The dollar is strengthening against all major currencies except the yen. That the currency of the nation where the subprime crisis originated — and where the Big Three automakers are begging for federal help to survive — should get stronger appears strange.
Why is this happening?
It’s because the dollar, the world’s de facto reserve currency, is experiencing a shortage as a result of the global credit crunch.
The U.S. Federal Reserve, which is churning out dollars in massive numbers at home, now has swap agreements in place with other central banks to meet demand for the U.S. currency in foreign markets. Nevertheless, dollars remain in scarce supply to an extent unseen since the close of World War II.
At that time, right after Japan’s surrender, many countries whose industries were destroyed in the fighting were in dire need of resources and raw materials for reconstruction.
But the ability to convert currencies wasn’t available to anyone — not even the victors. Britain and France, for example, found themselves short of dollars needed to import raw materials and resources. That’s why the United States provided them with dollars and other essential goods through the Marshall Plan and other schemes.
Japan faced a similar situation when it began rebuilding. Dollars were so scarce that Japan had to adopt a “stop and go” policy of limiting domestic growth while concentrating on exports, and then resuming growth after accumulating enough foreign-currency reserves to buy more supplies to rebuild.
But the current dollar shortage is different because it is both a global phenomenon and one that is occurring in the United States as well. Here’s why.
First, dollar-funded investments overseas are being withdrawn and repatriated because of the liquidity shortage in the United States and the need to compensate for losses. This is similar to what happened during the 1997 Asian financial crisis.
Second, the speed at which money changes hands has rapidly declined. This is the very reason why the liquidity surplus quickly dried up into a credit crunch even though the money supply in the U.S. is rising. The sudden switch was facilitated by information technology advances used to streamline securities and bond transactions in recent years.
Third, mutual distrust triggered by the financial crisis has paralyzed the ability to generate credit. Banks are concentrating on building or maintaining their capital adequacy ratios instead of lending, and the amount of money that circumvented banking regulations via brokerages and hedge funds was huge.
What we have witnessed these past few months is the reversal of these trends. People are now talking about expanding the capabilities of the International Monetary Fund and the World Bank in order to compensate for the evaporation of private-sector credit.
The U.S. dollar accounts for 62.9 percent of all global foreign-currency reserves, followed by the euro with 26.8 percent and the yen at 3.1 percent. This shows the dollar is still by far the most convenient international currency.
While the euro-zone countries have a common monetary policy, supervision of the EU’s fiscal policy and finance industry are still in the hands of individual nations. The yen, meanwhile, is dogged by security concerns while the yuan lacks convertibility in overseas markets.
It must not be forgotten that the dollar system itself has been under a lot of strain, given that the exchange rate with the yen has dropped from ¥360 during reconstruction to less than ¥100 today. Since the buck accounts for a major portion of the world’s foreign-currency reserves, concerns over its stability could easily prompt a flight to other currencies and accelerate its downfall.
In addition to the United States’ huge military expenses, the fiscal deficit will soon expand as the government’s hefty domestic stimulus measures put downward pressure on the dollar. This will be a huge test for President-elect Barack Obama’s team.
Right after the war, Japan was unable to participate in building the IMF and the United Nations. Global financial stabilization will be essential if the world expects to beat this global recession.
Japan must now work with the other major powers on designing a new, post-dollar international currency regime while converting its export-driven economy into one that can prioritize the needs of its people.
Teruhiko Mano is a professor at Seigakuin University Graduate School.