The Future of

Dollar in the
new Economic
Era

Author: “Leverage”
Vishal Singh : +91 9833655090 singhvishal2511@gmail.com

Prin. L. N. Welingkar Institute of Management & Research,

Mumbai
 Preface
The dictionary meaning of the word currency is the rate at which anything is
generally valued, the current value of the exchangeable commodity, a general
estimation of anything, etc. A currency is a medium to exchange products, goods &
services, ideas, thoughts, etc. It has perhaps become “the” thing for carrying out any
transaction in any part of the globe. And as the wave of globalization reaches every
shore of the world the impact and importance of “currency” is going to be of paramount
importance.

A glimpse of the past

Over the previous 2,500 years there have been more than a dozen currencies
that were regularly accepted as a form of payment beyond their own borders. (Greek
Drachma, Indian Silver Coins, Islamic Dinar, Dutch Guilder, British Pound and finally the
US Dollar). But since 1944, none of the currencies is more widely accepted than the US
dollar. Over the past several decades; since the end of World War II in 1944, the
greenback has enjoyed its status as world’s most powerful reserve currency.
After the World War II, United States of America emerged out to be the
strongest economy and its central bank which is The Federal Reserve as the most
trusted bank. After the fall of the Gold Standard, in the year 1971, countries started
pegging their currency with the US Dollar because Federal Reserve was built on the
word ‘TRUST’. Many politicians and Economists believed that the inability of converting
the Dollar into gold was not the collapse of the Bretton Wood System but the fall of the
American Empire. Few recognized that it was an opportunity to spread the US Dollars
influence even wider. With the rise of the US Dollar and the importance of it in the
world trade the US Government started to mint more and more Dollars to fund its
Vietnam War which had ballooning effect on the inflation not only for United States but
also for the global economies at large.
 Every major government and financial institution in the world now holds
significant quantities of U.S. dollars as part of their foreign exchange reserves. Many
countries like Ecuador have taken drastic steps in making the US Dollar as its national
currency and completely dethroning their own currency for economic benefits. This
time and again proves the confidence in the “Lender of the last Resort” which is the
Federal Reserve and the rise of a might called Dollar.

The Current Situation

The Sub prime Crisis which has been the worst crisis which has hit the global
economy after the Great Depression, 1929. The comparison between the current crisis
and the Great Depression is of not much relevance as the contraction in the GDP and
the unemployment level were far worse during the Depression period. (World GNP
declined by more than 13% and unemployment shot up to 24% in 1932) The current
crisis is more due to the integrated nature of the International Trade and Investments,
which was not at its helm during the previous crisis. The total loss in current crisis has
crossed the USD 2 trillion mark and GDP of the major economies of the world has
shrunk with the developed economies being in the negative zone with Japan leading the
fall of almost 9% in GDP, followed by Euro region with a 5% fall in its GDP and the US
economy itself is grappling with a sluggish recovery which seems to unsustainable. The
unemployment rate in the United States has also been at a record level of about 10%.
With all the mess which was created by the crisis and the USD being used as the global
currency, there was an acute shortage of dollars in the global market. It later turned out
to be a crisis for credit and the importance of a global currency was again questioned.
Generally at the time of any crisis in a particular country, the country’s own
currency is depreciated and what we see here is a complete opposite picture. The US
Dollar has been on a rise against most of the currencies after the crisis which started in
2007. This is due to the importance of dollar as the reserve currency world over and
most transactions being done with Dollar as the central currency. The demand for the
dollar increased in the foreign exchange market having an appreciating impact on it.
 The U.S. dollar could slowly be losing its reserve currency status, which could
lead to a major devaluation of the currency. In 1965, the United States of America was
the largest creditor nation in the world. Today, it is the world's largest debtor nation.
The most widely quoted figure for the debt of the United States is called the National
Public Debt. This public debt is currently $10.64 trillion. This is the figure quoted on the
famous US National Debt Clock in Manhattan. It has increased 385,465% in the past 100
years. The national public debt is all US federal debt that is held by states, corporations,
individuals, and foreign governments. But the national public debt doesn't tell the whole
story

