Threat to Dollar as the

Threat to Dollar as the World's Reserve Currency And Its Implications The United States' administration has been putting pressure on China over the last two years to float or revalue its currency. The U.S. Senate joined in by passing a bill in April this year, threatening China with a 27.5% tariff on all U.S. imports from China unless the yuan is allowed to float. A recent article in "Asia Times Online" opines that though referred to by the U.S.

administration as "yuan revaluation," what Washington is really "begging" Beijing for is dollar devaluation. (Gundzik, para on "Dollar devaluation, not yuan revaluation") Such devaluation of the dollar, which has already fallen over 30% in the last three years, is likely to end the dollar's long reign as the world's reserve currency. This paper explains how the dollar and U.S. economy has been able to retain their number one status in the world thus far and the implications of the dollar's loss as the world's reserve currency.

By most accounts, the primary reason why the United States still remains the world's leading economy and is able to support an increasingly unsustainable trade deficit is because of the U.S. dollar's status as the world's reserve currency. The dollar became the global reserve currency after World War II because America's exports flooded the world, and the profits from its exports allowed the country to become the world's greatest lender and the number one economy in the world.

Over the last few years, the situation regarding the exports has completely reversed. Now, some of the major trading partners of the U.S. have taken over as the leading exporting countries, resulting in a gargantuan trade deficit in the U.S. economy. The U.S. trade deficit has been rising steadily for the last few years: from $549 billion in 2003 to $617 billion in 2004 and expected to cross $700 billion in the current year.

The only reason why the United States has been able to sustain such a large trade surplus is because the rest of the world, mainly the Asian central banks have been willing to invest in U.S. dollars in order to prevent their own currencies from appreciating and to support their own export-led growth despite the risk of future capital losses. The absence of an alternate currency that could perform the role of a reserve currency is another factor in the continued support of the dollar.

The willingness of the foreign central banks to continue lending money to the U.S. has enabled Americans to sustain their consumer economy and to live beyond their means. The profligate nature of the American consumers is reflected in the personal savings rate in the U.S. (about 1% of disposable income) as compared to over 40% in China. (Gundzik, Para on "Consumption vs. investment") However, indefinite support of the rising U.S. current accounts deficit by foreign banks is unlikely. Private foreign investors have already stopped investing in the U.S.

since America now has the lowest real (in fact negative) interest rates in the world and over-valued stock and real estate markets. The Asian central banks have been making noises about diversifying their foreign exchange reserves that are almost exclusively in U.S. dollars. They now have an alternative currency (the Euro) that can perform the role of a joint reserve currency.

Most of all, the Bush administration is itself undermining the dollar's position as the world's reserve currency by not being overly concerned about its further devaluation, whose value, according to some analysts could be halved if the foreign central banks stop supporting it. The loss of the dollar's status as the global reserve currency would force America to live within its means. It would result in an economy in which consumption is limited by domestic production, and its borrowing is capped by its.