Before one starts composing a eulogy for the U.S. dollar, it pays to make two distinctions: 1) There's a difference between the dollar's decline and a collapse. 2) Any move away from the dollar as the world's reserve currency must include a credible replacement for it.
True, the dollar on Wednesday did weaken to a 14-month low versus the euro, to $1.4913, but investors should keep in mind that this comes after the dollar had risen about 20% versus the euro, pound and yen from mid-2008 to March 2009. Further, as Financial Times Columnist Martin Wolf points out, little occurred during the financial crisis' acute stage suggesting that a credible, universal effort is at work to abandon the dollar. On the contrary, during the horrible period of low banker-to-banker confidence, investors piled into the dollar on a flight to safety, driving its value up during the worst of times.Moreover, with confidence and perhaps the global economy now growing again, that money is starting to do what you'd expect it to do, Wolf says: flow out of the dollar and into higher-risk/higher-return investments. Hence, the recent dollar weakening is a positive development for the global economy, Wolf notes. The move also returns the dollar's value basically to where it was before the financial crisis.
And please don't confuse the above with "a collapse of confidence in the dollar." Of course, if one's sole source of information is the sometimes overdramatized and superficial analysis presented on 24-hour cable news networks, it's easy to see how one could conclude that the dollar's demise is imminent.
Instead, when investors see headlines on the TV news crawler like, "Is The Dollar Done?" or "Russia, China Want To Dump Dollar," they should ask themselves: What are these nations going to replace the dollar with? What will be the new, global reserve currency? These question don't have a quick and easy answer.
That's because the reserve currency isn't just a unit of account, a store of value, and a medium of exchange. It also must have a sovereign behind it that protects the value of money over time, that does not have a history of seizing assets, that's committed to the rule of law and to some universally agreed-to concept of fairness, and that has an independent judiciary or adjudicator powered to decide and reprimand when violations of the rule of law/fairness occur. So far, no such institution or regime exists in international relations. Quite possibly, the International Monetary Fund, with a system of special drawing rights, could play this role, but the world isn't there yet.
OK, so we're not going to see a "world currency" replace the dollar as a global reserve currency any time soon. But aren't major central banks around the world, along with institutional investors, reducing their dollar reserves and increasing their holdings of other, major currencies, such as the euro, British pound, Japanese yen and Swiss franc? Fine. That's just a sign that investors have confidence in these currencies as reserve currencies, as well. And a world where the euro, pound, yen and franc are accepted everywhere is a very liquid world -- and that's a very good thing for commerce and international trade.
Furthermore, wouldn't it be great if some day we could get to a point where the Russian ruble and numerous currencies from other regions (Latin America, Middle East, Africa) are as hard and as widely accepted as the dollar, euro, pound, etc. Imagine what that would say about the rule of law, monetary institutions and the judiciaries in these countries?
Finally, what about inflation? Well, what about it? Wolf incisively points out that investors in the U.S and elsewhere should cheer the appearance of mild inflation in the U.S. The immediate (and more serious) danger to the U.S. and global economies, given excess capacity, is deflation, not inflation.
An uptick in inflation implies an increase in aggregate demand, which is economicspeak for more people buying things, more businesses investing and eventually, more companies hiring. This is what one wants to see, particularly with a U.S. unemployment rate nearing 10 percent.
So don't despair over the dollar's value today. It's far from the catastrophe that lots of alarmists would have you think.
Intro to economics. But fun.View Course »