Future of Dollar

Table of Contents

1. Research Question ___________________________________________________________3

2. Overview of the Dollar as an International currency __________________3

3. Routes of the problems with the US economy ___________________________4

4. Reasons why the Dollar could collapse ___________________________________6

4.1 Inflation, interest and the role of the FED _______________________________6

4.2 Negative trends in Foreign direct investment ___________________________7

4.3 Changes in the US credit rating ____________________________________________7

4.4 Fall in Demand for the US Securities ______________________________________8

4.5 Dollar competitors emerging ______________________________________________9

5. Reasons why the Dollar may remain the international currency _____10

5.1 The current European turmoil __________ _____________________________10

5.2 The Dollar currency reserves within China ____________________________10

5.3 Unique Dollar feature to maintain its power ___________________________10

Conclusion ________________________________________________________________________11

Bibliography ______________________________________________________________________12

1. Research question

This essay will look into details as to why such changes have taken place and also will make an estimate as to what will be happening to the Dollar as an international currency in the short-term.

2. Overview of Dollar as an international currency:

These were the important factors affecting the choice of an international currency for all the major countries because of the fear of an economic or geopolitical crisis.

The existence of the accepted international currency provides economic benefits for countries worldwide, namely:

1. An International currency is used as a means of exchange and the Dollar plays the leading role in foreign exchange transactions conducted by public and as a key currency by governments to intervene in foreign exchange markets.

2. An international currency is used as a store of value. 1 Consequently the US Dollar is used by countries worldwide as an official foreign exchange reserves. The Dollar is used in international bank deposits and in international debt securities, thus creating more stability for financial management of the economy of countries in the times of economic crisis.

3. An international currency is also used as a quotation currency for international trade and investment transactions. Many governments throughout the post World War II period were pegging their currency to the Dollar or even replacing their national currency with the Dollar in order to increase the financial stability of their country.

Dollar has emerged first as a national currency of United States of America and now US is benefiting from the fact that their country's national currency was chosen to become an international currency, namely:

* With such worldwide use of the Dollar as foreign exchange reserves, interest free loans are provided to the US in case of Federal Reserves notes bought by other countries and low-interest loans in case of US treasury securities purchased worldwide.

* The exchange risks which are impacting all other countries in the world are insignificant for United States firms trading activities in the world markets.

* US banks have a competitive advantage in dollarized financial markets, since US banks have their special access to Federal Reserves (FED) resources and the US Treasury has the ability to print out Dollars unlimited, while banks in other countries have to pay much more in order to obtain Dollars - "Seignorage" effect for US.

* With the Dollar playing such a global role, the United States can delay and deflect the adjustments of the current account deficit. The power to deflect the costs of adjustment onto foreigners has partly reflected the ability of the United States to depreciate the currency in which it has borrowed funds from foreigners. 1 The yield on US assets for foreigners is much lower than the yield on assets of other countries, because by other countries such investment is considered as "safe".

3. Routes of the problems with US economy.

Historically the currencies around the world were supported with gold. When the decision has been made to make the US Dollar an international currency, the necessity for all other countries to have their currencies supported fully with gold has been eliminated and it was decided that only the Dollar will be supported with gold funds. All other currencies were initially pegged to the Dollar.

In the after war period with America having a boosting economy, the current account of the US was initially showing a surplus of almost 4% of its GDP. Over the following 30 years, the US had built up a significant creditor position in the world economy as American corporations made investments into countries around the world. 1

In 1971 this regime collapsed since there was such a large amount of Dollars existing in the international market and held by foreigners that there was lack of confidence among other countries that the US was able to meet its commitment to covert Dollars to gold.

This has resulted in a subsequent devaluation of the Dollar that is reflected on its current account, which changed into insignificant deficit, with negative merchandise balance and significant earnings from investment items build up overseas. 1

By 1985 the current account was showing a deficit of 2.8% of its GDP. At this point the US became a net debtor and a major recipient of foreign inflows, but the earnings on investment