Why the dollar is falling
On Tuesday October 20th, for example, the dollar index had slipped to 75.24, its lowest point in more than a year.
This hardly constitutes an outright collapse, nor is it necessarily cause for concern. American exporters, whose goods have become more competitive abroad, are happy with their weaker currency. Similarly domestic producers may be cheered that rival, imported goods are more expensive. And European tourists, who can buy more for their euros during weekend shopping excursions to America, may cheer too. However, the continued decline of the dollar does come against a backdrop of ominous murmurs from the likes of China and Russia, who hold much of their reserves in dollars, about the need to shift their reserves out of the greenback. Brazil’s imposition of a 2% levy on portfolio inflows is also a sign that other countries are getting nervous about seeing their currencies rise against the dollar.
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But it is hard, also, to think of a parallel in history. A country heavily in debt to foreigners, with a government deficit it is making little headway at controlling, is creating vast amounts of additional currency. Yet it is allowed to get away with very low interest rates. Eventually such an arrangement must surely break down, bringing a new currency system into being, just as Bretton Woods emerged in the 1940s.
The absence of a credible alternative to the dollar means that, despite its declining value, its status as the world’s reserve currency is not seriously under threat. But the system could change in other ways. A world where currencies traded within bands, or where foreign creditors insist on America issuing some debt in other currencies, are all real possibilities as the world adjusts to a declining dollar.
The issuance of USA government debt of any significant size in other currencies would be an amazing event, to me. However, that does not mean it won’t happen. In my opinion it is hard to justify the non-collapse of the dollar, and has been for quite some time.
The huge future tax liability imposed over the last few decades along with the failure to save by those in the country creates a hollow economy. Granted the USA had a huge surplus of wealth built up since the end of World War II. The USA has to a great extent sold off that wealth to finance living beyond the productive capacity of the country the last 20-30 years. But that can only go on so long.
The only thing saving the dollar is that other countries do not want the dollar to decline because they don’t want the competition of American goods (either being sold to their country or for the goods they hope to export). So they intervene to stop the fall of the dollar (and buy USA government debt). That can serve to artificially inflate the dollar for some time. However, eventually I think that will collapse. And when it does it will likely be very quick. The idea of the USA issuing debt in other currencies seems crazy now. It could then go from possibility to necessity within months.
You cannot print money forever to live beyond your means and have people accept it as valuable. The government can runs deficits if the citizen’s finance that debt with savings: and still maintain a sound currency. But the recent period, given the macro-economic conditions, don’t justify the value of the dollar. It should have fallen much further a long time ago. The other saving grace for the dollar is few large economies have untarnished economies. The Euro has strengths but is hardly perfect. The Chinese Renminbi is possibly the strongest contender but the economy is still very controlled, financial data is untrustworthy, political freedom is not sufficient… The Japanese Yen does have some strengths but really their long term macro-economic conditions is far from sound.
In the current economic environment investing in currencies is one way to look for higher returns and even to diversify and hedge your portfolio using forex trading strategies.
Related: The USA Economy Needs to Reduce Personal and Government Debt – Let the Good Times Roll (using Credit) – Federal Reserve to Buy $1.2T in Bonds, Mortgage-Backed Securities – Who Will Buy All the USA’s Debt?
Chart showing government debt as a percentage of GDP by Curious Cat Investing Economics Blog, 
Chart showing loan delinquency rates for real estate, consumer and agricultural loans for 1998 to 2009 by the Curious Cat Investing Economics Blog,