–The Euro...The New World Currency?
 

U.S. dollar dangles in the dust
By Paul Heise Saturday

The talk on the street -- Wall Street -- is all about the falling U.S. dollar.

It now takes $1.34 to buy one euro when, four years ago, you could buy one euro for 82 cents. Why is this happening, and do we have a problem?

The dollar is falling because America is spending too much and saving too little. The rest of the world is lending America almost their entire savings so that it can cut taxes, have wars of choice and continue it's binge consumption on their goods.
 

The U.S. is living off the world's savings, and the falling dollar shows it is tiring of it all.

While it is costing more, a lot more, for Americans to travel abroad, that is trivial. Long run, we could see a a fall-of-Rome type meltdown of the dollar and the whole financial system. That is not trivial.

We have been here before. As in 1972, America is bogged down in an uncertain war in Asia, the national debt is soaring and America is buying internationally far more than it can pay for. The U.S. now owes the rest of the world a net $2.6 trillion, an increase of $1 trillion in the last four years.

In 1972, the outflow of dollars led to the collapse of the international financial system, with exploding interest rates and runaway inflation. We had stagflation for the rest of the decade.

It is all happening again, only this time it will be much worse because America and the dollar are far more important than they were then. This time, the dollar could also collapse.

The dollar has become the world's currency. Foreign governments hold $2 trillion in dollar assets as reserves. The dollar is also the medium of exchange for all world sales in oil and most commodities. A large portion of world exports are denominated in dollars. No one has any idea how many dollars are actually out there sloshing around the world.

We do know that the total is increasing at the rate of $600 billion a year. America is undermining the world's currency like it was the peso of some banana republic.

Alan Greenspan, chairman of the Federal Reserve, has acknowledged that at some point this outflow has to end. He has even said that if you don't hedge a long-term falling dollar, you want to lose money.

But it isn't just Greenspan and Wall Street. Russian President Vladimir Putin announced that Russia is likely to switch some of its reserves from dollars to euros. The Japanese and Chinese central bank authorities talk about 'flexibility,' and the dollar drops another notch because they mean they may stop supporting the dollar. Individual Chinese investors are lining up to dump dollars.

Up until 2001, foreigners saw America as a good place to lend money because they thought they would get a good return. Since then, private investors began to have doubts. They cut their lending, and Asian governments, for political and not profitability reasons, took up the slack. The Chinese and other Asian exporters did this because they did not want to see a weak dollar.

Put yourself in the place of the Chinese. They want to sell their clothing, trinkets and TVs as exports to the United States because that creates jobs in their economy. A weakening dollar means Chinese goods become more expensive in America. Exports from China to America could drop sharply, and China would go into a recession.

The Chinese are avoiding a recession and perhaps a worldwide depression by buying up excess dollars and thereby supporting the value of the dollar. The fate of the United States, and the fate of the world, is in the hands of the Chinese.

The Chinese central bank and the U.S. Federal Reserve are in what has been called a dance of death, in that sometime there has to be a reckoning. The dollar has to fall; the question is how far and how fast. The longer we wait, the worse it will be.

The world waited on the presidential election. Now the president has specified his priorities for his second term, and he made no strong statement about getting the U.S.'s financial house in order. Rather, he proposed a Social Security plan that will require an extra trillion dollars of borrowing, a tax reform that is revenue neutral and tax cuts made permanent. The world is not reassured.

The real difference is that in 1972, there was no alternative to the dollar. Now there is the euro. People who do not want to lose money are hedging -- selling dollars and buying euros. When everyone agrees that there is one side of the boat to be on, everyone has a problem.

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The writer , Paul Heise, a resident of Mt. Gretna, holds a Ph.D. in economics and is professor emeritus of economics at Lebanon Valley College. He can be reached at: heise@lvc.edu