[OPE] Prospects for dollar-dumping?

From: Jurriaan Bendien (adsl675281@tiscali.nl)
Date: Thu Jul 10 2008 - 20:19:12 EDT

Massoud Hedeshi argues in Al Jazeera:

Standard monetary tools such as lowering or increasing interest rates can no longer provide quick fixes to the situation for both economic and political reasons. Raising interest rates would compound the mortgage crisis while lowering it would drive the value of the US dollar abroad even lower. But exercising control over the money supply could also damage the US economy: increasing the supply would lower the dollar's value even more, while decreasing supply would exacerbate the loans crisis. 

In any case, control over the money supply would be anathema to US economic policy given the country's 'addiction' to deficit financing and run-away consumerism in recent decades. So the US Federal Reserve is left virtually helpless. It has, however, tried to help Wall Street by becoming a temporary lender and allow many investment firms the opportunity to avoid bankruptcy. Such an action by the Fed has not happened since the stock market fiascos in the 1930s. The US government, however, can apply one clear fix to the situation - cut back overspending on a massive scale. But this option too is off the table in an election year where 'victory' is being promised in endless wars on 'terrorism'. (...)

In particular, the main currency used for global trade in commodities, the US dollar, has been in steady decline not just against the Euro, but also against most other convertible currencies. (...) the global impact of such a major drop in the value of the dollar is undeniable for two important reasons.  First, most global commodities traders utilise - and favour - the greenback over other currencies, despite a severe decline in its purchasing power. Secondly, most countries - mainly in east Asia and among the major oil and gas exporters of the Arab Middle East - use the dollar as their reserve currency. But they are paying the price. Despite their booming economies and elevated public spending, they are experiencing depreciating terms of trade and rising inflation. More importantly, they have seen the value of their strategic currency reserves drop with the dollar's waning global strength. (...)

World leaders, particularly among major oil and gas producers and those in East Asia and elsewhere with large foreign currency reserves, are coming under pressure to ditch one of the greatest causes of global inflation today - the fast-declining US dollar. 

Though many have been resistant to this idea, sooner or later economic realities will overcome political interests that negate its rationale.  Iran has spearheaded this idea with its own Oil Bourse that trades mainly in Euros and Yen, and by converting its reserves to other currencies. While Iran is already reaping the benefits of these moves, it however lacks the financial muscle to make a real dent in world trade trends.  The country that is most likely to realise this idea with both impact and impunity - and has some outstanding scores to settle with the US - is Russia.  (...)

In this regard, the St Petersburg Times however comments:

Some experts say the [Russian] foreign reserve, which has doubled to $226 billion since November 2004, is simply too large... But if Russia tried to exchange billions of its dollar reserves into euros, the downward pressure on the dollar would further decrease the value of the dollar holdings, defeating the purpose of such a transfer. After all, short-term currency trading is for speculators and traders, not for governments looking for insurance against an economic crisis, Gavrilenkov said. "I see no economic sense in Russia buying more euros than dollars," Gavrilenkov said. The best solution, he said, would be to diversify the foreign currency reserves by adding Japanese yen as Japan's economy stabilizes, and even the Chinese yuan when it floats more freely - that is, when its value starts to depend less on the value of other currencies. One of the biggest wildcards facing the world's capital markets is the possibility that some nations will start selling oil for euros or other currencies, rather than for dollars, which have been the world standard for decades. On Wednesday, President Vladimir Putin said Russia should sell oil and gas in rubles, and leaders in Norway, the world's third-largest oil exporter, have suggested trading oil in euros there. Meanwhile, Iran is in the process of setting up an exchange to trade oil in euros. (...) International observers say it would be hard for Iran to trade oil in euros without the cooperation of the Gulf states, but that could be difficult for them since abandoning petrodollars could be disastrous for relations with Washington. "Such a move will be seen by the United States as close to a declaration of economic warfare, causing the dollar to sink seriously and provoking a chain of events that will profoundly impact on the world economy," Youssef Ibrahim, managing director of the Dubai-based Strategic Energy Investment Group, said in response to questions sent by e-mail. "I do not see it now, but should it happen we would be entering a whole new ball game." http://www.sptimes.ru/index.php?action_id=2&story_id=17544
So whereas a "dumping of the dollar" could in principle occur in the sense of a shift to another currency for use in foreign trade, or in the sense of divestment from the US, this would lower the dollar exchange rate even further, with further negative effects on global trade. In reality, no significant divestment from the US is occurring. But point is, to dump very large foreign holdings of dollar reserves is much more difficult, simply because there would actually have to be buyers of those dollar reserves at dwindling rates, and the US would certainly strongly resist any such a move. That's a real obstacle, and that is why any exit from the dollar in foreign trade, if it occurs, would be most likely a gradual process, occurring through gradual diversification into foreign currency holdings. Thus, a very rapid dumping of dollars is unlikely to occur, except in an emergency situation (another major war for example).

Inexorably, pressure is building up in the US itself for sweeping economic reforms aiming to strengthen "economic fundamentals"...


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