The dollar's weak -- but it's not a crisis

There may be a lot of talk about the need to replace the dollar as the global reserve currency. But for now, that's all it is. Talk.

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By Paul R. La Monica, editor at large

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NEW YORK ( -- It sounds like the plot of a bad spy novel.

A group of international villains are holding a secret meeting in their headquarters -- which are naturally buried deep in the side of a mountain. They are thinking of grand schemes to destroy the American dollar and replace it as the global standard with a basket of other currencies and gold.

All we need is to have the group's leader stroking the pet cat sitting on his lap to make the scene complete. Mwa ha ha ha ha!

Now they say that the truth is stranger than fiction. But the notion that a group of oil-rich Middle Eastern nations, Russia, Brazil, France, Japan, India and China are actively looking to replace the dollar as the currency of choice for pricing oil in the not-so-distant future seems a bit silly at this point.

Yes, the dollar has weakened significantly in the past few months. And that has to be a cause for concern for oil exporters as well as nations that hold big chunks of other dollar-denominated assets such as U.S. Treasury debt.

But it doesn't appear as if the dollar is on death's doorstep just yet, despite what was reported in a very sensationalistic article in the British publication The Independent earlier this week.

Bond market not worried about inflation

The fact that U.S. Treasurys have rallied sharply in recent weeks is one sign that some of the concerns about the dollar are overblown. If people were so spooked about the possibility of skyrocketing 1970s style inflation, it's hard to fathom why anyone would be buying long-term bonds right now.

Yet, the yield on the benchmark 10-year Treasury is currently hovering around a relatively low 3.3%, down from nearly 3.9% two months ago. Bond prices and yields move in opposite directions and lower yields are usually a sign that bond investors aren't too worried about inflation.

With that in mind, Michael Strauss, chief economist with Commonfund, a money management firm based in Wilton, Conn., said he thinks that the recent surge in other inflation hedges such as gold and oil are more about speculation than anything else.

"There is a disconnect here. You look at gold and oil. Gold has no industrial purpose so it's not about supply and demand. Oil's runup doesn't fit with what the price of gas and other byproducts are doing," he said. "So if people are really worried about inflation, why is the yield on the 10-year this low?"

Keith Hembre, chief economist with First American Funds in Minneapolis, added that the recent surge in stocks also wouldn't be justified if the dollar was really headed towards obsolescence.

Sure, there is some element of people trading out of the dollar and into other riskier assets like stocks because there is a growing belief that the global economy is recovering. But Hembre argued that if people really feared that the dollar was expected to weaken much further, then there would be little reason to make bets on any U.S. companies or government debt..

"If there was a true dollar crisis, you'd also have a flight from dollar denominated assets," he said That mean would Treasury yields would be higher and U.S. stocks would be a lot lower."

And for all the talk of how weak the dollar is right now, it's not as if it's at all-time lows just yet. As the narrator on the canceled way too soon ABC show "Pushing Daises" would say, the facts are these.

The dollar is trading at about $1.47 against the euro. That's a 17% slide since the stock market rally began in March, but the dollar was 8% weaker at last year, at about $1.60 to the euro -- an all-time low. The dollar is also still about 7% above the low it hit in March 2008 against a basket of six other global currencies.

Of course, the trend lately is for the dollar to go down and that trend bears watching. Nobody wants to see the greenback come close to last year's levels, especially since that round of dollar selling also coincided with record high oil and gas prices.

Some benefits to a weaker dollar

But there are also some benefits to a weaker dollar. It helps make U.S.-made goods cheaper, which could provide a boost to demand for American exports.

"Looking forward, if consumer spending is not leading the U.S. economy, one way to finance growth is through a weaker dollar. In the context of an expanding global economy, the weaker dollar is positive for U.S. exports," Hembre said.

Big U.S. corporations also could get a lift to their profits because international sales will be higher when translated from stronger currencies like the euro back into dollars.

A cynic could rightfully point out however that it's not certain that the global economy is recovering but not yet recovered. So it may be a mistake to expect that consumers in Europe and emerging markets like China, India and Brazil are going to lead the United States out of its funk by buying tons of cheap American cars.

What's more, the currency translation bump to earnings is more of an accounting trick than anything else. It is going to be more critical for companies to report sales and earnings growth because of real demand, not favorable foreign exchange rates.

Still, there may be a floor to how low the dollar falls. Economists said the talk about replacing the dollar is probably due more from a desire to pump the dollar back up than a real wish to get rid of it as the reserve currency.

"The reason the dollar isn't dead yet is that you haven't seen a major fundamental change in many of the economies of the countries that are worried about a weak dollar and favor a strong dollar. They want their own exports to be cheap," said David Merkel, chief economist with Finacorp Securities, a broker-dealer based in Irvine, Calif.

"We could get back toward record lows on the dollar, but it would only be after a failure to intervene by central banks that are interested in keeping the dollar strong," he added.

There's also the issue of what a much weaker dollar would do to the investments that many countries have in U.S. dollar-denominated assets. China, for example, is the world's largest owner of Treasurys, with more than $800 billion worth of bonds.

"The dollar weakness may be putting pressure on China," Commonfund's Strauss said.

But other than trying to act tough, Merkel thinks there is not much China or other nations can do if they are unsatisfied with the dollar's decline.

Merkel said that selling bonds to minimize damage from further hits to the dollar is not an option just yet because selling Treasurys would just lead to a further erosion in value of existing holdings.

"If you are taking on too much dollar debt and you don't like it, then you have to take the pain. There may come a day when countries are willing to do so but they are not ready this go around," he said.

Hembre agrees. And he doesn't believe that there's much that will be done other than to let the currency markets run their course.

The Federal Reserve could try and prop up the dollar in order to quell long-term inflation fears sparked by concerns about the glut of money pumped into the economy in the form of stimulus and bailout packages.

But it appears that the Fed is going to keep rates near zero for some time in order to make sure the recession (which some believe is over) doesn't get worse.

Hembre thinks that is the right move because the risks associated with a weak dollar are far outweighed by broader concerns about rising unemployment and what appears to be a still fragile recovery in the housing market.

"The dollar is simply not an issue. Dollar weakness would only become problematic if it caused disruption in funding markets which led businesses or governments to be unable to finance their spending needs. We see no evidence of that," he said.

So it looks like all those nefarious plots to take down the dollar may not be coming to pass after all.

Talkback: Should the dollar be replaced as the world's reserve currency? Share your comments below. To top of page

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