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What's Behind the Falling Dollar?

With a barrel of oil near $100 and the dollar falling 16 percent against other currencies, Americans need to understand what's behind the falling dollar and what the consequences will be for them.

by Melvin Rhodes

You wouldn't know the dollar was falling and oil was about to reach $100 a barrel from a recent morning's news program on ABC. There, the "big news" was that Neil Diamond's famous song "Sweet Caroline" was inspired by Caroline Kennedy, daughter of the late President Kennedy.

My local newspaper, the Lansing State Journal, did not enlighten me either. But thanks to the Financial Times, I am aware of the ongoing international financial crisis aggravated by the millions of people defaulting on their mortgages and the consequent fall in the value of the U.S. dollar.

For me, November was very much a case of déjà vu.

It took me back 40 years to when I worked in a British bank. On the third Saturday night of the month television programs were interrupted to tell the nation that the British currency, the pound sterling, was to be devalued by 14.2 percent. In comparison, the American dollar dropped in value by 16 percent in just a few weeks in November.

Forty years ago, currencies had a fixed value, only fluctuating one or two cents either way. Shortly after the devaluation of the British pound, and partly because of it, fluctuating currencies became the norm, with values changing daily. In reality, they can and often do change every second.

A British news item from 40 years ago may not seem all that important today, but there are lessons from it that resonate in today's world news headlines. To understand this fully, we need to go back in time a little further.

A lesson from history

One hundred years ago, the British pound sterling was the international trading (or reserve) currency. A reserve currency must be stable. That's the only way other countries can depend on it when doing business.

Prior to World War I, if, say, China wanted to buy goods from France or Germany, the payment would have been determined in pounds sterling, not in any of the other nations' currencies. Only the pound could be relied upon to maintain its value from the time of purchase until the time payment was received.

Helping with this international standing of the pound was that the currency was on the gold standard. That meant pounds could be exchanged for gold. The Bank of England guaranteed this and Great Britain had the gold to back up its currency, no matter how many people might wish to convert paper into the precious metal. At the time of the Great Depression the British had to take their currency off the gold standard. However, sterling still continued as a major trading currency. By this time, the dollar was also in use for international trade.

Britain was greatly impoverished by World War II, but even after the war the British currency continued to be used for trade within the sterling area. These were mostly countries that had been British colonies and were still doing a great deal of trade with the mother country and with each other. This was roughly one quarter of all the world's countries. The system was advantageous to Britain as the various nations maintained substantial financial reserves in London.

By 1967 Britain was having serious financial difficulties. Manufacturing had declined. To boost the manufacturing sector, the Labour government at the time decided to devalue the currency, thereby making exports cheaper and more competitive.

They could not have foreseen that this decision would lead to the death of the sterling area and the end of the British currency as an international trading currency.

Could the status of the dollar change?

Here we find lessons for the United States today.

Since World War II, the American dollar has been the world's main trading currency. When Ghana, in West Africa, buys oil from near neighbor Nigeria, the oil is priced in U.S. dollars and payment is made in the American currency, not in the Ghanaian cedi or the Nigerian naira.

Neither of these currencies can be used for international trade. They are known as soft currencies; they cannot be changed over a bank counter anywhere in the world. Most nations' legal tender are soft currencies that are not accepted outside their own borders.

A few currencies are known as hard currencies. They can be changed almost anywhere in the world. Included in these are the American dollar, the euro, the British pound, the Canadian and Australian dollars and the Japanese yen. One reason they are hard currencies is that they generally maintain their value and all nations can therefore rely upon them.

Besides being a hard currency, the U.S. dollar is the world's reserve currency. Many commodities, including oil, are priced in U.S. dollars. This is to America's advantage. If the American media is anything to go by, few people in the United States realize the consequences of this changing. But it almost happened the weekend of Nov. 18.

OPEC countries meeting in Riyadh heard some of their members calling for oil to be priced in euros or a basket of other currencies. Only the intervention of the Saudi delegation stopped this from happening. When Rafael Correa, the president of Ecuador, stated that "OPEC needed to sell its oil in a 'strong currency,' he summed up the discontent widely shared by other OPEC members and expressed most volubly by Iran and Venezuela. 'If we continue to trade in a weak currency [the dollar]…we will need to sell more of our oil to buy the same amount of goods and services'" ("OPEC Looks at Switch to Strong Currency," Financial Times, Nov. 19, 2007).

