Is Our Dollar Being Stretched Thin?

On October 25, 2013, Forbes examined the strength of the American dollar, which currently is the primary world reserve currency.  It included the following chart, showing the dollar in green with about 60% of the reserves with the euro in red running a distant second at about 20% and the British pound sterling in blue coming in third with about 3% and the Japanese yen in purple not far behind.  The Chinese yuan is listed as “other” right now, but is becoming more important.

Just a few decades ago, the British pound sterling was the primary world currency and held that honor for about 200 years before it had a runaway deficit budget with the Labour party pushing high budget spending.  Unfortunately, this sounds a lot like what is going on the United States today.  

China is one of the countries looking for our dollar to be replaced as the world reserve currency. Liu Chang with China’s official news agency wrote: “. . . it is perhaps a good time for the befuddled world to start considering building a de-Americanized world.”

America’s budget and debt ceiling crises and the 2011 credit rating downgrade have created doubts about the strength of the dollar.  The quantitative easing of printing more dollars to pay our debts is disconcerting to the international community.  The current political environment is not conducive to making substantial cuts in our budget or to reducing our debt.  Let’s just “kick the can down the road” until it drops over the cliff.  The cliff is inevitable.  It’s just a matter of when we will run out of road.

What is a reserve currency?  The reserve currency consists of primary contributing monetary systems that are designed to provide stability for markets and currency throughout the world.  For example if a country were in financial difficulty, international speculators could sell their holdings of that country’s currency, thus depressing the value of that currency.  The country could allow the exchange rate for the currency to fall, but this would not be its first choice because it would make imports more expensive for that country.  However if that country had stable foreign currency reserves, speculators would not be interested.  In 1997-1998, a financial disaster was avoided since many countries had reserves of foreign currencies.  Most countries today protect themselves with extensive foreign exchange reserves.

The American dollar is still on top, but this may be changing much like a mud slide as water saturates the foundation of the soil until the weight carries the earth downhill.  One of the strengths of the dollar was “liquidity” in being able to be sold quickly.  As America’s financial structure shows weaknesses, the liquidity is more in question.  Also, the dollar is starting to lose its value because of the qualitative easing.  Printing more money is bound to devalue the existing dollars.  Other countries may start to obtain their reserves in other assets.  There are already agreements between China and South Korea to utilize their own currencies.  There even could be some ideological and political reasons why countries like Russia would want to convert to a different currency standard.

China’s renminbi could make significant strides toward obtaining a higher percentage of the world reserves, due partly to China’s huge economy.  The extensive foreign exchange controls by the government may make this currency look more dependable and stable than America’s dollar mismanaged by a “do nothing” Congress.

Countries have been increasing their total reserves at a strong pace. In the past decade, world reserves have quadrupled. With that growth rate, countries could greatly increase non-dollar reserves without having to sell any greenbacks.

About 30% of America’s debt is owned by foreign countries included in their currency reserves.  Our interest rates remain low because other countries are purchasing treasury bonds.  However, we are noting financial cracks that are exposing inflationary pressures within our country.  Of course, the way to offset the inflation is to increase interest rates.  Our countries may also increase prices for their imports.  Since our imports far exceed our exports, we would get hammered with this inflationary trend with an even larger trade deficit.  The current political response of printing more money will simply exacerbate the inflationary problem by increasing our money supply.  The dollar will be in the same position that the British pound was in years ago.  But who will bail us out? 

There are many distractions that have nothing to do with this issue.  For example, oil being priced in dollars is irrelevant because you can purchase oil in any currency.  Traders accept any currency at the appropriate exchange rate or you can have your bank covert to any currency.

It is very important that we focus on the real issues and avoid the distractions thrown up by politicians and the media, who do not have your best interests at heart.  There probably is a tipping point on the printing of money and running up a deficit, where we will have gone too far with no way to survive the impending disaster.  But it is incumbent on Americans to push their Congressmen to do the right thing by protecting the stability of our dollar by stopping the quantitative easing and by living within our budget.  If your Congressman cannot do this, then do not vote for them.