US dollar holds global economy its hostage

By Michel Morkos

The dollar's depreciation against major currencies, then against all world currencies, imposes a burden on the world economy. It preoccupies the political and economic strategies in the developed world, in emerging nations, and in oil-exporting countries. Expectations by the World Bank, the International Monetary Fund, major central banks, and other economic analysts indicate that the American currency will continue to depreciate, at least until the end of the current year.

So far, it still remains unclear whether the weakness of the greenback is attributed to the US subprime mortgage crisis along with the ensuing consequences and repercussions for the international financial markets and the investment funds associated with major banks, or to the fact that the US administration has adopted a "secret" economic policy to target world economies. Regardless of the causes, it is impossible to overlook the cost of the US war in Iraq which has so far drained over three trillion dollars in financial resources spent on unproductive activities.

It also seems that the decline of the dollar has negative implications on three levels, not only on the US but also on the global economy. In the US, the weak dollar achieved a significant surplus in the trade balance deficit, a surplus that would have been impossible were it not for the mounting export of quality US goods to international markets at competitive prices. In addition, the appreciation of other currencies compelled institutions in the region and on the eastern coast of the Atlantic to invest in United States. These included Canadian institutions investing in the neighboring country, European institutions that see production in the United States a means to export and compete, and sovereign funds that struggle to enter the American economy where it hopes to find opportunities for future gains. The same applies to investment and hedge funds that wish to acquire institutions that have lost their capital and to bail banks with lost savings out, thus acquiring a stake in their assets and management.

While these changes in the US economy may lead to a recession, they are natural as part of the effort to achieve economic recovery in the foreseeable future, perhaps not more than a year. On the other hand, the Federal Reserve may face difficulties in other areas although it is worth noting that the geographic scope of recession, unemployment and other negative indicators only affect part of the United States and not the entire country.

However, the weakening dollar has caught both developed and emerging nations off guard, especially those whose currencies are tied or pegged to the US dollar with respect to transactions and upward or downward variations, or even with respect to modifications of US base interest rates. As far as these countries are concerned, the weakened dollar leads to rising inflation which expands at the expense of growth rates because every percentage point of inflation cancels one percentage point of nominal growth. Hence, as inflation increases, these nations are forced to double their economic activity to maintain high growth rates. The list of emerging economies facing this difficulty includes China, Russia, and India. Arab countries, especially the Gulf states, also face a similar situation, as their currencies are pegged to the dollar and their economies rely on exports. In these countries, inflation rapidly eats into the public budgets heavily dependent oil revenues.

The European Union and Japan remain wary of inflation and the need to maintain significant growth rates since the appreciation of the Euro and the yen puts their economies in a difficult position, especially as the financial crisis has hit major banking institutions and investment funds that until recently were immune to losses.

In the face of all this confusion, it is not known whether the world will seek to end its currencies' peg to the dollar or will continue to stay hostage to it.

In reality, the greenback constitutes the majority of reserves held by major central banks, accounting for 64.8% of these reserves against only 25.6% denominated in Euros, 4.7% in pounds sterling, 2.8% in yen, and 2.1% in other currencies. It is noted that the share of the Euro has risen from 19.7% in 2000. Moreover, between November 2001 and November 2007, the Euro appreciated from 0.88 to 1.47 dollar, i.e. a 67% increase in value. Despite all this, the dollar remains the "king" currency of reserves and transactions. For example, negotiations over primary food commodities contracts are concluded in dollars, and so is the case with mineral commodity contracts. The price of oil is also indicated by this falling currency. So are the prices of precious minerals. Even the invoices for the European Airbus planes are denominated in dollars. All this implies that the greenback remains strong although it seems that something is undermining its foundations.

The Central Bank of China has already started to cut its dollar reserves by turning to more stable currencies such as the Euro. Asian companies such as the South Korean Hyundai no longer accept contracts in dollars. The French company Arriva signed its contracts with China in Euro, and many Indian companies do not accept the American currency. Even professionals seem to be avoiding dealing in dollars.

On the other hand, the weakening dollar threatens institutions and economies as if it were a tool by the superpower to exercise pressure to force the world to become its partner in the current financial and economic crises. In the Euro zone, for example, exporting firms such as Airbus lose up to a billion dollars every time the Euro appreciates by ten cents, whereas importing companies cash massive gains of about 20% in comparison to their gains two years ago.

In France, the appreciation of the Euro has led to the loss of 30,000 jobs, forcing institutions to invest overseas. The protestations of the French President attracted the attention of the German government whose minister of finance joined in to protest as the German economy started to show noticeable slowdown. On top of this, the European Commission found itself forced to review its expected growth rates for the current year.

Oil-exporting countries have become more inclined to end their dealings in dollars. Until now, however, they continue to price in dollars with the exception of Iran and Venezuela. Some of these states continue to maintain the peg to the dollar, suffering heavy losses in the value of their income and their citizens' although part of these losses is compensated for by the rising oil price. These states are unable to shift to other stronger currencies such as the Euro because this would force them to bear the consequences of an appreciating currency as this has both positive and negative outcomes.

A weak dollar has divided the world into three camps; one that benefits from its depreciation; one that suffers; and a third that bears the burden of pegging its currency to the dollar. Many are incurring heavy losses, inflationary pressures, and an economic recession that reins in growth.


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Author`s name Alex Naumov