Why the Dollar Hasn’t Already Collapsed

MSNBC has a good explanation on why the dollar is still holding up against the other currencies. Even though I’m bearish on the dollar for the next few years, its still a good read. I think the dollar will slide against a majority of foreign currencies including the yen and given that the Japanese real estate market has been flat for 15 years and only just picked up I think its a good time to get into the Japanese REIT market. But thats another post.

By John W. Schoen
Senior Producer

As the U.S. keeps adding billions to its trade deficit, and the government churns out billions more in Treasury debt, several readers are getting a little nervous about the value of the dollar. Just how come it’s not falling?

What I’d really like to know is why the dollar isn’t falling even faster: Given our status as the world’s greatest debtor nation, what is holding it up? And … why are people still pricing oil in dollars, rather than moving to a currency issued by a more solvent country, e.g. the yen, yuan or euro?
C. P. — Houston, Texas

There are certainly plenty of economists out there who will tell you that the dollar is headed for a fall. If the rest of the world stops buying our IOUs, the Treasury Department would have to keep raising interest rates until it could find buyers. That could, in theory, throw the U.S. economy into tailspin.

But for all its vulnerability, the U.S. dollar is still the most powerful currency in the world. And one big reason is that the U.S. economy is still the largest and most resilient in the world.

China, though it is growing more rapidly than either Europe or the U.S., logged $8.9 trillion in 2005 GDP. But China only recently began to gently unhook the yuan’s “peg” to the dollar — it remains to be seen what will happen when that currency tries to stand on its own two feet. And while the Chinese economy is growing rapidly, it’s not at all clear how long such rapid growth is sustainable. If they have a recession over there, it’s going to be a doozy.

Globalization no doubt puts added strains on the greenback. But we’ve seen this movie before. In the mid-1980s, the great Asian economy was Japan. As its economy surged, the value of the dollar against the yen was cut in half from March 1985 to March 1988.

The yen surge touched off a wave of hand-wringing on U.S. editorial pages amid fears that the days of the American economic supremacy were numbered and the dollar would be knocked off its perch as the global currency of choice. With all those swollen yen, Japanese buyers began snapping up U.S. real estate. When Mitsubishi bought Manhattan’s iconic Rockefeller Center in 1990, it seemed to some that the worst fears of the dollar’s twilight were being confirmed.

Five years later, with Japan’s economy in shambles, Mitsubishi couldn’t make its payments and basically turned over the keys to the holder of the mortgage. Today, Japan is finally digging itself out of a depression that’s gone on for more than a decade.

True, a U.S. trade deficit now running at an annual rate of $776 billion, on track for a fifth straight record year, is troubling. But you can also view that trade deficit as a huge vote of confidence by the rest of the world — which is still willing to take our Treasury bills in payment for its goods. No one places near that much faith in the economies of Japan, Europe or China.

It’s also why oil traders still want to be paid in dollars when they sell their barrels. The surge in oil prices is a big reason the dollar has take a beating — and the trade deficit has swollen. And anything that pumps up inflation hurts the dollar because it erodes the purchasing power of every one in your pocket. But the recent slump in oil prices should help the dollar perk up.

U.S. gross domestic product — which is basically the value of all goods and services produced here — came to about $12.4 trillion in 2005, according to the CIA Factbook. (To arrive at that GDP number, you add up all spending by consumers, investors and government agencies — then add the value of exports and subtract the value of imports.) That represents about a fifth of the total worldwide. So one out of every five dollars in global economic value is created in the United States.

Total GDP for Europe was roughly the same ($12.2 trillion). But though it relies on a common currency, the European economy is nowhere near as unified as the U.S. — thanks to the 25 separate economic policies pursued by its member countries. And, as anyone who has tried to sell a product across Europe has learned the hard way, marketing in 20 different languages at once can get expensive.

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