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Friday, October 23, 2009

"The Death-Defying Dollar"

Barry Eichengreen says the dollar isn't dead yet:

The death-defying dollar, by Barry Eichengreen, Commentary, Project Syndicate: The blogosphere is abuzz with reports of the dollar’s looming demise. The greenback has fallen against the euro by nearly 15% since the beginning of the summer. Central banks have reportedly slowed their accumulation of dollars in favor of other currencies. ...
The first thing to say about this is that one should be skeptical about ... predictions ... concerning the near term. Our models are, to put it bluntly, useless for predicting currency movements over a few weeks or months. ...
Over periods of several years, our models do better. Over those time horizons, the emphasis on the need for the US to export more and on the greater difficulty the economy will have in attracting foreign capital are on the mark. These factors give good grounds for expecting further dollar weakness.
The question is, Weakness against what? Not against the euro, which is already expensive and is the currency of an economy with banking and structural problems that are even more serious than those of the US. Not against the yen, which is the currency of an economy that refuses to grow.
Thus, for the dollar to depreciate further, it will have to depreciate against the currencies of China and other emerging markets. Their intervention in recent weeks shows a reluctance to let this happen. But their choice boils down to buying US dollars or buying US goods. The first option is a losing proposition.
In the longer run, Opec will shift to pricing petroleum in a basket of currencies. ... It hardly makes sense for it to denominate oil prices in the currency of only one of its customers. And central banks, when deciding what to hold as reserves, will surely put somewhat fewer of their eggs in the dollar basket.
Beyond this, the dollar isn’t going anywhere. It is not about to be replaced by the euro or the yen, given that both Europe and Japan have serious economic problems of their own. The renminbi is coming, but not before 2020, by which time Shanghai will have become a first-class international financial center. And, even then, the renminbi will presumably share the international stage with the dollar, not replace it.
The one thing that could precipitate the demise of the dollar would be reckless economic mismanagement in the US. One popular scenario is chronic inflation. But this is implausible. ... There may be a temptation to inflate away debt held by foreigners, but the fact is that the majority of US debt is held by Americans, who would constitute a strong constituency opposing the policy.
The other scenario is that US budget deficits continue to run out of control. Predictions of outright default are far-fetched. But high debts will mean high taxes. The combination of loose fiscal policy and tight monetary policy will mean high interest rates, sluggish investment, and slow growth. Foreigners – and residents – might well grow disenchanted with the currency of an economy with these characteristics.
Mark Twain ... once responded to accounts of his ill health by writing that “reports of my death are greatly exaggerated.” He might have been speaking about the dollar. For the moment, the patient is stable, external symptoms notwithstanding. But there will be grounds for worry if he doesn’t commit to a healthier lifestyle.

    Posted by on Friday, October 23, 2009 at 12:29 AM in Economics, International Finance | Permalink  TrackBack (0)  Comments (9)

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