The United States is responsible for many other financial obligations that are not
included in this calculation. The national public debt does not include intra government
debt obligations or contractual requirements of the US government. These obligations
include military and civilian pensions, retiree health benefits, federal insurance payouts,
loan guarantees, and leases. They add another $1.5 trillion in financial obligations of the
United States. But they pale in comparison to what is owed in the form of Social Security
and Medicare benefits. Current and future promised Social Security and Medicare
benefits amount to about $7 trillion and $35 trillion, respectively. Add it all up, and the
United States is really responsible for covering $54 trillion in total financial obligations
including public debt. But here's what really shocked me after looking at the numbers.
America's $65.5 trillion financial obligation exceeds the gross domestic product of the
world. It is almost 375% higher than estimates for 2010 US GDP. The shear size of this
financial responsibility is fair grounds to even question the solvency of the United
States.
If the world is unwilling to continue to accumulate dollars, the US will not be able
to finance its trade deficit or its budget deficit. As both are seriously out of balance, the
implication is for yet more decline in the dollar’s exchange value and a sharp rise in
prices. The central banks hold foreign currency reserves for the same reason that people
keep fire extinguishers in their homes or spare tires in their cars: they want it there in
case of any emergency, even if they hope they will not need to use it. There is not a
clear consensus about the appropriate level of foreign reserves, though most
economists think the minimum should exceed a countries short-term foreign currency
debt. Monetary authorities with the large foreign reserves in 2010 are: China – USD
2.648 trillion, Japan – USD 1.118 trillion, Russia – USD 401 billion, Taiwan – USD 305
billion, India – USD 300 billion. Countries having such high reserves denominated in the
US Dollar would then invest the excess in the low yielding US Treasuries which would
again defy the use of Dollar as the Reserve Currency.

Industry experts do believe that the value of currency should be evaluated on

3 basic parameters or use of international money: a store of value, an international
unit of account and a medium of exchange. Although the dollar maintains its status in
latter two it lacks severely as a store of value. As a result, calls around the globe are
getting louder to end the greenbacks status as the worlds reserve currency, a move
that could theoretically end its six decades of global dominance. But the question is
who will replace the greenback?

If Not Dollar then Who

Losing reserve currency status will lead to a series of economic and political
crises in the United States. This is something we know about from the United Kingdom’s
experience. Having a reserve currency status is like being able to write check after check
and not having anyone cash them. But when you loose the reserve currency status, it’s
as if all those checks are taken out form under the mattress, and suddenly cashed. It
may not be as simple as that, however. Before the dollar looses it crown, there has to be
a new contender for the throne.

1. The Might of Yuan

At USD 2.648 trillion as on 3oth September 2010, Beijing holds the world’s
largest forex currency reserves. About 70% of its foreign reserves are in US dollars
including treasury securities. China's Yuan, also known as the remnimbi, is the
currency of the most populous country on earth and many believe China will in
coming decades be the world's most powerful economy. China holds more US debt
than any other country - about $800 billion - and the further the dollar drops, the less
the value of the US debt owed to China.
For most of the decade the value of the dollar has been depreciating. With the U.S
busy in committing trillions of dollars in bailout packages to rescue the economy,
these countries fear inflation will further debase the dollar. China, which is thought
to hold some 70 percent of its massive $2.6 trillion Foreign exchange reserves in
dollars, is especially vulnerable.
Beijing’s determination of pushing Yuan as global reserve currency could be
seen through their latest $10 bn currency swap deal with Argentina, allowing
importers to make purchases in Yuan, instead of greenback. Already, South Korea,
Belarus, Indonesia and Malaysia have been transacting in Yuan. This is a clear
indication of China taking advantage of the greenback’s instability in the global
market. Experts believe that China is on its way towards challenging the dollar.

