Dollar apocalypse

A group of US financial analysts have been predicting a dollar apocalypse that will devastate economies and lives all over the globe. The problem, according to them, is the wayward dollar. The world’s reserve currency that has oiled international trade since the demise of the Gold Standard has been rapidly losing value as a profligate United States prints more and more dollars to cover its growing spending gap.

Since 1971 when the then US President Richard Nixon declared that the US dollar would no longer be backed by gold, the global financial community has relied on the prudence of America’s central bank, the Federal Reserve Bureau (better known as the Fed), to maintain the dollar’s credibility. For most of the years since then, the Fed could print more dollar notes than the US economy needed without increasing its reserves of gold or stoking domestic inflation. The system worked because in the decades since 1971, world trade burgeoned like never before and the demand for dollars to finance that trade remained high.
While every country had to sell something to get dollars, for the US government dollars were free, they could just be printed and used to buy things. There was, of course, a limit to the amount of dollars that the Fed would print. For, as every economist knows no responsible government can allow money supply to grow beyond some level considered prudent.
Financial experts, central bankers around the world and even governments closely watched the US Fed’s figure for money-supply growth, what economists call the M3 — the total of cash, bank deposits and so on. Then suddenly in 2006, the Fed stopped publishing M3 figures and left it to the financial community to guess just how much dollar liquidity was growing. At about the same time, it was clear that US trade deficit with China and other countries had gone through the roof and the Fed was having to raise more and more debt to finance that and a growing budget deficit. American spending had breached its earning envelope and was in free rise. The US federal budget deficit continues to surge and will hit $1.4 trillion this year.
US national debt is capped at the level of $14.3 trillion and US President Barack Obama needs to legislate if the government is to borrow beyond this limit. But if this is not done by August 2, then the US Treasury could actually default on loan repayment, an event that is certain to trigger a tsunami in global financial markets.
One way to avoid that would be to print even more dollars — literally print one’s way out of debt. Some financial analysts claim that the monetisation of the US debt has been going on for the past two years through the expansion of deposit currency. This could lead to dollar-hyper inflation and eventually, perhaps, the end of the dollar as the world’s reserve currency.
Already, the value of the dollar has been falling. Every strong currency has gained against the dollar; some exceptions include the South Asian countries, sanctions-hit Iran and troubled economies like Syria and Laos. In Europe, every single country has gained over the dollar except Turkey, Ukraine and Belarus. In Australia, for the first time in history, the local dollar is worth more than a US dollar! Even the battered Euro has risen 11 per cent against the dollar.
The impact of the inflationary dollar on world trade has been devastating, especially for countries with high levels of inelastic import demand. Since most globally traded goods are priced in dollars, as the value of the dollar falls, their dollar price tends to rise. This is one reason for the sharp increases in global commodity prices, including that of oil. In many parts of the world, investors, including central bankers, are gradually but surely divesting their dollar assets and buying gold and silver. The dollar is rapidly losing credibility. India is groaning under the weight of rising commodity prices, especially oil. India’s high dependence on energy imports has led to skyrocketing energy import bills, huge trade deficits and a consequent pressure on the rupee.
As energy imports get more expensive, India will find itself increasingly in trouble with the Indian rupee unable to compensate for the falling value of the US dollar. Unlike other strong currencies, the real value of the rupee will continue to plummet. At one level, India’s dilemma reflects a global issue: the lack of a credible alternative to the dollar. Despite periodic statements by world leaders that the global financial system needs reworking, nobody has been able to come up with a working solution that would do away with the dollar as the world’s reserve currency. Everybody is hoping that the US government will mend its ways, get its finances in shape and avert the inevitable crisis.
Problem is that all countries are resistant to change, especially when it threatens to affect their way of life. In Washington, too, there is no consensus on how to reduce expenditures: Democrats are looking at the whole problem as a social-spending issue; Republicans are resisting proposals to increase taxes on the rich; and President Obama, who clearly recognises the need to bring some budgetary order, is hamstrung by concerns about his re-election next year. To many American lawmakers, the global currency crisis might look chimerical, an unreal threat dreamed up by crazy financial experts. Problem is if it does break, it will not just bring down large parts of the global financial system but the power of the United States as well.

The author is an independent security and political risk consultant