The position of the US Dollar
The US dollar has held the position as the world’s principal save money since the signing of the Bretton Woods agreement in 1944.
Under this agreement, in a bid to prevent a repeat of the protectionist monetary policies of the 1930s which rule to a worldwide depression, developed nations fixed the exchange rate of their money against the US dollar. In turn, the US fixed the value of the dollar against gold and promised to redeem dollars for gold at any time. Being physically backed in this way, the US dollar provided central edges around the world with a liquid “hard” money that they could keep in save to settle international trade accounts. Everyone would accept the dollar as payment.
This regime ultimately broke down in 1970, when the United States’ persistent trade deficit rule to fears over dollar weakness and hence run on their gold reserves. In the modern day free float money world, the role of money reserves has changed. They are no longer held solely to pay for permanent imbalances in import-export imbalances, but rather used as investment funds that also deter attacks from money speculators.
Nevertheless, over the past several decades, the US dollar has remained by far the principal de facto global save money; 66% of international central bank money reserves is held in US dollars. This save position also method that every major commodity is priced and traded only in US dollars and traders must buy the US money in order to access commodities. consequently, the question of whether the US dollar can continue its privileged role as the international chief save money is meaningful to assessing future need, and consequently its value.
In recent years, the size of the United States debt obligations (currently around 65% of GDP) and a continuing budget deficit (currently running at 11% of GDP), coupled with the emergence of the EU as the world’s biggest economy, rule economic commentators to question the sustainability of the dollar’s save position.
In 2007 former Federal save chairman Alan Greenspan stated that it was “absolutely conceivable that the euro will replace the dollar as save money, or will be traded as an equally important save money.” Similarly, at the World Economic Forum in 2008, George Soros opined: “The current crisis is not only the bust that follows the housing expansion, it’s basically the end of a 60-year period of continuing credit expansion based on the dollar as the save money”.
In January 2009, the Russian central bank announced that the euro based proportion of its save assets increased to the level of 47%, exceeding investments in dollar assets which were 41%.
However, as the contagion of the financial crisis continued to spread in late 2009, and fears over sovereign solvency in the EU and the strength of the economic recovery in the US took keep up, dollar sentiment has found renewed strength. Risk averse investors, eagerly seeking “safe heaven” assets, flooded back to the low-yielding dollar. This inverse correlation between dollar strength and investor confidence, the so called “risk trade”, was summarised by Martin Wolf of the FT: “In the recent panic, the children ran back to their mother already though her mistakes did so much to cause the crisis.”
So whilst central bank save managers today keep nervous over the US fiscal position, essentially they are struggling to find an different money of choice. The sovereign debt crisis in the euro zone has brought into doubt already the survival of the single money, the financial position of Britain now looks already worse than the US, and Japan’s enormous debts loom large over the yen. Shortview in the FT summed up the continued, if hesitant, preference for the dollar: “Investors call it the ugly sisters problem: no one thinks the US dollar is Cinderella, but she’s probably the least objectionable of the bunch”.
consequently, whilst the US dollar may be currently back in favour, it appears to be due to reasons of relative strength and short term risk aversion, instead of a vote of confidence in long term US economic fundamentals. However, whether there exists a realistic different to cause central bankers to shift away from the dollar and into other save assets remains to be seen. If, or when, this save position shift might happen, and what the consequences will be for the US economy, are the meaningful questions that will excursion the long term value of the US dollar.
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