The dollar drops - your money grows! If...

Written By Brian Hicks

Posted August 22, 2006

The image is comical until you realize what it means. In an ad I saw yesterday for an Israeli foreign currency exchange service, Uncle Sam dangles from a parachute down your computer screen. "Wake up," the Hebrew letters read, "The dollar is falling!"

The next screen flashes, "Come look how your money is growing!"

Wherever you are in the world, the dollar matters. The twin systems of petrodollar recycling and World Bank support established during and just after World War II are now seen for their vulnerabilities, and US consumers may pay the price with their dollars slumping in purchasing power. And foreign exchange (forex) watchers know that one man’s fall is another man’s rise.

The slump is happening, many argue, because the international community has lost its faith. In a very real way, this is the Twilight of the Dollar.

Melting in the Sunset

As representatives of each of the 44 allied countries convened in Bretton Woods, New Hampshire in the summer of 1944, they set about regulating and supporting the international monetary system with the US currency at its base.

The World Bank and International Monetary Fund were conceived in the womb of Bretton Woods, and both institutions are still paired by the name of that northeastern resort town.

Soon, we may mark Maastricht as the Bretton Woods of a new era. Maastricht, a city in the Netherlands, was the site of the meeting of European Union member states in 1992 that lead to the creation of the euro, which of course is today’s European common currency. Though still unknown as a place and even as a political watershed to most of the world, Maastricht was the site of conception of a new regime in international currency strength.

Since its launch as a financial instrument in 1999, and then as a form of legal tender for all transactions in 2002, the Euro has achieved and then surpassed parity with the dollar. From a low of .8228 dollars for each euro, the European common currency is now stronger, as one needs more than 1.28 dollars to buy one euro.

This spells trouble for the "dead presidents" who grace banknotes stateside, and those of us alive today who have our eyes on the very vibrant and very worried Federal Open Market Commission (Fed).

The Fed recently halted its streak of benchmark interest rate hikes, and many analysts chalk this pause up to fears of a recession on the part of Fed Chairman Ben Bernanke and others. 

As interest rates increase, spending is less attractive than saving and not as much money circulates in the US economy. At the same time, dollar-denominated debt in the form of US bonds is becoming less attractive than firm holdings like gold to rising world powers like China, whose skyrocketing foreign reserves are expected to hit $1 trillion in the very near term.

Bretton Woods set the standard of foreign currency holdings as the dollar, which along with gold pads the coffers of governments worldwide. Some non-US governments, especially in the Persian Gulf, play a more integral role in the system than others.

King Saud of his namesake Saudi Arabia and US President Franklin Roosevelt met in year after Bretton Woods, in order to make the US dollar the currency of trade for international oil exchanges. Saudi Arabia, in turn, now uses its dollar-denominated income "petrodollars" to buy US bonds and finances Washington’s mounting debt.

These twin agreements in the WWII era bolstered the dollar from being a mere piece of gold-backed paper to being an almost magical leaf, instilled with the confidence of a world recovering from devastation and eager to trade and consume on a standardized basis.

For many, that system is now untenable and the dollar’s primacy is therefore cast in doubt.

Well Hello, Euro!

In 1999, France persuaded Saddam Hussein to accept payment for Iraqi oil in the form of euros. Though the euro was lower at that time, Baghdad was already reaping the benefits of the euro’s rise by the time of the US-led invasion in 2003. It should be noted as well that the US’s primary ally, Britain, is not a member of the Eurozone.

As Iraq found the idea of diversification appetizing, so would Iran, Venezuela, and others whose relationship to DC deteriorates by the day. Again, confidence in the dollar is shaken.

As for the Waking Dragon, China, Shanghai’s oil bourse held its first day of trading this August 19. This is China’s first spot and futures market for oil products, and though it is currently only a site for peddling refined products like gasoline, it will soon trade in petroleum and forms of natural gas. With the opening of this exchange comes the threat of further damage to the dollar, but nowhere close to what a strong Iranian oil market would inflict with a switch in preferred currency.

This does not even take into account the reality of Hubbert’s Peak, the model that projects our entering into an irreversible decline of world oil supplies. If the dollar depends on oil for even half of its current real value (the other half coming from the pixie dust of Bretton Woods), no oil means far less worth, and then the more money the Fed wants to print, the more toilet paper we will have.

Then we may see Uncle Sam jump for real. And this time he won’t have a parachute.

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