Global Watch on US Dollar... Bee is fallen in its own honey pot.

Global Watch on US Dollar... Bee is fallen in its own honey pot.

By

Vikram Mehrotra
Management Graduate
ICFAI Business School
Ahmedabad

In 2007 everyone just discussed about US Dollar, Fed Rates, Gold Bull Run, Euro appreciating and emerging markets zooming like anything. Going back to basics, in economics class we all learnt about central banks and it's functioning. Central banks can create money, fix the price i.e. interest rates.

So, its correct to say US Fed, which supplies the dollar to the central banks of other countries, will decide at what rate will it lend. Means by default US Fed is the central banker for the world. Tracking the current account deficit, Now US must able to attract $7bn dollars every day from the rest of the world in order to finance its current account deficit. In case the inflows to the US slows down or stop, the green back is doomed to fall in value very steeply.

As per IMF (2006) over 65 percent of forex reserve held by all the central banks and 41 percent of global loans are held in US dollar only. Asians are holding large part of US treasury securities, which is close to 57 percent and European nations are holding close to 21 percent. Out of total US equities, European nations are holding 57 percent, 26 percent by western hemisphere nations and 18 percent by Asians.

BIS reported that 43 percent of all forex transactions are in dollar term only; the oil sold by OPEC is also in dollar terms. Thus, it makes US dollar more of a global currency than a US entity and same is the case with US Fed- Its more of a global central bank than a US entity only. Out of the total dollar stock of $800 billion created by US Fed from its birth in 1931,less than one third is only circulated in US and rest more than two third is been exported.

But again going back – How did the US dollar becomes so important entity? In 1950's thanks to Bretton Woods agreement, the greenback becomes the official global currency, and after it collapse there was no alternative was available and US Dollar again regains the status of been the "Official Global Currency".

In 1991 when Cold war ended US took liberalization in a big way and US government opened its market in a big way, thus print more dollars to induce the demand. It printed $400 billion in just 12 years from 1996 to 2007, much more that it printed in last 82 years upto 1995. This is been done just to boost the consumer demand; US Fed cut the interest rates from 8 percent in 1990 to 1 percent in 2001. They were encouraging households to spend more, thus this results in drop in US household saving which eventually turned into negative savings in 2006.

Looking at the US current account deficit which was $300 billion from 1990 to 1999, jumped to $2.5 trillion in from 2000 to 2005. Results in indebted US government and households both.

Vikram Mehrotra
Management Graduate
ICFAI Business School
Ahmedabad

Source: E-mail January 17, 2008