At the beginning of 2003, one euro bought one US dollar. Eighteen months ago, it bought $1.20. Now it is pushing $1.50, and there is no reason to think that it will stop there. Three of the world's biggest oil exporters, Iran, Venezuela and Russia, are demanding payment in euros rather than U.S. dollars. Last week a Chinese central bank vice-director, Xu Jian, gave voice to the suspicion of many others, saying that the U.S. dollar was "losing its status as the world currency."
If that happens, then America loses a great deal. Other countries have to maintain large reserves of foreign currencies - most of which they keep in U.S. dollars - to cover their foreign debts, but the United States can pay its huge foreign debts in its own money. If necessary, it can just print more dollars. Having their own money as the world's reserve currency confers advantages that Americans would miss if they lost them.
The main reason for the collapse of the U.S. dollar is President George W. Bush's attempt to fight expensive foreign wars while cutting taxes at home. This involved deficit financing on a very large scale, and inevitably the value of the dollar began to fall - slowly at first, but with increasing speed as it became clear that the White House did not care.
"Ronald Reagan proved that deficits don't matter," as Vice President Dick Cheney told then-Treasury Secretary Paul O'Neill.
But they do matter. As the U.S. dollar fell in value, the price of oil (which is usually calculated in dollars) rose to compensate for it, but there was no comparable adjustment for foreign central banks that had huge amounts of U.S. dollars in their reserves. China, which was sitting on about a trillion U.S. dollars, simply lost several hundred billion as the currency's value fell. So various central banks started wondering if they should diversify their reserves, and some acted on it.
The downward pressure on the dollar will continue, because the United States is currently borrowing 6 percent of its Gross Domestic Product from foreigners each year to cover its trade deficit. Foreign banks were happy to go on lending so long as they had faith in the integrity of U.S. financial institutions, but that has been hit hard by the sub-prime mortgage crisis. Besides, other markets, notably China and India, now offer a better return - and Congress's resistance to foreign takeover bids, combined with tighter visa restrictions, make the U.S. a less welcoming place for foreign investors.
Above all, there are now alternatives to the U.S. dollar. The last time it faced a comparable crisis was in 1971, when a different Republican president was trying to run another unpopular war without raising taxes. Richard Nixon devalued the U.S. dollar and demolished the Bretton Woods system that had fixed all other currencies in relation to the dollar, inaugurating the current era of floating exchange rates.
There was no other candidate then for the role of global reserve currency, so the dollar stayed at the center of the system despite all the turbulence. This time, by contrast, there is the euro, the currency of an economic zone just as big as the United States, with the Chinese currency as a possible long-term rival. But nothing is likely to happen very fast.
Republicans are ruining our economy for their fatcat short term gains while permanently damaging our hardworking middle class.
23 December, 2007
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