Will the Dollar Rebound and Appreciate?

The bearish development of the Dollar, the world’s primary and dominant reserve currency is something of a great concern. “The dollar slumped to a postwar low of 80.63 yen in April 1995, only to rally 26 percent in the following two years. The Dollar Index reached a 10-year low in December 2004 on concern the U.S. current-account deficit was unsustainable, then rebounded 13 percent in 2006.” The precipitous decline have not ceased in 2009.

Washington is not the only one that is concern with the continuous depreciation of the dollar but all nations that hold their reserves in dollars. Many countries including China, Japan, Gulf Arab nations and many others that aid to finance Washington deficit by buying treasury bills, notes and bonds are panicking because they do not desire to see their investments dwindle in value.

Many African and developing countries including Nigeria and many others held their foreign reserves in US dollars.

China among them is worried endlessly because of her over $800 billions of US treasuries in her holdings, Japan has over $700 billions and “The Gulf Cooperation Council (GCC) includes Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates (UAE). Together, these Gulf nations hold more than $2 trillion in U.S. dollar reserves.” Therefore these nations are not sitting down until their investments depreciate to nadir value. They are beginning to look to other currencies especially euro and other regional currencies to diversify their reserves. Lately “Central banks around the world increased their foreign currency holdings by $413 billion in the second quarter, the most since at least 2003, according to data compiled by Bloomberg News. But 63% of that new cash was put into currencies other than the dollar. That’s a record-high percentage for any quarter with more than an $80 billion increase in holdings. The dollar’s 37% share of new reserves is down from about a 63% average a decade ago.”

In as much that these nations should be pragmatic, they must be strategic in their reactions and understand that dollar is the most reliable, exchangeable and robust currency since the end of Second World War. And they must not forget that America is the most stable and largest economy in the world.

After the end of Second World War, America has become the dominant political, cultural and economic force on the global stage. America has truly become a super power nation and its industrial and economic activities/output surpassed any other on the face of earth. With that comes the emergence of the dollar as currency of choice for the world community. The primary currency of the globalized trading and commercial community was dollar. But at the dawn of 21st century America has become the largest debtor nation with explosive trade deficits of about 1.4 trillion dollars for 2009. America saves too little but spends and consumes too much without the resources to pay for it. And with that comes deterioration of the value of the dollar due to collapse of confidence among major trading partners and competitors.

Recently there was a sprawling on the pages of newspapers that some nations were gathering together to talk in a secret meeting about divesting and diversifying their investments away from dollar. According to The Independent Newspaper: “Gulf Arabs are planning – along with China, Russia, Japan and France – to end dollar dealings for oil, moving instead to a basket of currencies including the Japanese yen and Chinese yuan, the euro, gold and a new, unified currency planned for nations in the Gulf Co-operation Council, including Saudi Arabia, Abu Dhabi, Kuwait and Qatar. Secret meetings have already been held by finance ministers and central bank governors in Russia, China, Japan and Brazil to work on the scheme, which will mean that oil, will no longer be priced in dollars.”

Although the report was denied but the damage has been already done. For the first time Comex division of the New York Mercantile Exchange reported that an ounce of gold appreciated and climbed over a $1000 (One thousand dollars) mark and few days ago gold recorded it highest outing at $1,065.95 at London Bullion Market. Concurrently some holdings in dollars were being converted to euros and yen as dollar continue to depreciate in value. Adding to the momentum was the comment by Sha Zukang, UN undersecretary-general for economic and social affairs who said, “important progress in managing imbalances can be made by reducing the (dollar) reserve currency country’s ‘privilege’ to run external deficits in order to provide international liquidity,” at the yearly gathering of International Monetary Fund and World Bank conference at Turkey.

But the advantage for dollar is that many of these countries in the so-called “secret meeting” are American allies and have pegged their currencies to dollar. They may defer abandoning dollar due to geo-political calculus especially their efficient political and economic relationship with America.

Most of what is happening to dollar is both psychological and perception compounded with the market reality most especially with the state and management of dollar. “The value of any currency is ultimately determined by the supply and demand for that currency. And the problem for the dollar at the moment is that there is a much larger supply of dollars than there is global demand for them. The solution rests not in Manila, Bangkok or Paris, but in Washington. Start with dollar supply, which is entirely a function of America’s central bank, the Federal Reserve. The Fed has been flooding the world with dollars in the name of preventing a U.S. deflation after last year’s panic, and it shows no sign of tightening any time soon. Last week’s awful September jobs report convinced markets that the Fed will keep the money spigot wide open well into 2010. And yesterday, Richard Fisher, president of the Dallas Fed and thought to be a rare hawk on the Fed’s Open Market Committee, chimed in that no one at the Fed thinks this is the time to raise interest rates.”

America has a big trade deficit with many of her trade partners especially China and Washington has a debt of over $12 trillion dollars. Then coupled with the recession, Washington has to borrow and print more money to finance her deficit and pay for her stimulus bill. Many of these nations holding gigantic sums of dollar holdings desire that Washington can do something to get her financial house in order before the value of their holdings slip into oblivion.

Washington may hold a strategic mind-set that weak dollar is good for American economy for export. “The weakening dollar has raised concerns in U.S. trading partners because it makes it harder for them to sell goods in the U.S., the world’s biggest economy. It is feared a weak dollar could thereby undermine nascent recoveries in those countries.” But America must understand that manufacturing sector has virtually disappeared in the country. And overt weaken dollar may invite inflation as Washington might raise the interest rate for treasuries, notes and bills in order to sustain their demands. At same time overt stronger dollar will discourage export especially in America and countries that peg their currencies to dollar.

When Washington prints more money to pay her bills she summons the risk of flooding the market and circulation with more money thus initiating higher inflation and subsequently devaluing the dollar. Without further incentives the zero interest rate of treasuries may depress demand. With this possible scenario the Federal Reserve Bank will therefore increase its interest rate as inducements for the buyers of the treasuries. But that is not healthy for the financial market in America. With high interest rate the liquidity of market might dried up due to lack of credit. It may probably diminish further the economic activities and prolong the duration of the recession with unending unemployment problem.

Another issue contributi

ng to problem of dollar may be power status and struggle. Many of the emerging nations and powers including Japan, China, Brazil, Russia and the European block are seeking multipolar world, a world without a dominant dollar. They desire to embark on the so-called “basket of currencies” for trading and investments. Therefore the issue of weak dollar is not essentially the entire motivation for diversification. These emerging and regional powers want their respective currencies to be part of the action.

With necessary reduction in spending and increase in savings dollar will eventually rebounds and even appreciates. The greatest case to make to the world is that dollar has a universal acceptance. The world has come to be familiar with dollar in spite of its vulnerability which can be corrected with end of global recession. Washington can rise to the challenge of cutting her spending and reducing her appetite by paying her bills with accumulated savings rather with borrowed and printed money.

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