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What's behind the dollar's decline?

By Lance Selfa | December 15, 2006 | Page 4

THE VALUE of the U.S. dollar has fallen by almost 25 percent on world currency markets since 2002.

Although this has been almost imperceptible to most Americans, it has raised alarm in some financial circles. "I think the dollar's going to hell in a handbag," David Bloom, currency strategist at HSBC told the Guardian. "The market is starting to think that the U.S. is going from a soft landing to a hard landing."

To understand why some experts are making dire predictions about the dollar, it helps to understand that, since the early 1980s, the U.S. economy has imported more than it has exported. The annual difference between the value of imports and exports, known as the "current account," has been in deficit since then.

This year, the current account deficit is estimated to be more about $750 billion--meaning that U.S. companies and consumers will have bought $750 billion more goods and services from overseas sellers than U.S. firms have sold to overseas buyers. Over the more than two decades of U.S. current account deficits, the U.S. has built up a total deficit of more than $14 trillion, a sum larger than the U.S. gross domestic product.

"Because of our country's profligate fiscal and over-easy monetary policies, the dollar has been undermined, so much so that, sadly, it may be no more secure as a store of value than the citizens of Baghdad are walking the streets," wrote financial expert Richard Benson.

If the U.S. were an underdeveloped country, such fiscal indiscipline would have been the excuse for the mandarins of the international debt police, like the International Monetary Fund, to force it to accept a "structural adjustment plan."

Instead, the U.S. can expect other countries to accept even devalued dollars--because other countries' economies have a vested interested in maintaining the U.S. as a "buyer of last resort" for the products they produce.

For instance, China, the current "workshop of the world," sells 21 percent of its exports to the U.S. market. In order to keep an economy that must absorb millions of new workers each year expanding, China relies on the U.S. market. Therefore, it is willing to accept a huge amount of U.S. dollars in exchange for being able to continue exporting to the U.S. market. Financial experts estimate that China currently holds more than $1 trillion in foreign currency--of which $700 billion is in U.S. dollars.

The dollar's decline is one aspect of "rebalancing" in a global economic system that has depended for years on the U.S. economy to be its engine of growth. Every expert agrees that economic growth must be spread more evenly around the world, and that various countries' economies should not be as closely tied to ups and downs in the U.S. as they currently are.

But there are advantages to a cheap dollar for U.S. rulers. A cheaper currency makes U.S. products cheaper on the world market, making U.S. exports more attractive. If U.S. exports were to increase while imports stabilize or decrease, then the current account deficit would decline.

For this reason, despite their rhetoric in support of a "strong dollar," U.S. officials like Treasury Secretary Henry Paulson and Federal Reserve Chair Ben Bernanke are content to see the dollar glide slowly downward.

With so many U.S. dollars, stocks and bonds in the hands of other country's firms and central banks, international investors can't be expected to hold onto an asset that's declining in value forever. With other currencies, such as the Euro, rising in value against the dollar, it is only rational for dollar holders to want to invest in other currencies.

As the Chinese People's Bank bluntly put it, "If the U.S. current account deficit growth continues to be higher than GDP growth, the investment value of U.S. assets will be questioned by global investors, and the willingness of investors to continue holding and buying U.S. financial products may weaken...If the external capital stops flowing into the U.S., the U.S. dollar may face a significant slide."

If Chinese, Japanese or other central bankers decide to sell off dollars and buy Euros, the U.S. dollar would plummet in value. This "nightmare scenario" is what the likes of Paulson and Bernanke want to avoid at all costs.

Its consequences would be ugly: a recession and sharply higher U.S. interest rates. In other words, ordinary Americans would experience a little of what countries like Argentina and Mexico have faced in recent decades.

For custodians of U.S. imperial power, a plummeting dollar also translates into plummeting economic clout on the world stage. Coming at a time when the wars in Iraq and Afghanistan are showing the limits of their military power, U.S. empire builders don't want to lose their economic edge either.

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