Consequences of the Dollar's Decline

10/14/2009 12:00 pm EST

Focus: MARKETS

Mary Anne & Pamela Aden

Co-Editors, The Aden Forecast

Pamela and Mary Anne Aden, editors of The Aden Forecast, say even if the US dollar loses its status as the world’s reserve currency, it won’t be the end of the world.

The US dollar fell again this month, to another new one-year bear market low. This is really nothing new.

The dollar has actually been falling for nearly 40 years, ever since 1971. That’s when President Nixon eliminated the dollar’s last link to gold.

From that point on, the US dollar became just another paper currency. The government could then spend what it wanted, and more dollars were simply created to pay for it. As more dollars were created, it made the dollar worth less. And as you’d expect, the US dollar has lost nearly 80% of its value against the major currencies since 1971.

This process will not only continue, but it’s now intensifying, because of the massive amount of deficit spending that’s taking place. Several countries are already taking action, and global dollar reserves recently hit a ten-year low. Momentum is clearly growing against the dollar’s role as the world’s reserve currency.

Reserve status is a privilege. Over the centuries, several countries have held this position, and they were normally the most powerful and sound nations, both economically and fiscally. That used to be the case for the US, but the US is currently the world’s largest debtor nation, and debtor nations are simply not entitled to this status.

So, the big question is, will the end come sooner or later? Our guess is that once the dollar breaks down to new record lows, the decline will intensify, and so will the calls for an alternative global reserve currency. But there isn’t a replacement waiting in the wings. The alternative, therefore, could end up becoming a basket of currencies.

This would be very bad news for the US, because it could no longer print the currency that their debt is denominated in. The US standard of living would decline, and there would be dozens of other repercussions involving trade, social issues, and so on.

Many believe that China is gearing up to eventually take over this reserve status role. China has been boosting its gold holdings by large amounts. It plans to increase these gold reserves even more, and it’s been encouraging its citizens to buy gold, too.

What would happen if China were to partly back its currency with gold? Money would move out of the dollar into yuan, and it would gain reserve status around the world.

Whatever the final outcome, none of this will likely happen in the near future. It’s a slow process but over the long run the US would learn to cope, like Britain did nearly 100 years ago. It’s doing just fine, and the same goes for Spain, France, and other countries who had this privilege in the past and lost it.

So, contrary to what many say, the end of reserve status doesn’t have to be a death sentence. Things will change, there will be painful adjustments, but it’s all happened before, and it will again.

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