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The U.S. Dollar in Peril

There is a story today in London's Independent newspaper that reports on "secret meetings" among Arab states, China, Russia, Japan and France that have the goal of eliminating the U.S. dollar as the currency for trading oil within nine years.

If true, this would be a seismic shift in the world economy -- and one that would severely diminish the U.S. As you might expect, the anonymously sourced report is being roundly and loudly denied by the named countries, and the denials have been sound enough to slightly delay the dollar's drop today.

But the Independent story is almost beside the point: It marks only the latest example of concern over the fate of the dollar.

Today, the dollar index -- a measure of the currency's strength against the currencies of its major trading partners -- is in the mid-70s. Six months ago, it was in the 80s. Part of that has to do with the stock market rally. The dollar usually trades opposite to stocks and, predictably, the dollar peaked this year in early March, as the stock market was bottoming.

But it's not all the market rally. Nations around the world are losing confidence in the dollar.

"The U.S. dollar is headed for also-ran status and it will continue to lose its value against many other currencies and assets," Miller Tabak equity strategist Peter Boockvar said in an interview today. "The rest of the world wants the U.S. dollar to lose influence, but no one wants it to be abrupt, as it's in no one's interest. An evolutionary process is what is wanted."

The U.S. dollar has been the world's reserve currency since World War II. That means the central banks and financial institutions of other nations hold dollars to pay off foreign obligations, or to influence their currency's exchange rate.

Commodities, such as oil, are priced in dollars, which also spreads the dollar's influence around the world.

In short, the dollar has been the world's currency for decades. But that may be changing, thanks to the events of the past year.

To help stave off deflation and pump liquidity into a seized-up financial system as the crisis escalated last year, the Federal Reserve turned on the money spigot. In the short term, that put lots of dollars into the system, which is good. In the long term, however, each dollar you hold is worth less because there are more of them in circulation.

This leads not only to inflation but to a larger devaluation of the dollar. When U.S. consumers think of inflation, that means higher prices. But when the world's other nations think of inflation, that means what they are owed is worth less. For nations that hold billions in U.S. debt -- for instance, China, the U.S.'s largest creditor, with $585 billion in U.S. debt -- a weakening dollar means that what we owe the rest of the world is getting smaller and smaller.

Imagine you loan someone $100. Then, the value of the currency drops so much, he ends up owing you only $50. That's good for him, but bad for you. You might suggest that the two of you change your loan repayment from dollars to something else, such as gold.

That's exactly what foreign nations have been grumbling about lately, as the U.S. shows no sign of working to pay down its national debt or stop its deficit spending. Foreign nations are telling the U.S.: The dollars you are using are getting so devalued, maybe you should pay your debts to us in something else. And maybe the globe's entire financial system should be based on a currency that's a little more solid.

“The greenback’s fortunes will depend heavily on U.S. choices,” International Monetary Fund President Robert Zoellick said in a speech in Washington last month. “Will the United States resolve its debt problems without a resort to inflation? Can America establish long-term discipline over spending and its budget deficit?”

The possibly shaky oil story in today's Independent is only the most recent data point in this discussion. China really started this whole ball rolling in March, calling for the dollar to be replaced as the world's reserve currency, prompting a quick and panicky response from Treasury Secretary Tim Geithner expressing confidence in the greenback.

But other nations followed. Admittedly, some are fringe players: In September, Iran shifted its reserve currency from the dollar to the euro, a move that is probably more political than economic. In March, Kazakhstan, which actually is a large economy, criticized the dollar and called for the creation of a new currencies it calls the "acmetal" (a coinage combining "acme" and "capital") and the "transital," a transitional currency on the way to the acmetal.

But others are not fringe players. Also in September, Russia said it is fine with the dollar as one reserve currency but said others are needed, as well, a move that would diminish the dollar. Speaking at an international investment summit last month, Russian Prime Minister Vladimir Putin criticized America -- that means Fed Chairman Ben Bernanke -- for "uncontrolled issue of dollars."

Both China and Russia have called for a "global supercurrency," similar but larger in scale to the euro, that would replace the dollar.

In his speech last month, Zoellick said the dollar is in trouble and likely to lose its place to the euro or the Chinese yuan.

“The United States would be mistaken to take for granted the dollar’s place as the world’s predominant reserve currency," Zoellick said. He said the euro provides a "respectable alternative" to the dollar.

What does all of this mean to the U.S. consumer?

"Imagine all the goods that Wal-Mart sources from overseas and how expensive it might get with a depreciating U.S. dollar," Boockvar says.

Or put it this way: Imagine walking into Wal-Mart and seeing Neiman Marcus prices.

-- Frank Ahrens
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By Frank Ahrens  |  October 6, 2009; 1:53 PM ET
Categories:  The Ticker  | Tags: Miller Tabak, Peter Boockvar, Wal-Mart, dollar, inflation  
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Comments

Oct. 6 (Bloomberg) -- Reverse mortgages may be the next subprime crisis, according to the National Consumer Law Center.

If the consumer is using dollars and the consumer choice is eliminated, they can charge what they want in ??? Oil is too high now and the dollar is buying less. Now they want to break the fixed income people. They'll want the fillings out of your teeth for oil next. Natural gas is going down around here. That is good.

Posted by: Dermitt | October 6, 2009 4:08 PM | Report abuse

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