Photo:Grooble, Creative Commons, Flickr
If you are predicting an Armageddon-style collapse of the once glorious U.S. dollar, it may be time for a reality check. The most recent Economist points out:
The dollar's place as a reserve currency always seems to be questioned when it falls. Weakness in 1977-79, 1985-88 and 1993-95 was each time met with predictions that governments were about to switch their reserves into another currency.
If the dollar has survived previous onslaughts, why are we so quick to dismiss the currency this time around?
Currency traders have been far too eager to declare an end to the dollar's hegemony. Markets, and to a greater extent, the financial press, have been incredibly short-sighted in the current debate over the greenback's status as the world's reserve currency. The short-term factors (subprime, credit contagion, Fed rate cutting cycle, recession etc.) have received a disproportionate amount of media coverage, and many observers have ignored what the bigger picture will look like over the next 50 years.
For example, the population dynamics of Europe and China may undermine the case for the Euro or Yuan to replace the greenback as the world's reserve currency. A young population may mean better prospects for future economic growth, and by this logic, the dollar should continue to dominate. GaveKal, a European-based investment-research boutique, recently released research that shows how the rapidly aging populations in Europe will decimate working populations and increase the governmental financial burden at a pace far faster than in the United States. According to some estimates, Europe's population is expected to decrease from its current 728 million to 658 million by 2050, due to declining birth rates.
Mainland China is facing similar challenges. Due to its one-child policy, China's number of elderly people may triple from 130 million to 400 million over the next five years, according to the Australian Broadcasting Corporation (ABC). Currently one young person in mainland China supports an average of four elderly people.
All else constant, the population dynamics of both Europe and China should weigh on their currencies over the next 50 years, undermining the attractiveness of the Euro and Yuan as global reserve currencies. In contrast, the U.S. stands out as the only leading industrial power with a surging population. Because of immigration and higher birth rates, the U.S. population is now growing 2 to 3 times faster than any other major country, far faster than that of China (which is strongly controlled). Other major countries like Russia, Japan and Germany are already starting to see their populations decline. Recent data shows that the U.S. population has officially topped 300 million. By 2050, some estimates predict that there will be 400 million Americans.
Population dynamics favor the greenback and so does valuation. Why would central banks, having lost out on the chance to diversify out of dollars when a euro could be bought for $0.86, now switch reserves to the Euro when the price is close to $1.50? Some analysts point out that the euro looks very expensive when looking at purchasing-power parity. "So it could be a bad time to swap from one horse to another," The Economist says.
The euro's attractions may be somewhat superficially enhanced at the moment. It has risen sharply in value, flattered by cyclical forces that have favoured it over the dollar. But only a year ago Italy's sluggish economy and fiscal problems inspired talk about a break up of the euro. Just five years ago the euro was considered irredeemably weak.
It worries me that the media has ignored the political instability that may dent the euro over the next few decades. Five years after its introduction we are still in the early days of the euro and much can happen. Many observers would agree that there is growing discord among euro members. The new French president calls for less independence for the European Central Bank, Italy is apparently fighting hard to regain competitiveness and Ireland has had to adjust uncomfortably. Such conflicting views should not be disregarded. Political instability within the Euro-group may also undermine the case for the euro as a reserve currency.
In summation, the dollar may continue to slide, and it probably will, but the media should stop writing a eulogy for the currency.
Disclosure: I don't have any currency exposures.