The World's Currency: The U.S. Dollar And Its Future Struggle For Supremacy

Includes: A, CNY, ERO, FXCH, UUP
by: Calder H. Lamb

The US dollar is used at the reserve currency for the rest of the world, but much like the English Pounds Sterling, that dominance might not last forever. With the dollar as the world's reserve currency, the US is insulated from foreign supply shocks, reduces transaction costs in trade, and contributes to the international transmission of US monetary policies. The dollar is likely to continue its global dominance of the currency markets in the near term; however, there are significant pointing towards a reduction in the dollar's world market share.

The transition in the computer industry from one dominant operating system to a few dominant operating systems is comparable to what is occurring in the currency markets today. 10 years ago when you purchased a computer you did not have the option of an operating system, you only got Windows. Now a person buying a new computer has many options to choose from. Like the computer industry in the past, advances in foreign technology and portability have set the stage for three major currencies to duke it out over the next ten years. The Chinese renminbi, the euro and the US dollar are all trying to dominate the global currency market.

The dollar has to overcome a few fiscal challenges if it wants to stay the major currency in the markets. As you can see from the graph of UUP, a fund which tracks the dollar's value, there has been a significant decline recently. US debt is approaching 75% of the national income, which is significant given that the US only raises approximately 19% of national income from taxes.

If this debt continues to increase, foreign users of the dollar will conclude that the US's only way out of debt is by inflating the debt away. If this conclusion is reached by foreign leaders, bankers, businesses and investors then a major collapse in the value of the dollar would occur. Based upon current US fiscal trends, some experts have warned this collapse could occur within the next 3 years.

The Chinese government is currently working very hard to make the renminbi an international currency. A recent and public display of these actions can be observed by the Bank of China offering foreign exchange services to American citizens. The Chinese have many more significant steps to accomplish before the renminbi is truly an international currency, but the Chinese government has shown a strong will to accomplish their fiscal goals.

Simply because the US government ignores the national debt does not mean that the rest of the world will also turn a blind eye. If the US debt continues to increase, there will reach a point when foreign investors, both public and private, will turn their backs on the dollar. Foreigners will conclude that massive inflation is coming, and they will sell the dollar in droves. When the smoke clears, the dollar will have lost the trust of the world, and the exorbitant privilege which comes with being the world's currency.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.