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Dollar versus Euro

"The dollar is not what it used to be. Over the past three years it has fallen by 35% against the euro and by 24% against the yen." writes The Economist (HT: Influx):
America has habits that are inappropriate, to say the least, for the guardian of the world's main reserve currency: rampant government borrowing, furious consumer spending and a current-account deficit big enough to have bankrupted any other country some time ago. This makes a dollar devaluation inevitable, not least because it becomes a seemingly attractive option for the leaders of a heavily indebted America. Policymakers now seem to be talking the dollar down. Yet this is a dangerous game. Why would anybody want to invest in a currency that will almost certainly depreciate? (...)
America's current-account deficit is at the heart of these global concerns. The OECD's latest Economic Outlook predicts that the deficit will rise to $825 billion by 2006 (6.4% of America's GDP) assuming unchanged exchange rates. Optimists argue that foreigners will keep financing the deficit because American assets offer high returns and a haven from risk. In fact, private investors have already turned away from dollar assets: the returns on investments in America have recently been lower than in Europe or Japan (see article). And can a currency that has been sliding against the world's next two biggest currencies for 30 years be regarded as "safe"?
In another for subscribers only article (excerpt at European Tribune), The Economist explains: "Contrary to popular perceptions, America's economy has not significantly outperformed Europe's in recent years. And to achieve this not-much-better-than parity, America has had to pump itself full of steroids."

The Foreign Policy Magazine lists the news that "Petro Powers Drop the Dollar" as one of the "Top Ten Stories You Missed in 2006:"
If you thought record oil prices this year were a pain in your wallet, there’s more bad news on the horizon. The latest Bank for International Settlements quarterly report, which tracks the investment trends of oil-producing countries, indicates that Russia and OPEC countries are moving their holdings out of dollars and into euros and yen. OPEC cut its holdings in the dollar by more than $5 billion during the first and second quarter of 2006. And Russia now keeps most of its new deposits in euros instead of dollars. That decrease is swift and significant—and helps to explain why the dollar recently fell to a 20-month low against the euro and a 14-year low against the British pound. Holding dollars while other currencies gain strength means less profit for oil producers. But if they rapidly divest themselves of dollars, it may weaken the currency and push up inflation in the United States. "This new trend may be bigger trouble for the United States than high oil prices and surging Chinese exports," says Nouriel Roubini, a professor at New York University’s Stern School of Business. If this year’s move away from the dollar is a sign of future thinking by oil producers, the pain felt at the pump may soon be the least of our worries.
The other Top Ten Stories You Missed in 2006 include "Iran and Israel Hold Secret Talks" and "United States Funds the Taliban."

Endnote: "German business confidence soars" titles the Financial Times:
"German business confidence has unexpectedly surged to the highest level for at least 15 years, highlighting the strength of Europe's largest economy despite a stronger euro and a big VAT hike looming next month." Will this business confidence last? I doubt it. Will the US dollar continue to be the world's main reserve currency? Probably yes, but not as dominant as it used be. What do you think?

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2020 on :

Since WW2 America's military budgets have never fallen back to any pre-war levels, in other words: America's economy got used to war-time growth. Problem is that investments in tanks, carriers and nuclear weapons generate security only but no profits - and that the investment in security is always financed through bonds. If you de facto have a war-time economy you shouldn't be surprised about the consequences, large budgets, larger deficits, inflation but also larger economic growth (but you better don't have a look at volume comparisons between bond and stock markets). The world participates in America's investments in security by buying these bonds for the promise of security and dividends and it is self-evident that the markets anticipate the secure future lack of profits with declining currency rates. Under more peaceful conditions, the 'peace dividend' could be shifted into the exploration of space, with Mars as the glittering price for investors. In the end, such an investment could do more for peace and mankind's security and market places than anything else.

