The recent crisis in Europe seems to have done the US dollar a favor. The fall of Euro and the problems in Euro zone mean that those who view Euro as a viable alternative to dollar will need to think again. Maybe, the dollar will reign supreme for a while, before it is challenged again by another currency.
The threat of declining US dollar
The possible decline of the dollar associated with a slowing of US economy is being increasingly perceived as one of the biggest threats to the global economic stability. The importance of dollar for the global economy, derives itselfpartly 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.
The current global economic crisis has magnified this risk many folds, and the latest developments in Europe have only reaffirmed the position of US dollar as the only international currency in the world. The million dollar question that seems to be on everyone’s lips is this – Can we say that the US dollar is safe now ?
What threatens the dollar ?
The origins of the fear of significant decline of dollar are rooted primarily in the perpetually inflating current account deficit of the US economy, that crossed 6% of its GDP during the last few years. So far this deficit has been financed by the capital inflows, largely from the same countries with whom there exists the trade deficit. The Middle East countries, exporting ever larger amounts of petroleum, accounted for a major of this imbalance. The remaining of this deficit arose from trade with East Asia, primarily China, whose trade surplus with US had actually begun to approach the trillion dollar mark before the strong winds of sub-prime crisis restrained it a bit. This has become a major issue in the US-Chinese relations and if no headway is made in recent future, as looks likely, there may be a lot more headlines on this account in future.
Till some time back, the Middle East and China were indirectly financing 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 due to the on-going crisis and especially if there are fears of a decline of the US dollar. Even more fearful was 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.
Among the measures that US government had attempted tocounter 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, which has now crossed the $ 2 trillion mark and is likely to keep growing further, something 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.
Fortunately, the bigger problem of petrodollar induced trade deficit has been mitigated to a considerable extent after the fall in crude prices. Yet, trade deficit with OPEC countries remains a persistent problem for the US trade account, and the failure of the official machinery to grasp the importance of oil, and forecast its prices may again aggravate the trade imbalances threatening the health of US dollar.
The Crisis in Europe removes Euro from the scene
However, the developments in Europe during the last few months have been the brightest spots in the profile of US dollar, as it has for all practical purposes ascertained the supremacy of the US dollar in the international currency market. Till last year, Euro was the only currency capable of challenging the dollar. Today, even the survival of Euro seems uncertain. The greatest challenge to dollar has disappeared from the scene without a fight !
Can there be any other challenger ?
Which will be the next currency to challenge the dollar, if there is one ?
In all probability, it will be the Chinese Renminbi. Strange as it may seem, like the Chinese economy during the last two decades, the Chinese currency has also been riding the US dollar for ensuring its stability, and without letting off the fixed exchange rate-glued to the dollar, both the Chinese economy and the Chinese currency has been creating a significant niche for itself in the global market. Recently, Pakistan joined a long list of countries willing to trade with China using Chinese currency. The day is still far when the Chinese economy will overtake that of the United States, but the current crisis has given China an opportunity to establish itself as the future global economic engine in more ways than one.
So, as things stand today, US dollar appears unchallenged for a while. We can wait for the next round, and in the meantime, see how China prepares for it.