The Hindu : Opinion / Editorials : THE DOLLAR AND ITS SHAKY PEDESTAL

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Tuesday, Mar 29, 2005

Opinion

Opinion - Editorials

THE DOLLAR AND ITS SHAKY PEDESTAL

THE U.S. DOLLAR's pre-eminence that has remained unchallenged since the Second World War in global trade and commerce and in the currency markets is now under threat. It was after the 1944 Bretton Woods agreement that the dollar acquired an official status as the world's reserve currency, and it was able to play out this role effectively aided to a large extent by the U.S. Government guaranteeing full convertibility of dollars into gold at a fixed rate. Even after the gold backing was abandoned unilaterally in 1971, the dollar's supremacy prevailed on the strength of the U.S. economy and the geo-political influence of the government. It continues to do so: it is the reference currency in foreign exchange trading rooms; a large proportion of global trade, including the trade in petroleum in its entirety, is invoiced in the U.S. currency. It would have been unthinkable, until recently, for anyone even to suggest its decline. However that is precisely what is happening now, with more and more influential opinion across the world contemplating, if not advocating, a lesser role for the dollar.

The main reason for the drastic change in sentiment is, of course, the sustained fall in the value of the dollar in relation to major currencies since 2002. That has prompted debates on a number of issues including its role as the world's reserve currency. Recently Nobel Prize winner Joseph Stiglitz, who was a member of the Clinton cabinet and is currently a professor at Columbia University, predicted the end of the dollar as the world's reserve currency. Reserve currencies must serve the role of being a good store of value, he said. The dollar is no longer serving that function. From a European perspective those who deployed euros to buy dollar assets three years ago would have seen the value of those assets drop by 40 to 50 per cent in terms of their own currency. The apparent indifference of the Bush administration to the dollar's fall reinforces the negative sentiment on the currency.

The fact that the reserve currency nation continues to be the world's largest debtor certainly does not help matters. Ironically, the U.S. Government's record trade and budget deficits are bridged almost entirely by savings from abroad and investments by Central banks, mostly Asian. This has led to an unhealthy mutual dependence. Central banks in countries such as India and China mop up dollars to prevent their currencies from appreciating and making their exports uncompetitive. With a growing store of dollars, they chose the easy option of investing this in low-yield U.S. Government securities, thus helping fund the deficit. That cosy arrangement has now come under attack from a number of directions. The dollar's right to the status of a reserve currency can no longer be taken for granted. There is finally an alternative to the dollar with the euro bidding fair to become a reserve currency. Central banks including those in India and China have started deploying a portion of their reserves away from dollars and in euros and yen. The trend will gather momentum if even a part of the global petroleum trade starts getting invoiced in euros. There is speculation as to whether Russia will pull the trigger, closely followed by Iran and Venezuela. In India, tradition may still let the dollar retain its key position in foreign trade and remittances. But the developments abroad present an interesting opportunity to move away from this over-dependence on the U.S. currency.

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