Is the Dollar Dying a Slow Death?

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Stacks of $1 bills at the Bureau of Engraving and Printing in Washington on March 26, 2009

The U.S. dollar seems to have as many lives as a cat. Even before 2008's financial crisis, as the dollar slumped against other major currencies, countless pundits and economists predicted its demise as the global economy's No. 1 currency. The doomsayers seemed vindicated when the U.S. economy descended into the worst recession since the 1930s, with its financial sector in tatters. How could an already weakened greenback maintain its value as American economic prowess withered? But then — surprise! — investors around the world decided the good old greenback was a safe haven in a time of great uncertainty. The dollar was resurrected, reversing years of slow decline.

That strength turned out to be temporary. A ballooning U.S. budget deficit and escalating government debt has made the dollar currency non grata in many quarters once again. An index that measures the greenback's value against a basket of major currencies, including the euro and yen, has fallen about 15% from a three-year high reached in March and is now hovering near a 14-month low. Economists and analysts expect the dollar to lose a lot more ground. Daisuke Uno, chief strategist at Japan's banking giant Sumitomo Mitsui, believes the Japanese currency could strengthen to 50 yen to a dollar by 2011 (from around 90 today) due to continued weakness in the U.S. economy. Harvard historian Niall Ferguson says the dollar could slide by as much as 20% on a trade-weighted basis over the next 12 months. The process may be protracted, he argues, but the dollar is dying. In 10 years' time, he said in October, "it won't be such a dollar-dominated world. I'm sure of that."

So has the dollar finally used up the last of its nine lives? There are worrying signs that the world is losing its appetite for dollars. The International Monetary Fund announced on Nov. 2 it was selling 200 metric tons of gold to India's central bank for $6.7 billion. News of the purchase sent gold prices to an all-time high. The move was widely seen as part of an effort by central banks around the world to diversify their extensive U.S. dollar holdings. Steven Englander, chief U.S. currency strategist at Barclays Capital in New York City, figures that in the second quarter, dollars accounted for only 37% of new reserves accumulated by central banks worldwide. That's the lowest proportion on record for any quarter during which reserves increased significantly. At a time when many central banks are boosting their reserves, they are choosing to buy euro and yen instead. "Central banks are doing more than talking about reducing the concentration of [the U.S. dollar] in their reserve portfolios. They are actually acting on their statements," Englander wrote in an October report.

If that shift from talk to action continues, the consequences could be severe and wide-ranging. Central bankers are the currency market's buyer of last resort, and thus the private sector's view of the dollar's value and stability can be heavily influenced by what they do. Still, there are many constraints to how far and fast the dollar falls. The issue facing central bankers is a complex one. They may wish to limit their exposure to a weakening dollar, but they don't relish the ugly fallout from doing anything to further weaken it. "We certainly don't think we're at the end of the dollar," Barclay's Englander told TIME. "It's in no one's interests."

One big worry of central bankers is how a softening dollar could impact a global recovery. Countries that have currencies strengthening against the dollar face the prospect that their exports would become pricier in world markets, a situation policymakers wish to avoid as their economies are just now crawling out of recession. China, one of the world's largest holders of dollars, doesn't appear likely to allow its currency, the renminbi, to significantly appreciate against the dollar any time soon, despite increasing political pressure from Washington to do so. China's Commerce Minister, Chen Deming, said at the recent Canton Trade Fair, a major showcase for China's manufacturers, that the "basic stability" of the yuan exchange rate needed to be maintained so exporters can have a predictable business environment. Another source of stability is the difficulty central banks have disposing of dollars they already hold. Dumping dollars on world markets would only depress its value further, undermining nations' own reserves. "Central banks will continue to get out of dollars on the margins, but they don't want to be seen selling dollars hand over fist," Englander says. Besides, with economies weak and interest rates at low levels throughout the industrialized world, there is a lack of better choices. "The dollar may not be attractive, but when you look at the alternatives, nothing is that exciting," says Englander.

These sources of support may not last forever. Warren Buffett warned in a New York Times editorial in August that the unrestrained buildup of U.S. government debt — and the likely need to print money as a result — would inevitably undermine the dollar's value. "Unchecked greenback emissions will certainly cause the purchasing power of currency to melt," the sage of Omaha wrote. "The dollar's destiny lies with Congress." Richard Portes, a professor of economics at the London Business School, believes that central banks will increasingly see other currencies, especially the euro, as more reliable storehouses of value. "The idea that there is no place to go is wrong," Portes says. If that's the case, the dollar better hope it has even more lives than a cat.
With reporting by Yuki Oda / Tokyo