The Dollar: Too Big to Fail?

There is an interesting article in this month’s Financial Planning Magazine which questions how realistic it is for the dollar to “fail” on a global scale. These sorts of articles aren’t unusual these days as much debate takes place over US debt, continued foreign investment, rising gold prices, etc. The article’s main contributor, Frank Wei of FundQuest, argues that the dollar is too important to both the global economy and the financial system for it to experience a sudden collapse. Any further declines, he argues, will be gradual.

Among the major causes for concern by investors right now is the long and continuous period of low interest rates which encourages the printing of new dollars. Because of how many global products are priced in dollars (i.e. oil) a collapse would instantly shock the world in a similar fashion to how systemic risk fears plagued the global equity markets and forced emergency policy action during 2008 and early 2009.
A weaker dollar means inflation, right? Not necessarily. The way Americans measure inflation is primarily through CPI, a measure of the prices of goods and services commonly consumed in our economy. As it currently stands, housing prices comprise roughly 40% of the CPI basket. Unless you believe housing prices will rise sharply during 2010, rampant inflation is unlikely, at least during 2010. Along those lines, the number of Americans struggling to make their ballooning mortgage payments will more than likely curb spending in other parts of the economy during 2010. If consumer spending remains flat, it becomes much less likely we’ll experience runaway inflation.
Next, we have the automatic defenses or “hedges” which surround the weak dollar. For one, US stocks have been rising as the dollar falls against other currencies. This relationship has been dominating the equity markets over the past few months although just recently we’re seeing equity prices rise even with a stronger dollar. As the dollar continues to drop, Asia, Europe and others have been snapping up US goods and services trading at sale prices. The subsequent rise in equity prices is good for the economy, at least in the short run. Second, as the dollar declines, US exports become cheaper, reducing the price of our debt payments. This helps China who can use the proceeds of cheaper exports to offset the potential for losses on US debt.
Even if the dollar continues to decline, which most money managers agree that it will, I don’t see doomsday coming. I mean, how many times have we seen this before? The dollar declined heavily in the 1970’s, the early 80’s and early 90’s. Everybody talked about China and others removing their peg to the dollar during those periods. What ultimately happened? People realized there isn’t an adequate substitute to the dollar and stuck with us. I would imagine the same thing is likely to happen again. Further, even if another currency were to ultimately replace the dollar globally, it probably wouldn’t be in collapse fashion but through a gradual transition. Because the US consumes a tremendous amount of goods and services, the manufacturers of those goods around the world want our economy, and our dollar, to avoid collapse. It would benefit those countries selling finished goods to the US for the dollar to decline at a measured pace rather than suddenly.
Question or comments? E-mail me.
Russell Bailyn

Wealth Management
Premier Financial Advisors, Inc
14 E 60th St. #402
New York, NY 10022
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