Why US Dollar Remains in Reasonably Good Shape

NEW YORK (ForexNewsNow) – The Subprime crisis, political deadlock in Washington, US Federal Reserve Chairman Ben Bernanke’s decision not to launch a new round of quantitative easing, terrible employment figures for Obama- the bad news just keeps on getting worse for the US economy over the past few months, yet despite the negative news the USD remains in relatively good shape.

As the Debt crisis continues to affect global markets, investors, especially forex traders, seem to still prefer dollar over the euro despite the current shortfall’s of both currencies. The market reaction following the weak employment numbers of August’s Nonfarm Payrolls clearly illustrates this phenomenon. Despite an extremely volatile market and a rush towards safe havens such as gold and the Swiss Franc, Forex traders continue to flee away from the euro towards the dollar. Why? Because the European debt crisis appears to be more systemic for the health of the euro than the US Debt crisis is for the greenback.

“As good as gold”

Institutional instability in the European Union could also contribute to the recent failings of the euro, but this is not enough to explain the entire phenomenon. In fact, one must go back to the year 1944 to fully understand what is currently taking place.  During this year at Bretton Woods, the dollar was famously declared “as good as gold”. At this time in history investors trusted the dollar as much as gold, as the dollar was the only robust international currency at the time. At that time one gram of gold was equivalent to $35 (today it is worth $60).

But from the 1960’s on, the US authorities progressively lose control over the creation of liquidities because of the Bretton Woods Paradox: in order to fill its role as the international monetary standard the dollar should be sparse, but in that case, the global economy risks of suffering from a shortage of means of payment, which hinders economic activity and global liquidity.

Yet today the dollar has gradually lost the qualities of a robust international currency -whether under a floating or a fixed exchange rate – but has remained the reference point of the entire global economic system because of the lack of an alternative international currency. Half of world trade is still denominated in U.S. currency and the so-called “dollarization” of emerging economies continues at a ferocious pace in both Asia and Latin America.

No competition

Even today, the US dollar continues to be the strongest international currency, yet this is mostly due to the lack of a better competitor rather than the dollar’s own inherent strength. Other currencies such as the yen, the Swissy, the pound and yuan are simply not strong enough to unseat the dollar and on the forex markets they are viewed mainly as temporary safe haven during the ups and downs of the dollar.

While the euro is gaining power it is still a regional currency at best. While it is the main payment instrument throughout Europe, the Euro must still wait until its global demand proportionally increases with the euro area’s trade surplus before being viewed as a realistic alternative to the dollar outside of Europe. In addition due to recent events, the euro and the yen continue to be weak as both Europe and Japan suffer from a lack of growth, power and confidence.

In contrast, the business world still relies on the United States. And while the trade balance may not be a US-strength any longer – it is still the capital account that matters most. The more capital being produced the stronger the currency. Non-economic factors also contribute to the dollar’s dominance, since the dollar embodies America’s global geopolitical, military, political and socio-cultural dominance of the world. This confidence in America’s power also lends itself to  confidence in America’s currency.

Conclusion

A closer look reveals that the dollar, which has been the unrivaled international currency for almost a century now, did not create the power of the United States but rather reveals its extent. Despite the US Subprime Crisis and the US Debt the dollar remains the lion of the world’s currencies – over the last decade, two thirds of the total allocated foreign exchange reserves of countries have been in U.S. dollars.

So while the dollar may no longer be “as good as gold”, it will remain at the forefront of the world economy until another nation or currency can put an end to the so-called “Pax Americana”.

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