Anonymous on :

Hmmm, seems to me that I have heard this analysis before. It makes sense theoretically. Comparing the US with the continental European countries we can see that the US has spent a larger proportion of it's GDP on 'useless' military spending and a much smaller proportion of GDP on 'social investment' for at least the last 30 years. Therefore they should be burying the US by now. A beautiful theory that is, but it's been slain by a brutal fact - that the continental countries are NOT outpacing the US economically or in almost any other way. There is very little evidence that welfare states ('social' investment) are a productive form of investment. What evidence exists seem to lie in Sweden and Denmark. Even in those countries the exvidence seems to be equivocal. One lesson from the Nordic states seems to be that working welfare programs must 'build muscle' in the recipients - they must demand much of the recipients. Just issuing a cheque will not do. Military spending certainly is not a particularly productive form of investment - but people working in defense industries do build job skills and life skills - which frequently are of use in the civilian economy. I have seen it personally. In comparing the two forms of 'waste' (social 'investment' and military 'investment') I think we need to look at the total scope of wastage as well as the programs themselves. If an continental Eu country 'wastes' 12% of their GDP on unproductive 'social' investment (and 1% on the military) and the US wastes 5% on social 'investment' and 3% on military 'investment' the result is that the US wastes 8% in total to the EU country's 13%..... Which is more efficient?

Pat Patterson on :

"Since WW2 America's military budgets have never fallen back to any pre-war levels..." and rightly so considering that prior to 1940 the US spent less than 1.5% of its GDP on the military. While during the war 32% of GDP was spent on the war effort. Immediately after the war less than 2.5% to 3% of GDP per year was spent until 1952-1954 when there was a short but large uptick to 10% due to the Korean War. In 1949 the creation of NATO bound the US to spend around 3% of GDP which meant that the so-called peace dividend had already been spent on the national highway systems and education had been spent. Further cuts at that point would have elicited howls of protest from the other members of NATOand an increase in the temptation to appease both the domestic hard left and the Societ Union through some kind of rapproachment. The US can spend huge amounts on the military simply because it has the money to do so. In 1946 the GDP was $222.6 billion yet by 2005 the figure had gone up 56 times to $12,455,825 trillion. If the definition of war time spending is 3% then I will have to concede the point but I don't think that's accurate or desirable. The last point would be in that indeed the US receives no direct return on investment as in say a dollar back for every bullet used. But I'm sure that General Dynamics, Rockwell, Raytheon, Chrysler and even EADS would dispute that the taxes they pay on their munition profits account for nothing to the economy. Plus investment in creating the internet, GPS, and much of the dual use space technology has hurt the US economy.

Pat Patterson on :

Last sentence should read, "Plus investment in creating the internet, GPS, and much of the benefits of the dual-use technology of the space program has not hurt the US economy."

joe on :

It is always a bit difficult to respond to a comment such as 2020’s which is spun in such a way as support a point of view that totally disregards facts. Defense spending when compared over time and between nations is expressed as a percentage of GDP not in monetary terms. During WW2 the US was spending more than 35% of its GDP to defeat Germany and Japan. Today defense spending is under 4%. Even within the US government defense outlays as a percentage of federal outlays continue to decline and are now at 19.8%. 2020’s statement therefore could have been made about any nation. As for the both the trade deficit and current account deficit one has to ask so what. Both of these deficits continue to be lighting rods for journalists and politicians and the uninformed. I had to smile at the comment of rampant borrowing which of course it less than the major economies of Europe and Japan when compared again to GDP. Then again this is supposed to focus on the shortfalls of America. Of course, if General Accepted Accounting Principles were used by all nations, one would find that most democracies are in fact bankrupt

influx on :

This just in: http://www.iht.com/articles/2006/12/27/business/dollar.php

joe on :

Not being from the 2020 or Gunter Glass School of journalism, it is interesting to note the facts contained in the report released last Friday by the IMF. It seems the 114 central banks which make up the IMF increased their reserve dollar holdings. This seems to be at odds with the gloom and doom from M$M and the glee of many of the comments. But one should never let facts get in the way of bashing the US. Link: http://online.wsj.com/article/SB116775028297464889-search.html?KEYWORDS=lindenmayer&COLLECTION=wsjie/6month

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