The Fall of the Greenback

In the econosphere these past few weeks, there's been much talk about the imminent collapse of the dollar and how its going to bring about chaos for the U.S and the world. This certainly didn't help last week when the Indian government bought 200 tons of gold to hedge against the global expectations of a falling dollar. And this definitely didn't help when the dollar fell 0.8% yesterday, amidst rallies across most of the major indices around the world.

I don't think that a correction in the value of the dollar is necessarily bad though. This is why: I think that the causes for our recent economic woes, while inextricably complex, can be boiled down to the existence of significant macroeconomic imbalances across the world--much of this has been exasperated by the recent strength of the dollar. For example, a strong dollar helped lead the U.S. to a large current account deficit (as a reminder, a current account deficit is when Imports > Exports). Look at a simplified view of the US-China relationship. Because the dollar was valued so much higher than the Renmenbi (though not as a result of natural market forces, but instead the Chinese government's decision to peg the RMB against the dollar), Chinese goods became cheap relative to America's, and as a result, the U.S. became a net importer and China became a net exporter. Helped by this, the U.S. began to develop a nasty habit of becoming the world's most powerful and extravagant consumers, and as China built up a current account surplus and started to accumulate U.S. dollars, it had nothing else to do with that money except 1) hoard it or 2) invest it (which it did both of--with the latter action being speculated to have helped indirectly worsen some of the real estate bubble over the last decade). Now take this U.S.-China relationship and apply it to most U.S. trade relationships across the world...and you begin to see how huge imbalances led to some of our problems.

A chaotic fall in the dollar would be catastrophic. However, a less extreme correction in the dollar would do great things in rebalancing much of the global monetary system and trade imbalances, because they are so heavily based on the dollar. It would help alleviate our current account deficit, and for once, help our exporters out. As we saw over the recent years, the world economy cannot be propped solely on the extraordinary consumerism of American and a few other large powers--demand needs to come from elsewhere. Rebalancing trade across the world will hurt America's economy in the short term (a fall in the dollar equals higher costs--thus lower demand and a slower recovery). But it will do great things in the long term, such as increase domestic demand in emerging markets (including the powerhouses of China and India), and help our global economy grow in a more stable and consistent manner--of which America, as well as the other countries, will certainly benefit from.

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note: just realized that the above example can't really be extrapolated to represent all of America's trade partners--as China is a special case and one of America's largest trade partners. In this situation, a simple decline alone wouldn't help. The RMB is pegged to the dollar, and so for any good to happen from this situation, Beijing would have to allow the RMB to appreciate relative to the dollar--which does them no good because it horribly depreciates the stockpile of cash that China has been hoarding. This then leads to a whole other problem that US/China needs to deal with...