Stop Writing Eulogies for the Dollar

If you are one of those predicting an Armageddon-style collapse of the once glorious U.S. dollar, it may be time for a reality check.The most recent issue of The Economist magazine points out that "the dollar's place as a reserve currency always seems to be questioned when it falls. Weakness in 1977-79, 1985-88 and 1993-95 was each time met with predictions that governments were about to switch their reserves into another currency." If the dollar has survived previous onslaughts, why are we so quick to dismiss the currency this time around?

I'm not suggesting the greenback is about to bottom, but I do believe currency traders have been far too eager to declare an end to the dollar's hegemony. I also believe markets, and to a greater extent the financial press, have been incredibly short-sighted in the current debate over the greenback's status as the world's reserve currency. The short-term factors (subprime, credit contagion, Fed rate cutting cycle, recession etc.) have received a disproportionate amount of media coverage, and many observers have ignored what the bigger picture would look like over the next 50 years.

For example, the population dynamics of Europe and China may undermine the case for the Euro or Yuan to replace the greenback as the world's reserve currency. A young population may mean better prospects for future economic growth, and going by this logic, the dollar should continue to dominate. GaveKal, a European-based investment-research boutique, recently released research that showed how the rapidly aging populations in Europe will decimate working populations there and increase the governmental financial burden at a pace far faster than in the United States. According to some estimates, Europe's population is expected to decrease from 728 million now to 658 million by 2050, due to declining birth rates.

Mainland China is facing similar challenges. Due to its one-child policy, China's number of elderly people may triple from 130 million to 400 million over the next five years, according to the Australian Broadcasting Corporation [ABC]. Currently one young person in mainland China supports an average of four elderly people.

Holding all else constant, the population dynamics of both Europe and China should weigh on their currencies over the next 50 years, undermining the attractiveness of the Euro and Yuan as a global reserve currency. By contrast, the U.S. stands out as the only leading industrial power with a surging population. Because of immigration and higher birth rates, the U.S. population is now growing 2 or 3 times faster than any other major country, far faster than China's (which is strongly controlled). Other major countries like Russia, Japan and Germany, are already starting to lose population. Recent data has shown that the U.S. population officially topped 300 million. By 2050 there will be 400 million Americans, by some estimates.

Population dynamics favor the greenback, and so does valuation. Why would central banks, having lost out on the chance to diversify out of dollars when a euro could be bought for $0.86, now switch reserves to the Euro when the price is close to $1.50? Other analysts point out that the euro looks very expensive when looking at purchasing-power parity. "So it could be a bad time to swap from one horse to another," says The Economist magazine. "The euro's attractions may be somewhat superficially enhanced at the moment. It has risen sharply in value, flattered by cyclical forces that have favoured it over the dollar. But only a year ago Italy's sluggish economy and fiscal problems inspired talk about a break up of the euro. Just five years ago the euro was considered irredeemably weak."

It also worries me that the media has ignored the political instability that may dent the euro over the next few decades. Five years after its introduction, we are still in the early days of the euro and much can happen. Many observers would agree that there is growing disharmony among the euro members. The new French president calls for less independence for the European Central Bank, Italy is apparently fighting hard to regain competitiveness and Ireland has had to adjust uncomfortably. Such conflicting views should by no means be disregarded. Political instability within the Eurogroup may also undermine the case for the Euro as a reserve currency.

The dollar may continue to slide, and it probably will, but the media should stop writing a eulogy for the currency.

Comments

[Douglasheld]

I'm surprised the Chinese one-child policy creates more elderly people!

[the finalhorseman]

i wouldnt let this convoluted logic worry you...the author seems to deal primarily with the next century. this would be roughly 92 years from now...unless my math is wrong.

[Ivo Cerckel]

There are two articles in The Economist.

Are you not overlooking the fact that The Economist says in the second article that the dollar has lost its status as a store of value - at least, recently.
(“Losing faith in the greenback”, The Economist, December 01, 2007. 77, p. 78)

[the finalhorseman]

since you will undoubtedly out live me, you have a valid point...somewhere.

100 years from now, nothing matters much.

however, common sense also says: the dollar lost about 1/2 its value to the euro.

as our beloved helicopter ben continues to melt down the printing presses, do we suddenly turn into zimbabwe or post war germany?

will dollar bills be more useful and cheaper than toilet paper?

the answer works only if we also can print money in our living rooms. unfortunately, the treasury department frowns on this type of activity.

as i dont think i will feel comfortable living in leavenworth, i will heed the law.

unless you have an unlimited potential for amassing dollars, you may wish to reconsider what you just wrote.

[MartinLowenthal]

Great piece. Read my piece called 'when supermodels opine' at www.lompie.blogspot.co... or at Tading, Investing and a look into the future.

[huangjin]

Nice summary of the long-term trends that will overwhelm the short-term trends pushing the dollar lower. Another thing to consider is taxation and regulation. Even the Democrats in Congress want to lower the corporate income tax at least to European levels.

I think you are right to highlight problems with China, but there's a lot of room to grow. The best case you make is with the Euro. Every problem cited for the U.S. dollar—aside from the trade deficit (which is over hyped anyway)—is worse for the Euro. I don't know why people are talking about 100 years from now, these problems will manifest themselves by 2020.

[Brian Croner]

728 million in Europe right now. America has 300 million. Europe is on the decline in population. America is on the increase. China claims their population problem is taken care of by 2030.

I'll add something. I read (if I'm correct) that China rewards rote memory capability over critical thinking skills. America is corrupt as hell, but a lot of different minds can trade equity for thrice the average income. Garbage trap minds are useless in engineering disciplines. I'm about broke right now, but I'm slated to enter the upper class in a couple of years for some work I've done because I encountered an opportunity to choose between focusing on what I was doing or pursue a very risky goal, and chose the path less traveled. Generally, in China, unless you're among that 1% that makes it to the best school (Peking University), either make it to secondary school and accept it, or learn to retread tires.

I can see how a barrista serving coffee should probably earn enough to live on. Triple his or her pay and that's closer to reasonable ($20 an hour or so). Out in Turkey girls work coffee shop jobs and get really reasonable pay- enough to live on. However, they get very comfortable with a stagnant equity development capability. They don't have much incentive to pursue a diverse skill set.

I also heard that in Sweden everything is handed to you. That's my idea of an ideal country. But this is not the first time I've heard that Europe has a rapidly aging population and is facing a severe skilled talent shortage of about 20 million able-minded highly-skilled workers.

Now my understanding is that capitalist expansion carries with it an expiration date on the system. It's a very vicious system, but in so being has a greater capacity to survive among other systems (where you find other vicious systems). My question now is how Europe affords to treat its young people so well yet is able to guarantee its older people such a strife-free retirement.

Italy certainly does seem to need to be schooled on how to do an economy right. 3 hours of ciesta luncheons with a party every night and maybe 4 hours of work during the day is as much as I heard about the Italian work ethic. Switzerland seems to enjoy its influx of Italian migrant workers to do their work for them. As happy as the bowls of pasta and bottles of red wine sound, the party's got to come from somewhere.

What the hell is going on in the rest of the world out there? I thought America didn't have its act together.

[huangjin]

Anonymous, your numbers are wrong. All of GDP is "profit" in the sense you are speaking of it. The U.S. can handle a lot more debt, perhaps double or even triple the current amount. Not that it would be prudent, or that there are even enough places to invest that money, but based on output, it can afford it.