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The dollar's decline: from symbol of hegemony to shunned currency

By Andy McSmith

Published: 17 November 2007

The decline of the dollar, symbol of US global hegemony for the best part of a century, may have become so entrenched that some experts now fear it is irreversible.

After months of huge and sustained turmoil on the money markets, lack of confidence in the world's totemic currency has become so widespread that an increasing number of international traders are transferring their wealth to stronger currencies such as the euro, which recently hit its highest level against the dollar.

"An American businessman over here who is given the choice would take anything but the dollar," David Buik of Cantor Index said yesterday. "I would want to be paid in yen, and if not yen then the euro or sterling."
Matthew Osborne, of Armstrong International, added: "The majority would say sterling. There are a few dealers in the City who may take the view that they'll take dollars now, while they're cheap, and hold on to them for 12 months.

"But the problem is so serious that there are people who in July or August might have been thinking, 'I'm paid in dollars, how annoying' for whom it's now a question of, 'Do you have a job; do you have a bonus?' "
The collapse of the sub-prime mortgage market in the US, which is fuelling the dollar unrest, has already brought down one British bank, Northern Rock, and has forced others to declare vast losses. Yesterday, just as it appeared that the dollar might have finally reached its floor, there was another warning that the sub-prime crisis is going to get worse. The US Treasury Secretary Henry Paulson, warned an international business summit in South Africa: "The sub-prime market, parts of it will get worse before it gets better." Huge numbers of US homeowners are still cushioned by introductory interest rates set when they took out loans in 2005 or 2006, he said. When these introductory offers run out, their interest payments will increase, setting off another wave of defaulting and repossessions. And the dollar is enduring its rockiest spell in recent memory.

Kenneth Froot, a Harvard university professor and former consultant to the US Federal Reserve, warned yesterday: "Part of the depreciation [of the dollar] is permanent. There is no doubt that the dollar must sink against periphery currencies to reflect their increase in competitiveness and productivity."

Professor Riordan Roett, of Johns Hopkins University in Baltimore, told Bloomberg News: "There is a loss of confidence in the dollar and the US. It may only reflect the widespread dismay with the Bush administration, but it is obvious that the next administration, of either party, will have a steep uphill struggle." As well as reaching its lowest level against the euro, which has been trading at more than $1.47, the dollar has also fallen to its lowest level against the Canadian dollar since 1950, sterling since 1981, and the Swiss franc since 1995.

Its plight was made still worse by a jarring signal from China that it was switching to other currencies. Cheng Siwei, vice-chairman of the Standing Committee of the National People's Congress, told a conference in Beijing: "We will favour stronger currencies over weaker ones, and will readjust accordingly."

The warning was reinforced by a Chinese central bank vice-director, Xu Jian, who said the dollar was "losing its status as the world currency".

China has stockpiled £700bn worth of foreign currency, and has only to decide to slow its accumulation of dollars to weaken the currency further. Last month, in a humiliating turn of events, the central bank in Iraq, four years after the United States invaded, stated that it wished to diversify reserves from a reliance on dollars.
Korea's central bank has urged shipbuilders to issue invoices in the local currency and take precautions against the weakened dollar, and three of the world's big oil exporters, Iran, Venezuela, and Russia, are demanding payment in euros rather than dollars. Iran insisted that Japan should make all its payments for oil in yen, rather than dollars.

Warren Buffet, who is reputedly the richest man in the world, was asked on the US network CNBC last month what he thought was the best currency in the world to own now. He answered: "Not the US dollar."

The Wall Street Journal ran an online poll asking people which currency, they would prefer to be paid in. The euro came top, ahead of sterling, with others such as the Canadian dollar, yen and Swiss franc trailing far behind. One respondent wrote: "Being an expat in Europe with a European employment contract, I am paid in euros, and happy to get paid in euros, and shop in the US, just as long as the cycle lasts through my retirement, so I can pick up pension in Europe and retire in the US."

The Federal Reserve has cut interest rates twice since September to revive the US economy, but the cuts – combined with the possibility that more were on the way – made the dollar less attractive to investors.

Yesterday, it recovered slightly when one Federal Reserve banker, Randall Kroszner, dampened speculation about further interest rate cuts, saying that rates were low enough to get the economy through a "rough patch".

Problems with the greenback, combined with cheap air fares, have encouraged more Britons to go shopping across the Atlantic. British tourists spent £785m in New York last year, the city's marketing and tourism organisation said yesterday. There were 1,169,000 visitors to New York from the UK in 2006, with 54 per cent going for four to seven nights and 31 per cent staying for two to three nights. They spent an average of £112 a day. The average age of the UK visitor is 40.

Christopher Heywood, director of tourism PR for NYC & Company, said he expected the dollar crisis to attract yet more British shoppers. "The savvy traveller who's coming here for the shopping can really get a bargain. They're coming with one suitcase and leaving with two or three," he said.

"We have people coming over here even for weekend trips to shop for the famous brand names. People are
coming for the department stores that everyone around the world knows, but also for the boutique stores out of the centre of Manhattan, anything from Madison Avenue and Fifth Avenue to Bleecker Street in the West Village and SoHo."

The dollar may recover, but the world will be different

By Hamish McRae
Published: 17 November 2007

It is fun that supermodels don't want to be paid in dollars but it is not what matters. What really matters is where investors want to put their savings and, currently, the answer seems to be anywhere but the US. The dollar has been weak before and has eventually recovered. So too, it needs to be recognised, has sterling – we know how to run a weak currency here.

And so, too, has the euro. Four years ago, the dollar was riding high and it was the euro that was on the ropes. The issue is whether this time things are different: that this time the dollar will find it harder to recover its position as the world's main currency.

There are three main reasons why this period of dollar weakness may persist. The first is that there is a rival currency covering an economic zone of comparable size to the US, the euro. Even since the currency was created, the eurozone has grown more slowly than the US. This year it looks like changing, with Europe growing faster. That inevitably creates a demand for the currency, for people want to invest in a place that is doing well.

The second is that the current account deficit of the US is larger relative to GDP than in any previous bout of dollar weakness. It is improving a little but is still about 6 per cent of GDP and that is huge.

Foreigners don't need to take money out of the US to put pressure on the dollar; they don't even need to stop investing; they merely need to stop putting so much money in. That is what has been happening in recent months, particularly since the summer.

And the third is that the relative size of the US economy has been shrinking, while the Asian economies – China of course but also India – have been gaining ground every year. Next year, China will pass Germany to become the world's third largest economy after the US and Japan and, on present trends, will pass Japan within a decade. So while the US will retain the title of the world's largest economy for another generation, it no longer dominates the world in the way it used to.

So what will happen? Currencies generally overshoot their true underlying value. Why that should happen is bound up in the mists of market psychology. The dollar is probably already undervalued but that does not mean that it will not become more so. Its reputation is being chipped away by a series of events, small in themselves but large in total.

They include the story this week that the United Arab Emirates may cut the link with the dollar, as Kuwait already has done. If there were a general loss of confidence then the dollar could fall quite a lot more. Eventually there will be a floor – there always is – but the collapse would be disruptive, not least to the European economy, where exporters are suffering from the surge in the euro.

If things really get out of hand, there may have to be some dollar rescue but that – for the moment at least – seems some way off. The big point is even when the dollar does recover the world will be different. Maybe we will still price oil in dollars but a lot more people around the world will think – and place their assets – in euros.