KoreaToday Dollar Losing Ground As Financial Crisis Evolves
‘Pax Dollarium’ on Decline
By Kim Tae-gyu
Staff Reporter
Suppose there is a household in which dad and mom are the highest earners in town. They are living in a posh mansion heavily guarded, thus getting respect and jealousy at the same time from neighbors.
But the thing is that the wealthy household is sure to spend much more than they earn while making ends meet through borrowing a huge amount of money.
The affluent way of life has been supported by debts for decades. Deficits are supposed to snowball and the household must head toward bankruptcy. But they manage to hold up as next-door people continue to lend money.
What's wrong with the neighbors? How are they certain that they will be able to recoup the loans? Are they forced to lend as the household in question constantly meddles in other homes based on its machine gun?
Not really! There lurks a genuine secret behind the scene ― the household has equipment in its basement to print the paper money. In other words, they can simply print money to redeem maturing debts.
Real World
In the real world, the household is the United States in the eyes of some economists who believe the nation is losing its ground and so is its currency ― the dollar.
Indeed, the U.S. is suffering from a ballooning amount of liabilities as its national debt amounts to more than $10 trillion at the moment. This is equal to approximately two thirds of its Gross Domestic Product (GDP), which burdens each American citizen with about $35,000.
The U.S. adds several billion dollars everyday to its debt total and the pace is likely to accelerate as the world's biggest economy eyes to implement gigantic stimulus packages against the financial crisis based on debts.
This earns the country a moniker of the ``Empire of Debt,'' the terminology that William Bonner and Addison Wiggin coined in their book of the same title.
The two financial analysts predicted that the U.S. empire built on debt would dwindle and the superior position of its currency in transactions ― dubbed ``Pax Dollarium'' ― will also vanish because of the chronic ailments of high indebtedness.
U.S. Dollar Index
Indisputably, the ballooning debts are caused by the double deficits in the federal budget and in the current account.
``The U.S. has chalked up several hundred billion dollars in annual trade deficits over the past years,'' said Lee Sun-yup, an analyst at Goodmorning Shinhan Securities.
``The fiscal deficit, which emerged in the early 1980s, also came to the fore in the 21st century again after the U.S. government cut taxes while increasing spending,'' he said.
According to the Congressional Budget Office, the U.S. budget deficit is projected to exceed $1 trillion this year even without taking into account the country's recently-announced stimulus initiatives.
As a result, the total federal government debt, which stood at $5.7 trillion in 2000 and surpassed the $10 trillion plateau in 2008, is likely to match the country's GDP of around $14 trillion in years to come.
Conventional wisdom states that persistent twin deficits and the resultant debts will eventually lead to currency devaluation. Hence, the dollar should depreciate in theory.
There is a measure to gauge how the value of the dollar changes, dubbed the U.S. Dollar Index (USDX), which estimates how much the dollar is worth relative to a basket of six other foreign currencies.
The USDX soared above 120 in 2001 and 2002 and since then it has been on the decline to as low as 70 midway through last year. Afterwards, it rebounded somewhat to move around 85 and 90 at the moment.
The USDX is a weighted geometric mean of the dollar's value compared to the six currencies ― the euro, Japanese yen, the pound sterling, Canadian dollar, Swedish krona and Swiss franc.
The USDX was introduced in 1973 with a starting value of 100. If the value is 120, this means the greenback added 20 percent to its value compared to that 35 years ago. Likewise, 80 represents a 20-percent loss in value.
Dollar Recycling & Pax Dollarium
``We can read two trends here. The first one is that the dollar is on a downward spiral although it recovered somewhat last year due to investors' preference for safe assets amid the financial turmoil,'' said Kwon Soon-woo, a senior economist at Samsung Economic Research Institute.
``The other one is that the dollar managed to maintain its powerful status as the key global currency despite huge U.S. deficits. That was possible thanks to dollar recycling,'' Kwon said.
By dollar recycling, Kwon means the process of dollars flowing out of the U.S. to exporters of oil or commodities but most of the outflows come back to America because they use dollars to buy U.S. bonds or stocks.
America Inc. adds up obligations on its balance sheet every year but it could reduce printing paper money to some extent as a good proportion of the dollar always come back to its economy.
The result: Exporters such as China and Japan have invested lots of money into U.S. bonds on top of building up trillions of dollars of reserves in total.
However, Kwon predicts the magic effect of dollar recycling is fast evaporating.
``Historically, the dollar's status as the major settlement currency has been under threat several times, for example in 1971 when its link with gold was severed, and the dollar survived them'' Kwon said.
``But this time around, things will be different. After its temporary rally in tune with the financial funk, the dollar will continue to lose its ground as a key currency because of the large debts,'' he said.
Kwon predicted that the dollar will maintain its status as the one of the major currencies in around 10 years but it will lose its dominant position that it has enjoyed over the past few decades.
Euro and Yuan
Operators of challenging currencies such as the euro and the yuan make no secret of their ambition to undercut the ruling status of the dollar.
French President Nicolas Sarkozy contended of late that the dollar will be no longer able to claim to be the only currency in the world after the Wall Street-originated financial storm.
The Chinese government announced that it will not buy more U.S. treasuries in the future, and even Korea said it will cut back its proportion of the dollar in its $200 billion foreign exchange reserves.
Worst-Case Scenario & Reverse Marshall Plan
Kwon warns of the worst-case scenario ― when the U.S. fails to bring the unbridled double deficits under control.
``If dollar recycling stops working due to shrinking confidence in the U.S., it will have to pay its debts by printing more paper money,'' Kwon said.
``The country will not default because it can print money to pay off dollar-denominated debts. But its value will plunge and the collapse of Pax Dollarium will gain pace,'' he said.
In this climate, Daewoo Securities Managing Director Hong Sung-guk said Asian countries need to help the U.S., worrying the nation may suffer from too abrupt a downfall.
``Based on huge foreign exchange reserves, East Asian countries such as China, Japan, Taiwan and Korea need to help out the U.S.,'' said Hong who gained prominence by exactly predicting the ongoing financial crisis a couple years ago.
``For instance, the Asian players can speed up the purchase of U.S. bonds to relieve its debt burden,'' Hong said, naming the scheme as a ``reverse Marshall Plan.''
Hong's logic: the strong status of the dollar is necessary over the short run to efficiently get over the financial distress. Subsequently, Pax Dollarium needs to be sustained for the time being under the reverse Marshall Plan.
In the aftermath of World War II, the U.S. helped the rest of the world, in particular Western Europe, reconstruct war-demolished economies through the Marshall Plan launched in 1948.
At the moment, the above-mentioned four Asian countries combine to have foreign reserves amounting to about $3.5 trillion with China accounting for more than half with upside of $2 trillion.