Is a Crisis Looming for the Dollar?
Sep 29, 2006 5:00 AM PT
The U.S. dollar is still the world's dominant currency. But, there are rumblings that could foretell a great weakening of the dollar and a loss of its hegemony.
For example, the European Union is currently gathering both members and economic power. Its combined gross domestic product now exceeds that of the U.S. And, since January 1, 2002, the Europeans have been, by and large, using the euro as their currency and eschewing the dollar.
Spending More Than Saving
To gain membership in the European Union, each prospect must, among other things, meet certain relatively strict fiscal and monetary requirements. Based upon our situation today, I'm not sure if the United States could become a member of the EU since I doubt very much that we would qualify. We are spending too much and saving too little. As a consequence, our imports far exceed our exports.
I shared my concerns with Clyde Prestowitz, the president of the Economic Strategy Institute, and the author of the book Three Billion Capitalists.
In his book he discusses the changing economic and political dynamics in the world today and gives some very interesting remedies as to how the U.S. can extricate itself from a dollar debacle.
Here are some of Mr. Prestowitz' responses to my questions concerning the health of our dollar.
Q: Clyde, I'm very concerned about the dollar. How vulnerable do you think the dollar is?
A: The problem is that nobody knows. And, the fact that nobody knows gives you a degree of vulnerability. Clearly, there is a degree of vulnerability [for the dollar]. [Warren] Buffet keeps talking about moving out of dollars.
I was in the Middle East recently and a number of the Middle East central banks and monitory authorities are moving out of dollars. The Russians have just moved much more into euros.
The problem is, if not the dollar, what? And, sure, the euro [can fill in for the dollar] to some extent. But the euro markets are not liquid enough, deep enough, seamless enough to absorb the amount of money we are talking about.
Q: Do you think that there is an imminent problem with the dollar?
A: I just think that things are uncertain. It wouldn't surprise me if things blew up within six months. It wouldn't surprise me if it took 10 years.
Q: Is there something systemically wrong with the way we are handling our economic fortunes?
A: I always come back to fundamentals. And, what I think I know is that America is always consuming more than it produces, spending more than it earns. And I don't think that any person, company, or country can do that indefinitely.
Q: What about the recent surge in popularity of hedge funds and its possible impact on a financial crisis?
A: Many of the financial people I talk to are nervous. I know that there are a lot of risk factors out there. There's a lot of leverage, there's a lot of debt. There are derivative markets nobody understands. There are hedge funds that increasingly are major factors in international capital flows. They're not regulated. They're opaque. I don't think that anyone knows where the risk is.
Q: Do you see the hegemony of the dollar eroding?
A: I do. I think that there's already a flight from the dollar. What I think I am seeing is that the smaller players are already hedging and moving somewhat out of dollars.
Even some of the bigger players, the OPEC countries, are moving more into euros and other assets -- some of it gold, some of it other currencies. More of the burden of financing is put on the big guys: China, Japan, Saudi Arabia. In a way, I think that there is an already subtle, stealthy, flight from the dollar.
Q: Let's say tomorrow OPEC priced oil in euros, rather than dollars. Do you think that this would be disastrous?
A: It would be dramatic! I think they're not going to do that. I think that's not going to happen.
But, let's suppose a basket currency was used: 1/3 dollars; 1/3 euros; 1/3 something else, like the yen. This would make some sense, given OPEC's sources of revenue.
I think that a change in pricing like this would lead to a strengthening of the euro and the yen and a weakening of the dollar. It says that America can't keep running large trade deficits anymore.
Q: In your book, Three Billion Capitalists, you talk about the three NAFTA countries, the U.S., Canada, and Mexico, joining with Japan to form one common currency. Your reasoning is that since Japan owns over (US)$800 billion in dollar-denominated U.S. assets, it stands to take a tremendous hit to its treasury if the dollar plummets or if it is devalued by the United States. This consolidation of four rather disparate currencies into one is quite a startling statement. How was it received by the Japanese?
A: Typically, the first reaction of any Japanese that I mention it to is kind of shock and rejection. However, I had an interesting meeting with a Japanese guy who is the vice president of the Asian Development Bank. He is a former official of the Bank of Japan and a very sophisticated global economist and strategist. I mentioned it to him and his immediate reaction was 'Gee! I wish that I'd have thought of that.'
You have to get kind of behind knee-jerk nationalism sentiment. And, you also have to be a somewhat sophisticated observer of the global financial scene.
Q: Finally, how does our country's international standing and perception by other countries affect the dollar, because obviously we're not looked at by other countries the way we were six or seven years ago.
A: I think that our power is a very important element of support for the dollar. There are a lot of people around the world who look at the U.S. as a safe haven -- their own security is dependent on that of the United States. Because of that, they are inclined and willing to finance us. To the extent our ability to elicit respect and fear is diminished, and it has been diminished, the long-term role of the dollar comes much more into question.
Theodore F. di Stefano is a founder and managing partner at Capital Source Partners, which provides a wide range of investment banking services to the small and medium-sized business. He is also a frequent speaker to business groups on financial and corporate governance matters. He can be contacted at Ted@capitalsourcepartners.com.