The US dollar, which has served as a world reserve currency for nearly 38 years appears to be in jeopardy as far as its status of a reserve currency goes. The world seems not to blindly trust the US dollar any longer for this purpose as its intrinsic value seems to be under challenge. ‘Intrinsic value’ is what seems to hold the answer for this changing trend. While, the US economy was strong and was in a leadership position to consume what the rest of the world produced, the US dollar demonstrated its strength on the back of a strong economy. But, now economic prowess seems to be getting redistributed to nations in Asia. Thus, while as of now there may be no single currency in Asia, which can act as a replacement to the US dollar as a reserve currency, the usage of the US dollar as a reserve currency seems to be under threat.
The latest moves by various nations to move away from the dollar as the main reserve currency became quite apparent, when India swapped nearly 6.7 billion of its dollar holding, with 200 metric tons of gold on sale by the IMF. Alongside, the Chinese have also quietly been beefing up their gold reserves from domestic production. China, which is the largest producer of gold in the world, has reportedly increased its gold reserves by 76% since 2003 to 1054 tons. Alongside, the Chinese and the Russians have agreed to reduce their dependence upon the dollar for trade and use their own currencies instead. Another nation that has increased its gold reserve holding includes Sri Lanka.
However, a US strategic ally like Saudi Arabia has extended its support to the dollar and stated that it will continue to peg its currency to the dollar and that oil trade would continue to be priced in dollars. A declining dollar implies that oil producing nations have to pay more for their non-dollar denominated imports, which is not a very attractive and sustainable proposition for them in the long term.
China, on the other hand finds this an attractive proposition and does not want to let go off the Yuan-dollar peg as a weaker dollar means a weaker Yuan, which in turn makes Chinese exports cheaper and increases their exports. However, this can turn out to be a zero sum game for China as it is also one of the largest holders of US dollar reserves. Any decline in the dollar leads to a depreciation in the value of their dollar holdings, but the peg allows the losses to be annulled due to an increase in exports. However, the Chinese may be quietly beefing up other currency and gold reserves such that proportion of US dollars in their overall mix of their forex holdings eventually becomes smaller. Late developments suggest that even China is considering de-pegging the Yuan to the dollar and working on an alternative currency of baskets for determining the value of their currency.
However, the invisible hand of Adam Smith or the market clearing mechanism works in a way as to correct market anomalies automatically. A weaker dollar is actually helping the US economy by making its exports cheaper and imports more expensive. Thus, the Americans are being forced to produce more for exports and consume less from overseas by the invisible hand of Adam Smith.
All said and done, a strong dollar seems to be the desire of the American government as suggested by the late statements of U.S. Treasury Secretary Timothy Geithner. As per the statement, a strong dollar is necessary for the health of the US economy. However, the case appears to be the other way around. A weak dollar for now can help the US economy reduce its current account deficit by curtailing imports and promoting exports. At the same time, improving exports require higher production in the US, which means generation of employment. Higher employment resulting in greater income and demand can revive the US economy in a more certain way and a weaker dollar is what can do this for the US at this point of time. Thus, the US may need to contend with a weak dollar for some time to come so that its economy recovers and becomes stronger. A stronger economy is what can eventually return the dollar its intrinsic value and perhaps its status as a reserve currency!