Unit 4 Macro: Exchange Rate Economics - Where next for the US Dollar?

Is the US dollar going to be knocked off its perch as the only true global currency? Professor Barry Eichengreen, the author of Exhorbitant Privelege argues that there are strong reasons to believe that the US dollars’ position in the world financial system will decline in the years ahead.

The US dollar has been for many years the world’s most powerful currencies but this power seems to be waning as other currencies rise in significance and the US economy struggles to recover from their financial and economic crisis and the fiscal challenge. Eichengreen argues that there will be three truly global currencies going forward - the dollar, the Euro and the remnimbi.

Influences on the external value of the US dollar

1. Multi-polar world economy - there are different centres of growth now and the size and impact of the economies of emerging market fast-growth countries is changing the landscape of the currency markets

2. Trade: The US Dollar is accounting for less of the annual value of world trade year by year and a smaller percentage of foreign currency reserves held by central banks

3. Convertibility and transparency: It is now much easier to exchange currencies and convert into others - several monies can compete on the global stage and immediate real time information gives traders instant data on macroeconomic performance. Just last week there was news of an agreement between China and Japan to facilitate full currency convertibility between the two countries (read: China and Japan plan direct currency exchange agreement) See also: China to make more yuan currency available for trade

4. Slower growth for the USA: There are deepening worries about future trend growth in the US economy causing a structural decline in the size of the US economy in the global economic system. High unemployment rates and the prospect of years of fiscal austerity are two key factors behind slow GDP growth forecasts

5. BoP: The USA continues to run a persistent current account deficit – will it always be able to finance this through capital account surpluses?

6. Politics: Political gridlock in the USA (a dysfunctional political system) will constrain macro policy options and undermine financial market confidence in the US economy in setting the stage for a durable recovery

A depreciation of the US dollar would clearly help to improve US export competitiveness and perhaps provide a boost to their economic growth rate in the short term. But international holders of US dollars might get very nervous of the risk of capital loss if depreciation became a rout.