The U.S. government has pulled out all the stops to try to get the economy back on track following the Great Recession: It is running a huge budget deficit, the financial sector has been bailed out, and the Federal Reserve is keeping interest rates ultra-low.
But these very efforts to get the economy going again create risks of their own. One of the biggest is that the value of the dollar could decline in ways that are abrupt and disruptive.
The dollar has already been drifting gradually downward as a result of large U.S. trade and budget deficits and the growing economic might of the rest of the world. It is down 36 percent against six other major currencies over the past decade — and was down even more before the 2008 financial crisis prompted fearful investors to plow money into dollars.
The downward trend is likely to continue over the years as the other economies continue to catch up with the United States. The risk now is that large U.S. budget deficits, a lack of political consensus over how to reduce them and the Fed’s low interest rate policies will transform the slow decline into a precipitous fall.
“There is an ongoing very gradual diversification away from the dollar,” said Barry Eichengreen, an economist at the University of California at Berkeley and author of “Exorbitant Privilege,” about the unique role of the dollar in the world economy. “That movement could be very significantly hastened if foreigners grow concerned about deficits as far as they eye can see and the pressure the Fed will feel not to normalize the level of interest rates, resulting in inflation.”
For the moment, both the dollar and U.S. Treasury securities are trading at prices that reflect investor confidence in the future of the greenback. The dollar is still the preferred currency for a vast array of transactions, even many that take place outside of the United States.
Read more at The Washington Post.