Tuesday, October 13, 2009

Dollar is losing its reserve status

An article from the New York Post, citing the International Monetary Fund, reports that that dollar's share of central bank's reserves has fallen to 62%, the lowest on record.

As an economist, the idea that the dollar will fall in real value is not scary as the dollar's depreciation will be offset by a falling current account deficit (rising current account balance). The scary notion comes if the dollar does actually lose its reserve status and is perceived as less of a safe bet which may make it harder for the US to borrow to fund its deficits.
The way to strengthen the dollar relative to other currencies would be to start raising rates prior to other central banks rate hikes. I agree with other economists' estimations that the Fed won't raise rates until the spring as they have to curtail the monetary easing (buying alternative investments such as mortgage backed securities and commercial paper) which has reduced the real interest rate into negative territory.
But I worry that Mr. Bernanke is repeating a doomed play out of Mr. Greenspan's book: keeping rates too low for too long. Banks already have a license to print their own money taking advantage of the spreads between borring at effectively 0% (LIBOR has hovered at 0.3% for months) and lending at ~5-6%. I wonder: is preventing an overcorrection in the housing market the right thing to do? Sure it is if you're a homeowner (I'm not). But has the Fed, in preventing market forces to determine the natural equilibrium, caused long-term damage to the economy? I'll have to do more research, but only time will tell the true answer.

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