2. Super Sovereign (SDRs)

Special Drawing Rights (SDRs) are a synthetic currency created by the
International Monetary Fund (IMF) in 1969 in an effort to stabilize the international
foreign exchange system. When SDRs were created, the IMF also suggested that
member nations could convert their US dollar holdings into SDRs to diversify away
from the dollar without driving the value of the dollar down.
Although IMF's initial requests, SDRs never became the alternative choice
for any countries. Experts believe that making SDRs the world's reserve currency
include the fact that the US dollar, the Euro and the Pound – which make up the
large majority of SDRs – have all lost value since late 2007 when the recession
began. Also, SDRs do not contain the Chinese Yuan, Indian Rupee, Australian
Dollar or Canadian Dollar, all of which are important benchmark or secondary
global reserve currencies.

3. The Emergence of Euro

The euro is the world's most actively traded currency after the dollar and so is
highly liquid, making it easy to buy and sell euro-denominated bonds without
disrupting the market. As a result, the share of global foreign exchange reserves
held in the euro has grown since its 1999 inception and stands at 25.9 percent from
18.1 percent. But does a weakened dollar mean a rising Euro? Can Europe really
cope with this appreciation?
If the last couple of years are to go by European exporters have coped by
reducing their margins. Although their dollar export prices increased by 10% their
dollar depreciated by over 30% so what it means is they cannot keep reducing the
margins and reduction in European exports to the US is unavoidable. Even with the
improved European capital market it is largely quite fragmented. Moreover holder of
international reserves cannot hold only euro denominated securities. What also
matters is the type of security one holds on too. The role of the euro is likely to
increase in the coming decades with the non-euro members of the European Union
increase use of the Euroland countries like Tunisia, Egypt , Morocco. Even then euro
is not big enough to displace the Dollar at the global level. The European Central Bank
has also refrained from promoting the euro as a reserve currency, as doing so it
would stoke demand from central banks and push up its value against the dollar. A
strong currency could hamper euro-zone growth.
As a result, dollar financial markets still have an edge over euro markets and
thus the euro is not yet in a position to match the role of the US dollar as a reserve
currency.
 4. Other Challengers
Emerging economies such as Brazil, India, Japan, Russia and Saudi Arabia have
accounted for at least 30% of the net US treasury buying. However, they are worried
by the fact that their currency is either falling- as in case of Brazil and Russia- or no
longer rising in case of Japan. The Japanese Yen also threatened to dislodge the
dollar from the top spot, but the factors such as low yield which is less than 1% on
short term securities and high ratio of debt to GDP which is well over 100% did not
help the cause. Japan is also facing a stagnant economy and cannot handle anymore
appreciation in the yen. Although they are accumulating reserves past evidence
does not suggest that a higher yen will reduce their surplus sufficiently to stop this.

Conclusion:
The US dollar is not likely to lose it reserve currency status anytime soon, unless it collapses
drastically due to some unexpected reasons. The greenback has been losing value for almost a
decade, yet no major countries have switched to some other currency to settle international
transactions an indication that there is no other currency that is large enough to replace the
dollar as the world currency. The technical and political hurdles in implementing China's
recommendation are enormous, so even if backed by other nations, the proposal is unlikely to
change the dollar's role in the short term.
In the longer-term, however, Yuan seems to have what it takes to challenge the US dollar. But
in order to make that happen, China would have to loosen controls over its economy and
financial system to allow the currency to flow more freely and the likes of central banks and
foreigners to invest freely. With President Barack Obama's current trillion dollar annual
budget plans, the dollar could find itself in real trouble as the reserve currency. The dollar
could fall so low that foreign nations may eventually decide to dump their dollars in favour of
Yuan, Euros or SDR’s. But if it turns into a reality then we may see an even greater financial
crisis and another depression.
 Bibliography

Websites:
http://static.seekingalpha.com/uploads/2010/2/7/saupload_china_reserves.png

http://survivingglobalrecession.files.wordpress.com/2010/03/shrinking-dollar.png
http://links.org.au/files/KelloggPicture%202.png
http://dshort.com/inflation/decline-in-purchasing-power-of-dollar-since-1871.gif
http://thinkexist.com/dictionary/meaning/currency/
www.in.reuters.com
www.en.wikipedia.org
www.goldworld.com/articles/us+dollar-reserve-currency/359
www.crisil.com
www.Bloomberg.com
www.federalreserve.gov

Books:
Biography of the DOLLAR – Craig Karmin

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