If oil were priced in euros, it would cost Americans more to buy it. Further, if the dollar should ever become a soft currency due to its unreliability, the United States would have to actually pay in euros or another hard currency. For example, that could mean that the United States would have to sell sufficient goods to Europe to buy oil from the Mideast.

Americans have had the luxury of enjoying cheap oil partly because the precious liquid was priced in dollars. Other countries have seen wild fluctuations and shortages of supply because they have not only had to contend with price increases in dollars, but they have also had the problem of coming up with dollars in the first place. The United States could soon have that problem with euros.

Where would the euros come from? Especially now, when, according to Fareed Zakaria in Newsweek, "The United States is the only major country in the world to which travel has declined amid a tourist boom… Every American who has a friend abroad has heard some story about the absurd hassle and humiliation of entering or exiting the United States" ("America the Unwelcoming," Nov. 11, 2007).

What's the root cause?

The root cause of the problem can be summed up in one word, debt. Americans have been overspending for decades, both at the governmental and personal levels. More recently, that debt has been financed by other countries. Only the United States could do this, precisely because the dollar is the world's trading currency. Other countries would accept U.S. dollars as payment for goods and were happy to bank those dollars to pay for their own future needs.

But this is no longer the case. Increasingly of late, there is a realization around the world that those dollars are decreasing in value. Consequently, countries want to divest themselves of their U.S. dollars, but they want to do it slowly, to avoid a panic that might wipe out the value altogether.

That's exactly what China is doing—diversifying into other currencies.

Debt is the primary reason for the present crisis. The subprime mortgage crisis was the trigger, itself a reflection that too many Americans were over their heads in debt.

Perhaps without realizing it, Americans have been guilty of breaking the Tenth Commandment, "You shall not covet" (Exodus 20:17; Deuteronomy 5:21). Coveting is wanting something that doesn't belong to you. Explaining the literal meaning in the original Hebrew, Unger's Bible Dictionary explains coveting as "desire" and "dishonest gain." The Greek means, "The wish to have more." The 2005 Compact Oxford English Dictionary defines "to covet" as "to long to possess something belonging to someone else."

What is unique in all of this is that Americans go forward as if everything will be fine. Blessings are often the other side of curses. Americans by nature are optimistic and a people who pride themselves on Yankee ingenuity. No star seems too high to reach, no mountain too high to climb, no debt too great to overcome! We'll work our way out of this with our business acumen and hard work.

It is much like ancient Babylon taking confidence in its walls. The adversary just found another way of breaching the vaunted security. What about America? Americans must come to recognize that their blessings ultimately come from a source few today have time to think about—Almighty God.

Banks have made it possible, through credit cards and personal loans, for people to live way beyond their means, buying things they want to have whether or not they really need or can afford the items.

Faced with mounting numbers of people filing for bankruptcy to get out from under credit card debt, banks launched a major campaign to get the U.S. Congress to change the law so that it would be harder for Americans to avoid their accumulated debt. This, along with the tremendous increase in adjustable-rate mortgages, has backfired on the banks who are now finding that people struggling to pay their credit card bills and ever-larger mortgage payments are ending up in foreclosure.

America is not the only country affected. According to the BBC, after the United States, the United Kingdom and Australia are the next two countries with the highest amounts of personal debt. All three countries seem set to weather some rough financial storms in the immediate future!

Most Americans seem blissfully unaware of the dollar's decline or of the likely repercussions for them on a very personal level. At the very least, the fuel they need to get to work is set to substantially increase in cost. This will, in turn, affect food prices. Ironically, neither fuel nor food is included when the government reports the core inflation rate, which may be used to determine an annual cost of living increase. Life seems set to get harder for most Americans in the months ahead!

This also gives the U.S. Federal Reserve Bank a headache. Wall Street is calling for a further drop in interest rates, which are set by the Fed at its monthly meetings. However, the rest of the world wants to see interest rates either held or raised so as to stabilize the dollar. This dilemma led to the following front-page news item in the Nov. 17 issue of the Financial Times, "Fed and Markets set to Clash on Rates."

It will be interesting to see whether the Federal Reserve chooses to try to save the dollar and its global role as the world's reserve currency or bows to domestic pressure for relief for debt-strapped Americans and for increased corporate profits. By the time you read this, you may know the answer—and you'll have a better understanding of the long-term consequences of the choice. WNP


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