Editorial: The dollar keeps going south
Published by The Straits Times, Singapore on 2004-10-29
BLAME it all on Thomas Jefferson and Governeur Morris. They persuaded the Continental Congress in 1785 to adopt "dollar" as the name for the United States currency, when America's founding fathers convened in New York to create a new currency for their new nation. Jefferson and Morris were animated by the fact that the term "dollar" wasn't associated with any form of official English currency - although just 12 years later, the Bank of England, in a moment of mischief making, minted dollar coins, but then hastily withdrew them from circulation. Since that time, the "Almighty Dollar" has pretty much been the currency of choice in everything ranging from international trade to individual savings.
Now the dollar is in trouble, having depreciated by more than 20 percent over the last two years, at least partly on account of the dramatic increases in the US federal and current account deficits - the first a consequence of higher defence spending by the Bush administration and concurrent slashing of taxes, and record oil prices; the second because of the continuing profligacy of American consumers which, of course, has helped Asian exports. America's outstanding debt is US$8 trillion, or 70 percent of its GDP, and well over internationally acceptable warning limits. Asian central bankers are now increasingly worried, and rightly so, not so much about the direction in which the US dollar is headed - south - but the rate of depreciation. That's because Asia has traditionally financed American deficits through purchases of US Treasury bonds. Asian central banks hold more than US$1 trillion in T-bills, privately held government bonds and debt of government-sponsored agencies, such as mortgage buyer Fannie Mae. Asian investment also helps the US Federal Reserve to hold down interest rates and encourage domestic growth - which in turn creates more demand of imported goods, mostly from Asia. In effect, while the US remains the engine of global growth, Asia is the single most important driver of US domestic growth through the financing of deficits. If the US dollar declines rapidly - especially if currency speculators drive down the dollar - Asian treasuries risk the loss of billions of dollars. Already this year, China has seen the whittling down in value of its US$500 billion foreign exchange reserves, held mostly in US dollars, by some US$10 billion.
In order to reduce their dollar risk, Asia's treasuries must shift some of their cash reserves - currently US$2.2 trillion - to financial instruments offering better returns than the insipid US T-bills. But they also need to be cautious about "spooking" the US debt and currency markets by precipitous action. Asians must also be careful that their own currencies don't grow stronger too rapidly. That would make their exports more expensive for the world's biggest market, the US, and also lead to job losses throughout Asia. But if they allow their currencies to stay weak against the dollar, they risk importing inflation. This weekend, as the world awaits next Tuesday's US presidential election in which the deficit issue should have figured more prominently, you can be certain the Asia's central bankers are pressing hard on their worry beads.
Senior Writer and Global-Affairs Columnist