“The world is changing, and the dollar is losing its status,” said Fabrizio Fiorini in an interview with Bloomberg this week. As one of those in charge of the $12 billion Aletti Gestielle SGR in Milan, Fiorini cannot be dismissed as some anti-American crank.
But Fiorini is only one of a legion of financial experts lamenting the dollar’s bleak prospects. So obvious and profound is the dollar’s predicament that CNBC’s Lawrence Kudlow recently felt compelled to pen a piece plaintively titled “Save the Greenback, Mr. President.” On Tuesday Reuters ran an article by James Saft headlined “Dollar Faces a Long Journey Downward.”
The roots of the dollar’s trouble are not difficult to trace. The main culprit is the breathtaking fiscal irresponsibility in Washington, D.C. With deficit spending completely out of control our government has been contracting obligations it cannot meet and the world is catching up with the fact. The fear is that the American government will do what governments almost always do when they find themselves facing an insurmountable debt: They inflate their currency to lighten the burden. This is, of course, a dishonest way to dispose of one’s obligations, because investors are paid back with debased money.
Faced with the prospect of holding increasingly worthless dollars, players around the world are looking for ways to unload the greenback. They have every reason to do so. In the last ten years the dollar has lost one third of its value. The spend-crazy policies of the Obama administration have had an especially aggravating effect. In the last six months alone the dollar is down by more than 10 percent. Bloomberg explains why:
“President Barack Obama’s effort to lead the world economic recovery by spending the U.S. out of its recession is undermining the dollar.”
The move away from the dollar is particularly significant when it comes to foreign central banks which have traditionally held American dollars as their currency reserve. The make up of their reserve balances, however, has been changing in recent months. Steven Englander, who used to work for the Federal Reserve and now is the chief U.S. currency strategist at Barclays in New York, had this to say:
“Global central banks are getting more serious about diversification, whereas in the past they used to just talk about it. It looks like they are really backing away from the dollar.”
Echoing Englander’s point, Bloomberg observed:
“Central banks flush with record reserves are increasingly snubbing dollars in favor of euros and yen, further pressuring the greenback after its biggest two quarter rout in almost two decades.”
The New York Post has reported that in the last three months central banks have placed 67 percent of their new cash into euros and yen. This makes for a shocking reversal, since – given the dollar’s status as the world’s reserve currency – the dollar would normally comprise two thirds of central banks’ currency holdings. At the present moment just above 60 percent of reserves are in dollars. This represents a truly dramatic drop from past levels.
But the central banks are not the only ones backing away. Institutional and individual investors are likewise decreasing their greenback exposure. In June of this year Bill Gross, the manager of the Pimco Total Return Fund – the world’s largest bond fund – advised dollar investors to diversify. He predicted that central banks would do the same before the year is out. Why did Gross think they would do this? Because of the deepening US budget deficit. It turns out Gross’ advice was both sound and prescient. Recently the Congressional Budget Office reported a record $1.4 trillion deficit for the fiscal year that just ended and central banks are indeed moving away from the dollar.
The dollar’s decline means that we are in the midst of a seismic shift. The whole edifice of the global monetary system – which has since World War II been backed by the dollar – is coming apart before our very eyes. It goes without saying that this will have far-reaching consequences, most of which will be decidedly unpleasant. For this we can thank the recklessness of our political class. Greedy to spend more than we could afford, they have pilfered our national wealth and devastated our finances. Sadly, this may not be the worst of it. In the past America used to be a rock of fiscal stability in a shifty and uncertain world. The word of the US government – its faith and credit – was almost as good as gold. This is not the case anymore. Stephen Roach, chairman of Morgan Stanley Asia, articulated this humiliating truth recently. Speaking about how Asian investors view the promises of the Obama administration to bring America’s fiscal house in order, Roach said:
“The most important thing coming from investors in Asia, where I am, is despite all these lofty assurances by U.S. officials that there’s a credible exit strategy from both fiscal and monetary stimulus, they understandably don’t believe it.”
As the dollar’s decline shows all too clearly, Stephen Roach is correct. The world is quickly losing faith in America’s ability to do what’s right. This is surely not the kind change we were hoping for.