Mr Dollar

While disposing off old papers, I came across a news report of August 2007 that Brazilian supermodel Gisele Bundchen refused to sign a dollar denominated contract with Procter & Gamble for representing Pantene hair products. She demanded that she should be paid in euros only. According to Forbes magazine, she is the highest paid model in the world and also the sixteenth richest woman in the entertainment world. She proved to be a shrewd analyst of US dollar. In another story, it was reported that some of the tourist sites, that used to demand payments in dollars, now started demanding that payments should be in local currency.

Why this loss of confidence in dollar? Even though dollar already lost nearly 36 percent since 2001, the biggest investors and most accurate forecasters say it will weaken further.
The US dollar’s decline since 2001 can be attributed to structural factors rather than cyclical. High dependence on oil has cost dearly. For the last several years, there is increasing demand for energy coming up from emerging markets, particularly China and India. This sustained demand for energy has been taking heavy toll on American economy. Secondly, US domestic saving rate has witnessed sharper declines in the same period, leading to deterioration of the US current account. The conviction that house prices will appreciate forever had lead lenders to extend loans without following the basic prudential norms of checking the credentials of borrowers, which eventually unfolded a crisis, whose end is not in near sight.

In the same period, Euro started showing its prowess as an alternative global currency demanding greater attention from the central bankers across the world. Some of the oil-rich countries are reported to be demanding that all contracts shall be in euro-denomination. While all this happening, US treasury and Fed Reserve remained as moot watchers to the on-going drama, giving rise to the impression that it is in the US interest to have dollar depreciate to make US exports cheaper and further demand for domestic manufacturing industry. Despite that, US goods cost a tad higher than that of emerging markets. Last but not the least important liability is the on-going low-intensity conflict in Afghanistan and Iraq, where US troops are deployed, proving to be a costly affair in terms of provision of funds.

What is the future of dollar then? Will it be able to regain its lost glory in the near future or fade away making way for an alternative currency to take its position? Or a basket of currencies rule the forex markets?

Jim Rogers, the author of ‘Hot Commodities’ says “The dollar is a terribly flawed currency and its days are numbered’. He cites the huge foreign held debt as the biggest cause. George Soros, one of the most intriguing and globally influential men of our time, goes a step further and predicts that the credit crisis would damage the dollar’s dominant role in the global economy. It is the end of a 60-year period of continuing credit expansion based on the dollar as a reserve currency. World’s richest investor Warrant Buffet is also quoted as saying in a CNBC interview that the dollar was destined to become worthless. He later corrected his statement saying what he really meant was that dollar is worth less.

Nearly two thirds of the world’s central-bank reserves remain denominated in dollars. Majority of the global trade transactions occur in dollar denomination, be it oil, gold, silver, sugar etc. China, largest economy in Asia, pegged its currency to dollar. Though Euro is the second most important currency, it is doubtful whether it would be able to emerge as a viable alternative to US dollar, given the slowing GDP rates among the EU economies. European financial institutions have been badly hit by the US sub prime housing crisis.
Though the US is yet to get rid of the sub prime crisis, the US economy’s intrinsic strength might come to its rescue in the short to medium term horizon. The immediate objective should be to focus on the macro economic fundamentals, uninfluenced by the movement of indices on the Wall Street and Forex markets.

The fact remains that strength of a currency is directly related to the strength of underlying economy. The need of the hour is to search for the refresh button. Depreciation of dollar vis-à-vis other currencies particularly those of emerging countries can be arrested in the near future if the US can cut down drastically some of the wasteful expenditure and allow foreign direct investment by sovereign wealth funds into corporate entities badly in need of equity/debt capital. Prudential norms shall guide the issuance of credit, rather than enthusiasm to invent newer and more complex credit derivatives packaged and marketed in a style depicting the Hollywood movie releases.

They say nothing is permanent. What goes up, comes down. American Dollar emerged as the global currency following the retreat of British Pound from the centre stage in the wake of World War II. British Pound remained as global currency for pretty long period till then.
Do we need a third world war to change the dynamics of the global economy? I don’t think so. If Central Bankers and oil producers decide to switch over to some other currency or a basket of currencies, then that will become a weapon of mass depreciation for Mr Dollar, making it worth less.