Is the dollar about to collapse?

Around the world, from boardrooms on Wall Street to kitty party soirees in South Mumbai, one conversational topic is gaining enormous amounts of mind space and chatter power: the feared collapse of the US dollar. But is the greenback likely to melt? And if it does, how will it impact the world? DNA dig out some answers.

Should we dump the greenback? Everywhere, the almighty US dollar has taken a beating. The rupee has gained 5 per cent since this time last year, the euro has gained 18 per cent. Gold has risen in value by 17 per cent against the dollar since the start of the year.

The oil-exporting world is worried, for oil is priced in dollars. The Indian infotech industry is worried. The bulk of its earnings are in dollars. The Chinese are practically paranoid, for they are the world’s biggest lenders to the US. With a $2.27 trillion hoard, most of it held in US government bonds, they are fretting about what a dramatic decline in the dollar will do to their hard-earned assets.

Zhou Xiaochuan, the governor of the People’s Bank of China, wrote in a recent essay that the world needs a new global currency to replace the dollar. If China dumps the dollar, the currency’s value will certainly crash.

That won’t happen, for China is unlikely to shoot itself in the foot. But around the world, from company board rooms on Wall Street to kitty party soirees in South Mumbai, one conversational topic is increasingly gaining enormous amounts of mind space and chatter power: the feared ‘collapse of the US dollar’ and what it means for the world.

Burden of toxic debt

Some of the dollar’s recent losses are, of course, a manifestation of the perceived return to normalcy in the financial world, and a reversal of global capital’s “flight to safety” in the dollar last year at the height of the financial crisis. As appetite for riskier investments returns, capital is moving out of the dollar comfort zone in search of better returns.
But more deep-seated concerns about the structural weaknesses in the US economy — principally, a toxic mountain of debt and the absence of a strategy to overcome it — are giving rise to a chorus of concerns that the dollar is at risk of collapsing and being dislodged from the pedestal of its global reserve currency status.

“The US has significant structural problems,” notes risk consultant Satyajit Das, author of Traders, Guns And Money. “Talk of a ‘collapse’ of the US dollar is premature… (but) the risk is of a major event which triggers a reassessment of the dollar.” What could those events be? “It’s impossible to predict the event that will lead to the tipping point,” says GoldMoney founder James Turk, author of The Coming Collapse Of The US Dollar. “It could be another major bank failure in the US, or when China or other trade-surplus countries stop accumulating dollars…. But once the tipping point is reached, history shows that the currency has less than a year before it collapses.”

Life after the dollar
In the absence of a viable alternative to the US dollar as a reserve currency, it’s impossible to visualise what a world that doesn’t revolve around the dollar might look like, particularly because the debate moves beyond economics to geopolitics. “The path forward is far from clear,” says Das.

Others venture to make short-term predictions. “In the next two to three years, it is highly unlikely we’ll see the dollar replaced,” says Eswar Prasad, senior fellow at the Brookings Institution in Washington. “Over the next decade, though, we would expect to see other currencies play a much more significant role.”

Peter Boockvar, equity strategist at institutional trading firm Miller Tabak, points out that while the “rest of the world wants the US dollar to lose influence, no one wants it to be abrupt as it’s in no one’s interest… An evolutionary process is needed.”

Impact on india

In the short term, economists foresee a further appreciation of the rupee. Crisil principal economist Dharmakriti Joshi stands by a Rs47/dollar forecast for March, 2010, and Rs44-45 a year from now.

Typically, an appreciation in the rupee will negatively impact exports, but will make imports cheaper, dampening inflationary expectations. In Joshi’s estimation, however, the rupee’s appreciation won’t affect exports much as they are demand-dependent, although IT companies’ margins could be impacted.

But commodities and garments exporters are already squealing in anguish. “If the rupee continues to appreciate, our plight will go from bad to worse,” says Rajendra Hinduja of Gokaldas Exports, a garment exporter. “We hope the RBI will intervene.” As a defensive measure, the industry has moved towards short-term currency hedging of 2-3 months’ forward cover, he adds.

There are, however, factors working to moderate the rupee’s rise beyond the short term. “Pullback factors include fiscal uncertainty, monsoon supply-side shocks, and an equity market correction ahead of a Reserve Bank policy rate hike,” says UBS economist Philip Wyatt.

In the meantime, a rupee appreciation may hold some advantage for the consuming class — insofar as it will make imports — and overseas holidays — relatively cheaper. This group is sure to welcome the decline of the dollar. RIP.

(With inputs from Uttara Choudhury)