For quite a few years there has been a steady drum beat of fear over the value of the dollar. For the most part, the fear is unfounded. Almost, but not quite. There are actually three different worries that, in aggregate, create the perception that the dollar is about to collapse. First, people worry about the Feds quantitative easing. The term refers to the Federal Reserve printing electronic money. These worriers imagine the Weimar Republic and people using wheelbarrows to carry their money to the grocery store. Second, quite correctly, people worry that the dollar will lose its status as world reserve currency. This will likely happen, not in favor of the Euro or Yuan, but in favor of an actual world currency. The scenario is that as dollars are not needed to transact international business all the countries will dump the dollar and flood the Forex markets, collapsing the U.S. dollar. Third, people worry that as China releases the Yuan to float to its market value it will cause a panic sell when the dollar falls vs. the Yuan. All currencies are fungible and a drop in the value of the dollar against the Yuan will create arbitrage opportunities in all currencies. This could result in a panic sale of the dollar. OK, despite all of the above, the dollar is not going to collapse, though the future market pressures may mean that a decrease in value is more likely than an increase. There are two reasons for this. First, the Federal Reserve, now that it is not averse to the use of supply manipulation, has absolute control over inflation, which the target around 2%. I wont get deep into this, since it really requires graduate level Econ to understand. Simply put, the Fed buys bonds, so far Treasuries and mortgage backed bonds. This tends to increase inflation and by increasing demand, lower interest rates. It has not, but it could sell bonds which tends to decrease inflation and increase interest rates. By changing the discount rate, it can manipulate the interest rate and while it does tend to increase or decrease the inflation rate, it does not do so as much as buying and selling bonds. By combining the two monetary tools, we are moving to a future where the Fed will be able to manipulate the economy sufficiently to stabilize the currency and, save for extreme events, eliminate the business completely. Two, a Forex collapse of the dollar would be a global economic disaster and would benefit no nation. I favor a World Currency. If Saudi Arabia sells oil to Germany it is silly for the Germans to use their Euros to buy dollars, give them to Saudi Arabia who just turn around and sell them. It makes much more sense for International transactions to be done in a global currency. However, a global currency will not happen without U.S. participation and because nobody benefits from a dollar collapse, the Fed will not be confronted by anything it cant handle. There is also a fear that China will reduce its dollar denominated assets in order to float the Yuan to a natural market value. China is now willing to do that and despite raising the cost of Chinese products in dollars, the U.S.is in favor of it, too. It is inevitable that this will weaken the dollar against the Yuan, the two nations agree to do this deliberately so as to minimize volatility in the Forex markets. So, while the dollar is likely to fall moderately in the Forex markets over the long term, this should be limited to the Yuan. Domestically, while disastrous economic events happen, there is no credible evidence that the Fed is in danger of losing control of inflation. If you see one of these articles forecasting a collapse of the dollar, read the last page first. Almost certainly the punchline is that you need to start buying a lot of gold, which they are ready to sell you.
Posted on: Wed, 03 Dec 2014 15:02:46 +0000
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