Doomsday for the US Dollar: Post Mortem for the World’s “Reserve Currency”
by Mike Whitney
December 14, 2010
Paul Volcker is worried about the future of the dollar and for good reason. The Fed has initiated a program (Quantitative Easing) that presages an end to Bretton Woods 2 and replaces it with different system altogether. Naturally, that’s made trading partners pretty nervous. Despite the unfairness of the present system–where export-dependent countries recycle capital to US markets to sustain demand—most nations would rather stick with the “devil they know”, then venture into the unknown. But US allies weren’t consulted on the matter. The Fed unilaterally decided that the only way to fight deflation and high unemployment in the US, was by weakening the dollar and making US exports more competitive. Hence–QE2.
But that means that the US will be battling for the same export market as everyone else, which will inevitably shrink global demand for goods and services. This is a major change in the Fed’s policy and there’s a good chance it will backfire. Here’s the deal: If US markets no longer provide sufficient demand for foreign exports, then there will be less incentive to trade in dollars. Thus, QE poses a real threat to the dollar’s position as the world’s reserve currency.
Here’s what Volcker said: “The growing sense around much of the world is that we have lost both relative economic strength and more important, we have lost a coherent successful governing model to be emulated by the rest of the world. Instead, we’re faced with broken financial markets, underperformance of our economy and a fractious political climate…..The question is whether the exceptional role of the dollar can be maintained.” (Bloomberg)
This is a good summary of the problems facing the dollar. And, notice that Volcker did not invoke the doomsday scenario that one hears so often on the Internet, that China–which has more than $1 trillion in US Treasuries and dollar-backed assets–will one day pull the plug on the USA and send the dollar plunging. While that’s technically true, it’s not going to happen. China has no intention of crashing the dollar and thrusting its own economy into a long-term slump. In fact, China has been adding to its cache of USTs because it wants to keep its own currency weak and maintain its hefty share of the global export market. Besides, China didn’t become the second biggest economy in the world by carrying out counterproductive vendettas against its rivals. It’s going to stick with the strategy that got it to where it is today.