Living Economics

Sinking Dollar
The US dollar has been losing its value as an international reserve currency due to its persistent trade deficits.

Gisele Bundchen, the Brazilian supermodel, was reportedly insisting that she be paid in a currency other than the U.S. dollar.

This story was subsequently denied by Gisele’ agent. But the damage to the dollar’s reputation as an international reserve currency was done.

Gisele is, however, not the first party to question the future value of the dollar. Warren Buffet, the dean of American investment guru, has long panned the dollar because of America’s ever ballooning trade deficits and its entrenched debtor nation status.

OPEC members have been mulling dumping the dollar as the international settlement currency for oil transactions. If the dollar depreciates in terms of the oil exporters’ home currencies or other currencies from which the oil exporting countries import non-oil products, the purchasing power of their oil dollars would fall.

Even China, the biggest buyer of US Treasury bonds, is wondering aloud if it should continue to fund America’s spendthrift ways and whether the value of its sizable US bond holdings would be protected. The fact that the US government is pestering China to revalue its yuan upwards is telling China that the value of its bond holdings would not be protected. If one dollar buys fewer yuan after the revaluation, the value of China’s bond holdings (denominated in dollars) would be worth less in terms of yuan.

China’s unwillingness to revalue its currency is perfectly understandable. It is being asked to voluntarily suffer a capital loss from its US bond holdings. Furthermore, America would simply import from other cheap-labor countries which have not revalued their currencies if China’s imports cost more to America after yuan’s appreciation.

China is not the cause of America’s huge trade deficits and its consequently weakening dollar. China is just an easy scapegoat. Cheap imports are an inevitable result of a globalized labor market in which American labor is increasingly uncompetitive in the manufacturing of mature consumer products.

America is unfair in criticizing China for its autocratic government while expecting China to use its autocratic authority to swiftly make most of the economic adjustments. Meanwhile, Americans fault China for not understanding that America’s democratic institutions and entrenched vested interests would not allow it to change its domestic policies quickly.

While the dollar is sinking, we can expect to see more finger-pointing than easy solutions.

References:
  • WSJ. “Gisele Dumps Ben.” 11/6/2007: Page No. C14
  • WSJ. “Inflation forces gulf to rethink peg to dollar.” 11/20/2007.
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