Currency: Does US Dollar Deserve To Be Strong?

This article is written by Abd Ghani Hamat. He shares his view on why US Dollar remains strong despite a faltering economy and what the reality may potentially unfold.

"The poignant reminder simply won’t go away. Last week, investors bracing for a global recession traded the US dollar to two-year highs against major currencies except the yen. In fact, the British pound suffered its biggest one-day percentage drop on Friday since September 1992, Reuters reported.

It’s unsettling to note that the greenback had firmed up against the likes of euro and sterling even after the US financial system has hit the rocks, dragging down the world with it.

Why has the world continued to accept an artificially strong dollar and not let it slide? It’s untenable. Sooner or later, the dollar will find its true value.

The world will wake up one day and realise that the game is up; it cannot continue to prop up a currency whose country has run up a federal deficit of almost US$1 trillion (RM3.53 trillion) or 7.5% of GDP in a single year and national debts of US$10 trillion.

It’s not right for the world’s biggest debtor to have a strong currency. A time will come when the greenback will be subject to the same argument that resulted in Argentina, for example, devaluing its peso by 30% in 2002.

The only reason the dollar has remained strong — as the whole world is aware by now — is that too many countries have too much money to lose on a cheap dollar.

A sudden withdrawal of the foreign money, which had been a big contributor to the steady appreciation in US asset prices, would lead to massive writedowns and losses. But what is the point of holding on to assets and securities that have shrunk to a fraction of their values with no guarantee whatsoever of their restoration in the foreseeable future?

The situation in the US is truly dire.

Federal Reserve chairman Ben Bernanke, in explaining the US$700 billion bailout package last week, said: “If we don’t do this (bailout), we may not have an economy on Monday.”

The general consensus in the country is that the financial meltdown has not played out fully, and main street is bracing for the impact at any time.

“Wealth has eroded enough that you will see some changes in the US style of living,” reads a comment on a US investing website. Of course, there are also less savoury comments, like the one calling for a lynching of Wall Street barons.

But why is the world ignoring US economic fundamentals and continuing to have confidence in the dollar? After all, the writing has been on the wall for the longest time.

In March 2006, the UNDP’s International Poverty Centre issued a report saying “the growth of the US economy since the 1990s had relied on sucking in foreign savings at an alarming rate”.

Terry McKinley, the author of the report titled The monopoly of global capital flows: Who needs structural adjustment now?, said the inflows of capital into the US were almost twice as large as the amount needed simply to finance its current account deficit.

He said this implied that the corresponding capital outflows from the US were almost the size of the current account deficit itself.

“This suggests, in turn, that capital inflows are not only financing excess consumption by US citizens but also reciprocal investment by US private investors abroad.

“In other words, central banks in other countries are helping subsidise US foreign investment and profits.”

Sobering thought. The rest of the world had helped the US become a monster!

Now, the question is, are central banks the world over helping to keep the dollar artificially high to give themselves time to unwind their positions in the US? For, surely the world has realised that it is doing itself a lot of disservice by backing a declining world economic power. If that is the case, the dollar is due for a very rough ride.

But where do you put the money, or what’s left of it, that you pulled out of the US? Where ever it is, I suppose, it should be a major consideration in all this talk about a new global financial architecture.

It is important to note that the decline in US financial strength has coincided with the emergence of new global economic powers in the likes of China, India, Brazil and Russia. Not only have the new economic powers eroded the dominance of the US and Europe in world economy, they are also transforming the flow of trade and capital.

As we look to contain the impact of the looming global recession at home, we simply cannot ignore the changing economic landscape.

While we keep a close watch on commodity prices, we must note that the world post-recession will not be so West-centric as it is. Therefore, efforts to contain the immediate impact of a global financial turmoil should not be at the expense of finding our rightful place in world economy later on.

No doubt, with so many new economic powers about, it would be harder to carve a market niche. That’s why we should start ridding ourselves of the inefficencies and set proper goals now.