Dollar demise?
Vivek Sharma
26 November 2007

Jim Rogers, the well known investment guru, is as close to a showman you will get among investment legends. After making his money, roaming around the world first on a bike and then in a car, and re-branding himself as the messiah of commodities, he has now become a born-again Chinese. Like most members of born-again faiths, he is nearly fanatical in his convictions about a future that will be all Chinese.

In line with his convictions, Rogers recently predicted that the Chinese Yuan can appreciate in value as much as three to four times over the next decade or two. If that prediction turns out to be true, going long on the Yuan - or the Renminbi as it is officially called - will be one of the best investment opportunities of our times. Rogers is backing his words with his deeds - he has already sold off his last dollar and has taken all his assets overseas.

Rogers is not an exception, though he is probably the most vocal in shunning the dollar. The greenback has steadily lost ground against other major currencies in recent years. The Canadians celebrated recently when their currency, called the loony in currency trading circles, achieved parity with that of their snobbish neighbours. The Europeans maybe complaining publicly about the loss of export competitiveness, but secretly they must be enjoying the increasing influence of the euro.

But, can we take the demise of the dollar for granted? While weak fundamentals of the US economy and the shift in global economic power to large emerging economies make it likely in the very long term, the dollar decline may not happen as fast as many hope it would be. Here are some reasons why the dollar may survive the doomsday scenarios.

The US will remain on top for some more decades
Even if the large emerging economies sustain their high growth rates in the long term, which won't be easy, the US will remain the biggest economy for at least two or three decades more. Going by the most optimistic projections, China will catch up with the US in total economic output only by 2035. Until then, the US will remain the primary driver of global economic growth. All the talk of global growth having decoupled from the US economy is a bit premature and untested so far.

Yes, the US economy is very likely to go through a rough patch next year and, possibly, the year after that too. But, there is nothing to suggest a prolonged recession and it won't be long before US growth picks up to its long term average of around 3 per cent per annum.

US trade and fiscal deficits are a problem, no doubt. But there is already some improvement on the trade front, as exports receive a boost from the weak dollar, and may get healthier if imports slow down in line with lower economic growth next year. The fiscal situation is alarming, but not beyond repair. With a Democrat in the White House by next year, which appears to be very likely as of now, some of the Bush tax cuts may be withdrawn - which may bring down the deficit.

Currency diversification may not be easy for the rest of the world
The worst scenario one can imagine for the dollar is that, one fine day the Asian central bank heads wake up and decide to dump the dollar-denominated assets they have been hoarding for many years now. Fears of this happening have worsened recently as some Asian countries, especially China, have gradually brought down the proportion of dollar assets in their exchange reserves.

But, beyond a point, currency diversification may prove to be difficult for one simple reason - absorption capacity of competing assets. It is likely that rapidly growing Asian economies will continue to see huge accretions to their forex reserves and they may struggle to find enough non-dollar assets to park the funds. Even if they can find other assets, huge flows will push up the prices of those assets and, beyond a point, make them unattractive to buyers. It is more like large institutional equity investors sticking to large cap stocks as small caps do not have sufficient liquidity.

Another threat to the dollar is the possibility of large oil exporters switching to billing in euros. Earlier this month, Saudi Arabia - a strong US ally - had to fight off a proposal to do so from other OPEC members like Venezuela and Iran. But this move is unlikely to succeed easily as long as the US remains the biggest importer of oil. Surely, the Americans will not pay in euros for imported oil. Why would other large importers like China and India agree to billing in other currencies, when the cheaper dollar has helped them to lower the pain of record oil prices? Venezuela and Iran may continue to make noises, but the dollar billing is likely to remain.

Americans won't surrender the crown easily
Imagine a situation where you can print your own currency, put your signature on it and buy whatever you want from the glitzy new mall that has come up in your neighbourhood. Yes, that is what counterfeiters do and not law abiding citizens like us. But, for a moment assume that it is perfectly legal to do so. The cost of printing a Rs1,000 note should not be more than a hundredth of its face value as these days even small laser printers will give you excellent quality prints. Bartering your currency note for stuff worth a hundred times the cost of producing that note should make you happy, even if you may wonder what a fool your counter-party to the trade is.

This is similar to what the Americans have been doing for many years - before them the British and before the British, whoever. It is one of the many privileges enjoyed by the dominant nation as its currency is the natural choice as the world's reserve currency. The rest of the world will readily accept that paper and give away the fruits of their sweat and toil. It is this exalted position which helped Americans to sustain their consumption binge in recent years, as foreigners chased US treasuries and lapped up the dollar in the process.

The trouble with most of the perks that come with power is that they are all addictive; it is too difficult to make a down shift when the tide turns. It would be naïve to expect the Americans to stand back and watch their currency lose its pre-eminence. Even if they fully know that it is a losing battle in the long run, they will not allow the dollar to be slain and buried without a fight. They may allow a short to medium term dollar decline if it suits them, but surrendering the reserve currency crown is an entirely different ball game.

Peering into the crystal ball
Warren Buffet is not known for his failures. One of his rare fumbles, and probably the costliest in his long career, happened a couple of years back when he tried to pull off what George Soros is famous for - betting against currencies. Soros' legendary gamble against the British pound nearly broke the Bank of England in the early nineties and is rumoured to have earned him more than a billion dollars. But Buffet was forced to cut his losses and exit his short positions in the US dollar when the greenback held ground even when US deficits worsened.

If only he had held on to his positions, Buffet would have made a pile for his shareholders by now. It is not that he has changed his view; he continues to believe that the dollar would keep falling. But now, he is betting against the dollar through a different route - by buying non-US stocks, mostly in Asia.

So, what does the future hold for the still mighty, but weakened and more vulnerable dollar? There is no doubt that the dollar will lose its status as the bully in the currency street and become merely one of the boys. But that decline will be a train wreck in slow motion, not a high speed Formula One crash. The dollar will remain the 'first among equals' among major currencies for many decades. Its burial will only happen when the Discovery channel launches a new programme titled 'The rise and fall of the American empire', probably sometime during the second half of this century.

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