US dollar losing ground as world's reserve currency. What does that mean to your children and grandchildren?
May 29, 2013Most of us don't really understand international currency economics. But most of us understand this illustration: Suppose you make five thousand dollars a month. And suppose you have a mortgage payment of a thousand dollars, and car payments of five hundred dollars. By the time you add your insurance, utilities etc. you have, typically about two hundred dollars left at the end of a typical month.
Now suppose you send your mortgage payment in one month and the bank calls you and says you'll have to send the another five hundred dollars or they'll foreclose on your mortgage. Or, they say, alternatively, you can send them a thousand dollars' worth of Chinese yuan. So you go to a currency exchange to buy 1000 yuan. They tell you that you will have to pay $1500 for the yuans. You're back where you started. The next month the auto finance company does the same thing. And the next month the insurance company demands 50% more in premiums to keep your coverage in force.
How are you going to pay these increased payments?
If you are the U. S. Government you might decide to just print more money. But then the bank finds out you're doing that and they demand even more dollars because the dollars you offer them are worth less.
You get the point. You'll go broke.
No one knows at what point foreigners will refuse to accept American dollars or when they will begin to demand more dollars to cover our debts, but at some point it becomes a real problem.
Contrary to what some argue, there is no harm in the government spending more money than it takes in (running a deficit) provided the deficit is not so large that it devalues the currency. That is the real risk America faces, or more precisely the problem your children and grandchildren face.
Jeff Cox, writing at CNBC breaks it down for us:
The U.S dollar is shrinking as a percentage of the world's currency supply, raising concerns that the greenback is about to see its long run as the world's premier denomination come to an end. Click here to read the rest of the story.
blockquote>The U.S dollar is shrinking as a percentage of the world's currency supply, raising concerns that the greenback is about to see its long run as the world's premier denomination come to an end.
When compared to its peers, the dollar has drifted to a 15-year low, according to the International Monetary Fund, indicating that more countries are willing to use other currencies to do business.
While the American currency still reigns supreme -- it constitutes $3.72 trillion, or 62 percent, of the $6 trillion in allocated foreign exchange holdings by the world's central banks -- the Japanese yen, Swiss franc and what the IMF classifies as "other currencies" such as the Chinese yuan are gaining.
(Read More: Hedge Funds Reap Billions on Yen Bets)
"Generally speaking, it is not believed by the vast majority that the American dollar will be overthrown," Dick Bove, vice president of equity research at Rafferty Capital Markets, said in a note. "But it will be, and this defrocking may occur in as short a period as five to 10 years."
Bove uses several metrics to make his point, focusing on the dollar as a percentage of total world money supply.That total has plunged from nearly 90 percent in 1952 to closer to 15 percent now. He also notes that the Chinese yuan, the yen and the euro each have a greater share of that total.
"To the degree that China succeeds in increasing its market share of the world's currency market, the United States is the loser," Bove said. "For years, I have been arguing that the move of the Chinese makes perfect sense from their point-of-view but no sense for the Americans."
For a country with a budget deficit in excess of $1 trillion a year, the consequences of losing standing as the world's reserve currency would be dire.
"If the dollar loses status as the world's most reliable currency the United States will lose the right to print money to pay its debt. It will be forced to pay this debt," Bove said. "The ratings agencies are already arguing that the government's debt may be too highly rated. Plus, the United States Congress, in both its houses, as well as the president are demonstrating a total lack of fiscal credibility."
And hug your children and grandchildren the first chance you get.