| Strength of the dollar |
Two spin offs of the crisis was the sudden strengthening of the dollar against other currencies. This was actually quite strange for two reasons. The dollar had been in long term decline before the US financial crisis. It had been losing its value so consistently that OPEC was considering moving its reserves away from the dollar regime.
The process should have accelerated since the financial crisis had its genesis in America. The second reason: the financial crisis is going to completely unhinge US fiscal policy. The government is expected to run off deficits that would saddle it with debt for years to come.
Why then the rise of the dollar? The answer lies in the fact, that though US markets have crashed, they have fallen less than other stocks markets. The Indian stock market for example lost more than 50% of it value. The Russian stock exchange had to be closed several times to stop the slide in the stock prices. Stocks markets around the world saw similar crashes. The US economy thus remains a safer bet in periods of crisis. America FIIs were pulling out money from stock markets around the world, to meet their financial obligations which were for the most part in dollars.
Despite the fact that the US has been steadily losing its financial clout, a process that would be accelerated after the financial crash, it still remains as the world’s growth engine. Its consumers fuel the economies of countries around the world.
If the US economy slows down, the results would be disastrous for the world at large, and not just for the US. China, possibly the second most important nation in the world today in economic terms, would see a significant decline in its GDP if exports to the US were to stop. The trouble with China is that the recession in setting in before the habit of spending was properly wired into its public. The same can be said about other developing nations; the virtues of thrift, hard learnt during the period of economic stagnation, is difficult to shake off. It certainly won’t happen during a recession.
What this means is that, in the aftermath of the crisis, the world would potentially be worse off than the US, because of its dependence on the US economy. The dollar therefore is the currency of safety.
How this scenario would pan out, once the counties around the world set the process of decoupling from the US economy in motion, as China intends to do, is anyone’s guess. But certainly, the Fed’s recent move to print dollars to tide over the current situation represents a long term risk to the dollar’s strength.
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