The dollar is considered one of the soundest currencies in global commerce. Nations often buy dollars as an investment when they want to find a safe place to park their savings. This has kept the demand for the dollar high and has given U-S policy makers a great deal of flexibility in managing domestic economic affairs. But the dollar is losing its luster and for the first time is faced with a strong competitor, the euro. Some say the greenback is at a turning point and could forfeit its status as the dominant currency for global reserves.
“Gates and Buffett bet against the dollar” read headlines when two of the world’s richest men, Bill Gates and Warren Buffet, recently decided to trade billions of their dollar assets into euros and other foreign currencies. Microsoft chairman Gates and renowned investor Warren Buffett, say that they expect the dollar to extend its three-year drop because of widening U.S. trade and budget deficits. Since January 2002 the dollar has fallen 33 percent against the euro and the United States trade deficit ballooned over 24 percent to a record $617 billion in 2004. Like the two American corporate titans, central banks around the world are also eyeing ways to move away from the dollar. A recent survey of 65 central banks showed that most of them plan to shift between 20 to 30 percent of their dollar assets into euros. They jointly hold reserves of well over two trillion dollars.
The world’s central banks buy US currency to boost their own reserves and thereby support their currencies. But with the falling dollar they suffer substantial losses. Some economists say the dollar’s preeminence is at risk. Pam Woodall, an editor of the British magazine “Economist”, in a recent interview noted the dollar is failing to fulfill the main functions of a global currency.
“A reserve currency is meant to be a secure store. But the dollar has already fallen, and it could fall further. A reserve currency should be backed by sound economic policies. The fact that the United States has been running a current account deficit and has what I would call an unsustainable fiscal policy is not a good background from which you run a reserve currency. But most important of all, the main reserve in the world has been a net creditor. America is now the world’s largest net debtor country,” says Ms Woodall.
Christian Weller of the Center for American Progress agrees there is a general sense that America is profligate, that it spends more than it has. "We have trade deficits approaching six percent of the domestic gross product. Many crisis countries have had trade deficits much smaller before they entered a crisis. So financial markets are worried if the U-S will be able to repay all the debt it is amassing. Central banks are showing reluctance to continue to finance massive borrowing by the U-S government. They have been moving out of the dollar into other currencies, and they have made their reluctance clear by not showing up to treasury auctions.
To cover its over $600 billion trade deficit, the US economy needs an infusion of at least $1.8 billion a day, says Mr. Weller. He adds that if central banks stop buying large amounts of American treasury bonds or begin a quick divestment of American IOU’s, the U-S economy could sustain a major blow. But Irwin Staltzer of the Hudson Institute says this is not the first dollar decline. During the Reagan presidency it fell 40 percent, yet bounced back. The strength and resilience of the American economy make it the best place for investment, says Mr. Staltzer.
"Remember our economy is growing faster than other economies. Companies here are awash in cash, likely to increase dividends and you see this huge wave of merger deals. The latest figures on investment flows show they have increased to America. Where else would you put your money? So long as the American economy grows, it will continue to attract capital."
The euro is still too young a currency, says Mr. Staltzer and there is too many uncertainties about the functioning of European institutions. The 12 states that make up the eurozone have trouble maintaining a single fiscal policy.
“If you have a uniform monetary policy with one interest rate for all countries, that puts an enormous strain on fiscal policy, and I am not so sure that you can sustain this one interest rate fits-all countries position. Remember we have had other monetary unions in countries that have not worked. That would be a long-term worry if I were a central banker”.
Still, Mr. Staltzer, like other analysts, acknowledges we are in uncharted territory when the world's reserve currency has so much outstanding debt.