Bellhops aren’t the only ones whose love affair with the dollar is over. Since the dollar’s peak in February 2002, it has now fallen 20 percentage points against a basket of global currencies including the rupee, Canadian dollar and real, with 3 percent of that fall coming in the past three months. Countries all over the world are dropping their local currency pegs to the dollar, and eurobonds are beginning to compete with the almighty T-bill as a reserve currency in places like Russia and Sweden. There’s even a movement to start pricing Brent crude oil in euros rather than dollars. “Are we seeing the demise of the dollar?” asks Hans Redeker, head of foreign-exchange strategy at BNP Paribas. “Quite possibly, yes.”
Not so long ago, that would have been reason for panic. But the disaster scenario of Asians’ dumping the dollar, hastening its fall and triggering a global recession, never materialized—like cripplingly high oil prices, it turned out to be a phantom threat. In fact, the slow and steady slide of the dollar is helping to offset yet another threat—the massive U.S. trade deficit. All this is happening as America sheds its role as the world’s unilateral superpower—something that is turning out to be a good thing, not only for Americans, but also for the rest of the world. The OECD in Paris predicts that U.S. GDP will rise only 2.1 percent in 2007, down from 3.3 percent last year. But the world’s economic picture will be better than what it has been in years, thanks to the resurgence of Europe (led by Germany), the revival of Japan and the growing importance of countries like China and India.
As U.S. growth has waned, developing countries have begun de-pegging their own currencies from the dollar. Three weeks ago Kuwait made the move, following China, Russia, Malaysia and others. By dropping their dollar pegs, emerging economies free themselves from the constraints of U.S. monetary policies that are tailored to suit a slowing economy. This allows emerging economies to set interest rates to hit growth targets, rather than currency values, enabling them to control the risk of overheating. The shift has had several knock-on effects. Countries including Iran, Iraq, Libya, Venezuela and Russia are considering selling their oil in euros rather than dollars, in part for political reasons, but also because some of them (Russia and the gulf nations in particular) tend to buy more of their imports from Europe and lose purchasing power when converting their dollar earnings to euros.
Meanwhile, central banks that are less reliant on dollar moves can begin diversifying away from T-bills, and into more-productive, higher-yielding investments. Arab nations like Dubai, Bahrain and even Saudi Arabia are beginning to pour money once held in foreign reserves into inward investment projects. The Chinese government last month took the radical step of using $3 billion of its vast dollar reserves to buy a 10 percent stake in American private-equity firm Blackstone.
Eurobonds are also heating up, as growth across the eurozone outpaces the United States for the first time in six years, further deepening European capital markets and thus attracting more buyers. Half of last year’s international bond issues were euro-denominated; nearly twice the proportion conducted in dollars, according to the International Capital Markets Association, a London-based trade group. In total, euro-dominated debt now comprises more than 45 percent of outstanding international bond debt, while the dollar makes up just over 36 percent. A recent Deutsche Bank report predicts that the euro will account for 40 percent of the world’s foreign-exchange reserves by 2010, up from 19 percent in 2001, and 26 percent today. That in turn will give Europe new political clout. “Being the world’s chosen reserve currency gives prestige, and colors people’s view of that country [or region],” says Neil O’Brien, director of the London-based think tank Open Europe.
It will also allow Europeans to borrow money more cheaply, even as America’s phenomenally low credit rates rise. As the holder of the world’s most liquid currency, Americans have long enjoyed disproportionately low interest rates, resulting in a yearly savings of some $100 billion a year in borrowing costs relative to the rest of the world. (Charles de Gaulle once referred to this boon as America’s “exorbitant privilege.”) As the world economy diversifies away from the dollar, “Americans are going to lose this privilege,” notes Harvard economics professor Kenneth Rogoff. Economists expect the shift to add about half a percentage point to the average American mortgage bill.
But even as homeowners and greenback-toting tourists abroad feel the pinch, the demise of the dollar will ultimately be a good thing for both the United States and the world. The rebalancing would offset America’s $765 billion trade deficit. It would also help reduce the cost of labor and keep more work at home. The diversification of reserve holdings could also help ease U.S. political tensions with China and the Mideast by diminishing the notion that those countries stockpile dollars in order to retain a competitive trade advantage.
But the most important benefit is also the most obvious—a more balanced global economy. Nearly every major financial crisis of the past two decades has turned on overly rigid exchange-rate regimes (think Russia in 1998 and Argentina in 2000); recent moves to de-peg various currencies from the dollar will help mitigate that risk in the future. Likewise, global growth no longer hinges on just American consumers, but also on Chinese manufacturing, Arab investment and a new Indian middle class. “The world economy is no longer single-minded,” says Holger Schmieding, head of European economics at the Bank of America, summing it up. “It’s not a zero-sum game anymore.” That’s ultimately a welcome change, for bankers and bellhops alike.
