis that few presidential candidates want to talk about, but it is something that the next administration will be forced to address.