Decline Of The Us Dollar

Ever since the Second World War, US dollar has been the primary international currency of the world. However, now there are voices raising concern over the future of the dollar, the loudest of which have recently come from China. The unsustainable levels of US indebtedness and its trade deficits are also endangering the role of US dollar as international currency.


The possible decline of the dollar associated with a slowing of US economy is being increasingly perceived as the single biggest threat to the global economic stability. The importance of dollar for the global economy, derives itself partly from the role

of US as the biggest engine of global economic order today, accounting for nearly 30% of world GDP. However, equally important is the role of US dollar as the single most important international currency, which in turn, is largely due to the belief that it is the most stable and reliable currency, and hence the best alternative for all those who want to store their wealth in a particular currency, as well as those who wish to do business at least currency risk.

Fears of Significant Decline of US Dollar

The origins of the fear of significant decline of dollar arise primarily from the perpetually inflating current account deficit of the US economy, rising to over 6% of its GDP last year. So far this deficit has been financed by the capital inflows, largely from the same countries with which the United States has a trade deficit. The Middle East countries, exporting larger amounts of petroleum at ever increasing prices, account for the largest chunk of this imbalance. The other major imbalance arises from East Asia, primarily China, whose trade surplus with US has been over $250 billion and is expanding further, leading to current on-going efforts of US-Chinese economic dialog. So far, the Middle East and China have indirectly financed this deficit by buying dollar denominated securities in US, including treasury bills, but the clouds of uncertainty hang over their willingness to do so in future, particularly if there are fears of a decline of the US dollar. Even more fearful is the possibility that in order to mitigate their losses arising from the decline of the US dollar, these economies may try to shift to assets denominated in another currency like Euro, which may actually create a very strong signal for a lot of other investors to exit and the resultant mayhem may actually send the dollar packing, hurting in turn probably everybody in the world including those who may cause its decline in the first instance.

An Unsustainable Situation & the Gravest Dangers

To say it simply, the persisting US current account deficit is not sustainable, in the opinion of most experts and commentators. Some authors have tried to use the 'Net International Investment Position' (NIIP), which is a measure of the total indebtedness of an economy to the rest of world, to show that a current account deficit of more than 3 to 4 % GDP may not be sustainable in the long run. In other words, if the US economy continues to have such large trade deficits, sooner or later, we may witness a dramatic decline of US dollar that could be detrimental to the global economy.
Unfortunately, the bigger problem of petrodollar induced trade deficit has so far been overlooked by the advisers

of US government, primarily under the belief that it is a temporary phenomenon. The failure of the official machinery to grasp the importance of oil, and forecast its prices may be indicated by the fact that the Energy Information Administration (EIA) of US Government had to revise upwards the long term projected oil prices frequently during the last few years. Still, most experts believe, largely on false hope, that oil will not play a great role in future. It is here that the biggest dangers of future imbalances lie.

The Role of Self Fulfilling Expectations

Another important ill understood phenomenon pertains to the self fulfilling role of expectations in the economy, particularly important when it comes to foreign exchange rates. Asian financial crisis was a classical example of this phenomenon. Simply put, if you expect a currency to decline, you exit from it. When a lot of people do that there is lesser demand and higher supply of that currency and it actually goes down providing proof of the validity of the expectation, thereby inducing many more to do so, resulting in the self-fulfilment of expectation of a crisis. Therefore, it is very important that expectations of decline of dollar are prevented from being exaggerated. Unfortunately, some experts have been trying to create this threat of decline of dollar to garner support for the US demands on China and other East Asian economies for appreciation of their currencies. In the process they are also exaggerating the probability of decline, which may create an expectation of decline and itself pose a greater threat than any real current account deficit.

US is still the central fulcrum of global economy, and dollar denominated assets dominate in the US wealth. So actually there should be no reason for assessing the stability of US deficits by NIIP, because all the US assets are liquid, unlike assets of any other country in the world. Therefore, its capacity to endure imbalances is also much larger. In may be a big mistake to exaggerate the possibility of decline, and this mistake may prove to be costlier than any real imbalance related to economy.

The Future Outlook

Among the measures that US government had attempted to counter this threat so far, is to pressurize China to allow its currency, the reminbi, to appreciate, as per the market forces. So far, China has controlled the dollar-reminbi exchange rate through interventions of its Central Bank which buys dollars in the market to maintain its foreign exchange rate, leading to a burgeoning foreign exchange reserve to levels unprecedented in world history, and something almost unimaginable till a few years back. The attempts of US government have resulted in very little so far, and given the current geo-political situation and China's aspirations to establish itself as an economic superpower, are unlikely to bear fruits in the future either. The efforts by US administration seem to be based on their much more successful use of the same strategy with Japan, but then in today's world, China and Japan are not at all similar, when it comes to pressure by US.

Article Written By V Kumar

I am a freelance writer. I write for the passion of writing. Life has blessed me an opportunity to be a witness to many interesting aspects of life and people around the world. Indeed, these are very interesting times and we who live in this era are privileged to experience it. You can find my articles at

Last updated on 28-07-2016 179 0

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