Rising US trade and budget deficits pose a serious threat to the world’s confidence in the dollar. A sudden withdrawal of money in dollar-denominated assets would bring the world economy to a halt. How have we reached this situation? The US ran up a goods and services trade deficit of $726 billion in 2005, 18 per cent higher than in 2004. Higher oil prices alone do not explain the rapid rise of the US trade deficit in recent years. Its deficit with China increased by $40 billion to $202 billion in 2005, accounting for the entire increase in US non-oil trade deficit. The US borrows abroad to finance its trade deficit, China and Japan being among its principal creditors. These two countries invest in US securities in a bid to contain depreciation of the dollar, so that their exports continue to flourish. The dollar has been on an upward march between 2000 and 2005 despite the trade deficit widening over this period. This militates against market logic. The dollar is estimated to be overvalued by 30-40 per cent. For the world to avert a disaster, the dollar should depreciate in a gradual manner. A sudden crash is, however, not a remote likelihood. The US internal or budget deficit, at $800 billion, poses a serious threat to currency stability for its inflationary impact, prompting the government to be secretive about money supply. In fact, inflationary expectations have started to erode investor confidence, as foreign governments are not buying US securities like they did earlier. They could turn off the tap if inflationary pressure erodes consumption in the US, rendering unviable their efforts to prop up the greenback. The US must rethink its tax cuts and war spending to rule out a run on the dollar. Interest rate hikes will not contain inflation when fiscal policy is so lax. The US must realise that while its consumption drives the world economy, its budget deficits cannot promote growth beyond a point. But the larger issue is: Why entrust the keys of world economy and finance with a fiscally and politically irresponsible country? China, Japan, Malaysia, Thailand, Singapore and India should work towards floating a unified currency along the lines of the euro, so that assets are not concentrated in a single currency. The euro emerged as an alternative to the dollar for many OPEC countries, Iraq included. In fact, this prompted a jittery US to step up its political involvement in the Gulf. The US should realise that the emergence of other strong currencies will enhance the dollar’s stability, even if that leads to the emergence of countervailing centres of financial and political power.
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