The Hindu Business Line : The mystique of dollar

In the humdrum of life, it is not uncommon to find people joining the villain’s camp after unsuccessfully resisting him. Well, this is exactly not pusillanimity. Instead it is survival.

In this world it is not only the fittest who survive but also those who enter the sanctuary of the fittest no matter whether the fittest is really fit or has built an aura of fitness around him through clever positioning or head-start.

Something similar has happened to the US dollar over the years. In the immediate aftermath of the Second World War, the US took the lead in setting up the Bretton Woods twins IMF and the World Bank in league with its staunchest ally to date, the UK, and lost no time in foisting its currency as the international reference currency on practically the entire world.

Gold standard

To be sure, the bait was one ounce of gold for every $35, in an ingenious exercise that came to be known as gold exchange standard. The first oil shock in 1973 did upset the dollar’s applecart when oil sheikhs and petrodollar rich countries called the US’s bluff by demanding gold in return for the huge pile of petrodollars these countries had accumulated on the back of sale of black gold at steeply climbing prices, thanks to cartelisation of crude oil trade.

But by then, the dollar had wormed its way into everyone’s heart and had become the byword for foreign currencies a la Xerox for photocopying and closer home ‘Surf’ for detergent powders.

Small wonder then today when the US stands accused of being an economic rogue state by permitting unbridled risk-taking in the name of financial engineering, its currency is coming to its rescue what with the beleaguered nations of the world dependent on the US patronage for its products and services swearing by the dollar and reposing faith in the US treasury bonds.

The collapse of the gold exchange standard opened up the market for foreign currencies and many floating currencies, especially in Europe, appeared in the horizon culminating in a common currency euro which one thought would give the dollar a run for its money and get as much international attention.

But the euro, these last eight years of its existence, has unfortunately not caught the fancy of international trade and investment in a big way so much so that the dollar continues to rule the roost.

With the US accounting for 25 per cent of the world’s GDP, it certainly is not possible for one to decouple from its economy, especially if exports have been the prime driver of one’s growth.

This explains the looming recession in Japan, South Korea and China but does not fully explain why the rest of the world cannot break free of the dollar. The explanation lies in the fact that bulk of the foreign exchange reserves of the world are designated in the dollar.

Mystery Resolved

China, for example, is sitting on a forex reserve of close to $2 trillion with bulk of them parked in US treasury bonds. It is therefore in China’s interest that the dollar doesn’t collapse. Ditto for the petrodollars, except that bulk of them are in the form of eurodollars, that is, parked in the offshore market for US dollars primarily in London, Paris and Zurich.

All these nations have a vested interest in strengthening the dollar because collapse of the dollar would mean collapse of their assiduously built investments. In a way therefore countries of the world are finding themselves caught in a web carefully woven by the US when it positioned its currency as the international currency and gave it the first mover advantage from which perch it has not been dislodged, thanks to the perception that it is wise to be belonging to the leader’s camp.

This perception is not entirely born of economic factors alone. The domineering presence of the US in all the trouble spots as well as its formidable military and technological might too might have found adherents for its model as well as for its currency in a manner of teenagers swooning over their icons.

Add to this, the huge demand for dollars to pay off import bills, and the riddle of weak-economy-strong-currency is answered. In the Indian context, our economy is performing far better than the US’s on all parameters including purchasing power of its currency, but what has set the rupee in a steady downhill course is India’s heavy oil import bill unfortunately designated in the dollar.

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blfeedback@thehindu.co.in) (The author is a Delhi-based chartered accountant.

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