This year the dollar has depreciated against all major developed countries’ currencies and almost all emerging markets’ currencies, including the Turkish lira, with the major exception of the Chinese RMB, which has been re-pegged to the dollar since mid-2008. On Friday, the dollar DXY spot price index, which measures the US currency against a basket of six major currencies, closed at very near its 52-week low. Since 2002, the US dollar DX futures price index has followed a sharp downward trajectory, with a cumulative decline of about 35 percent from its peak, interrupted briefly during the first three months of this year, when rising global risk aversion benefited the dollar as the safe-haven asset.
The Peterson Institute for International Economics has projected that if the US’s gaping budget deficits continue, the current account deficit will rise from a previous record high of 6 percent of gross domestic product (GDP) in 2006 to over 15 percent, in excess of $5 trillion annually, by 2030. The US’s net debt will jump from the current $3.5 trillion to $50 trillion, amounting to 140 percent of GDP. The critical issue now is not whether the dollar’s downward trajectory will continue, but whether its orderly decline might turn into a rout with a sudden massive depreciation, ending in yet another global financial crisis. This is still an unlikely doom scenario. Gold, on the other hand, has appreciated sharply from $734 to $1,116 per troy ounce in spot trading since the beginning of the year. Since 2002, the US dollar gold price has followed an upward trend, rising from around $300, but with significant cyclicality.
The dollar is depreciating due to the combined loose US fiscal and monetary policies, worsened by the heavy overhang of the huge US dollar net foreign liabilities, denominated almost entirely in US dollars. The practically zero short-term US interest rates, courtesy of the overly generous Federal Reserve, have turned the US dollar into a funding currency for carry traders, who borrow lower-interest currencies to invest in higher-interest currencies, practicing risky uncovered interest rate arbitrage. By borrowing and then selling US dollars for other higher-interest currencies, carry traders contribute to the dollar’s depreciation.
The dollar’s role as the primary official global reserve asset is under increasing scrutiny as its value declines relative to other major currencies as well as gold. Since last March, when the Chinese central bank governor questioned the dollar’s reserve currency role (see my column “China challenges US dollar’s dominance,” March 30, 2009), the global primacy of the dollar has become more controversial. Last week, the International Monetary Fund (IMF) released a study titled “The Debate on the International Monetary System,” which underlines the inherent weakness of the present reserve-currency based system that relies heavily on the US dollar: The US runs fiscal and current account deficits to satisfy the growing global demand for official reserves but without a mechanism to force either the US or current account surplus countries, such as China, to adjust. This inherent weakness has been exacerbated by the tendency of emerging market economies to increase their foreign reserves sharply as a self-insurance against the balance of payment crises that had bedeviled them earlier. The IMF study considers and compares several reform options that range from multiple reserve currencies to multilateral assets such as the SDR or an actual new global currency.
But realizing that a fundamental reform of the present system would be difficult if not impossible in the near future, many countries are anxious to diversify their foreign reserves away from dollar-denominated assets, mostly in US Treasury bills. (The estimate of global foreign exchange reserves, at 2008-end, was around $7.5 trillion, with the dollar accounting for about two-thirds.) Their objective is to minimize their future capital losses from the depreciating dollar. Last month, India’s central bank purchased 200 metric tons of gold, worth $6.7 billion, from the IMF, which had put 403.3 tons of its gold stock up for sale in September, to strengthen its financial position and to increase its subsidized loans to poor countries. India’s purchase gave the strongest signal yet of the inclination of central banks and sovereign wealth funds to build up their gold reserves by selling dollars. It signaled the end of the anti-gold position prevalent among central banks, which had been net sellers of gold during the last two decades, reducing gold’s share of global official reserves from 33 percent to 10 percent. Actually, the Chinese central bank, which still has less than 2 percent of its close to $3 trillion reserves in gold, almost doubled its gold holdings earlier this year. Several other central banks have also bought gold in recent months. There is speculation that China, which is believed to hold 70 percent of its reserves in dollars, could buy the rest of the gold on sale from the IMF. The countries with rapidly rising foreign exchange reserves such as China, Japan, Russia, Taiwan, India, Singapore, Brazil and South Korea, also hold a much lower proportion of their reserves in gold than most advanced countries. (Turkey holds about 5 percent of its official reserves in gold.) Therefore, they have relatively high potential demand for gold as the ultimate global reserve asset. That demand, rising faster than supply, is bound to put continued upward pressure on the price of gold in the years ahead. Except for gold bugs, it would be wild speculation, however, to say we are witnessing the gradual de facto return of the gold standard, frustrating US efforts during the last 65 years, especially since ending the dollar’s gold convertibility in 1971, to demonetize gold.
But the growing dissatisfaction with the dollar’s reserve currency role is also fueled by deep resentment toward the exorbitant US privilege of being able to borrow in its currency and to earn seigniorage (profit from money creation) from the global use of the dollar. With its foreign assets primarily in foreign currencies but its liabilities almost entirely in its own currency, the US not only benefits asymmetrically from financial globalization by attracting the lion’s share of global capital inflows but also reaps net capital gains from dollar depreciation, which has been estimated in excess of $1 trillion cumulatively between 2002 and 2007. Sooner or later, the free lunch enjoyed by the US, as the issuer of the principal global reserve currency since 1944, during and after the Bretton-Woods system, will end, with or without the return of the gold standard.
Benzer Haberler 
