• English Site
• >Business
• >Economic and Financial Crisis
• >

  The Dollar Nosedive: Why America's Currency Is the World's Problem

The Dollar Nosedive Why America's Currency Is the World's Problem

Part 7: The China Factor

A key role now falls to China. Ironically, this (officially) communist state now has the power to determine whether the bastion of capitalism will implode. If China were to unload even just a portion of the dollar reserves it has accumulated over the years onto the market, the dollar's exchange rate would crash.

But in doing so China would inflict great harm on itself. Its remaining reserves would be almost worthless, and who would be able to pay for the vast quantities of consumer goods its factories pump out every day? Both sides, the Americans and the Chinese, benefit from the current system, which provides the former with cheap consumer goods and the latter with dollars in abundance.

Nevertheless, this mechanism appears to be reaching its limits. Recognizing this, Western politicians have been urging the Chinese leadership for years to abandon the artificial undervaluation of its currency, but with little success. Aside from a few minor revaluations, nothing has happened so far.

Jean-Claude Juncker, the chairman of the Euro group of euro zone finance ministers, traveled to Beijing this week to urge the Chinese to revalue the yuan once again. German Chancellor Angela Merkel said in an interview last week on the N24 television station: "We are working internationally on achieving a reasonable balance among currencies."

But the work she referred to consists of little more than visits and appeals, because what is lacking is a set of suitable instruments to ensure that actions can follow words. Most of all, however, there are serious doubts that the Americans are interested in a strong dollar in the first place.

Senior officials in the German Finance Ministry strongly suspect that the US policy -- as it was in the 1960s and 70s -- is systematically oriented toward reducing the value of the currency through higher inflation, thereby reducing the country's debt to the Chinese and other Asian nations. According to a high-ranking official in the Finance Ministry, exchange rates of $2 per euro are possible in the medium term, even if, as some conjecture, there is a short-term correction next year.

"From the US's perspective, there is little pressure to do anything about the weak dollar," says Michael Heise, chief economist with German insurance giant Allianz. "Pressure on the government and the Federal Reserve will only grow if there is a true crisis of confidence in the currency and the flow of capital begins to ebb as a result." But this is a risk Heise doesn't see materializing, not yet, at least.

Because the Americans are apparently unwilling to take any steps against the weak dollar, there is growing support for the Europeans to take a more proactive approach and boost the US currency by buying dollars and selling euros on the currency markets. "The ECB (European Central Bank) must make it clear that it will not accept a continued rise of the euro and could even intervene," says Gustav Adolf Horn of the Düsseldorf-based Macroeconomic Policy Institute, a group with ties to trade unions.

However, interventions in the foreign currency market are usually effective only if all central banks cooperate, as happened seven years ago. Securities dealers are only impressed when they notice that all major players have joined forces. Then they no longer have the confidence to bet on a declining dollar. Those who speculate against the combined power of the central banks have rarely walked away as winners.

But the central banks and their governments are a long way from the necessary unanimity. The Americans, most of all, would not play along.

Besides, there is disagreement over whether interventions would even be effective in the current situation. Joachim Poss, the deputy head of the Social Democrats parliamentary group in the German parliament, believes "an attempt to bolster the dollar could dissipate all too quickly."

The reason being that there are enough countries that are simply waiting for the right opportunity to shift at least some of their dollar reserves to euros. If the ECB intervened against the dollar, there would be great temptation in these countries to take advantage of higher dollar prices to buy euros.

"Additional dollars would enter the markets again, which would fully or partially eliminate the intended stabilization," says Poss.

Rarely has the ECB been as powerless as it is today. It can do nothing against the weak dollar, nor can it perform its real task of protecting the intrinsic value of the euro. Inflation in Europe rose above the target level of 2 percent some time ago, which should have prompted the ECB to raise interest rates. But this would make the euro even more expensive against the dollar -- and do even more damage to the economy.

For this reason, many economists fear that the ECB can do nothing but follow the Fed's example and continue reducing interest rates. But this sort of monetary policy has its price: higher inflation.

This leaves politicians and central bankers with little choice but to take a helpless wait-and-see approach -- and hope that the end result will not be quite as bad as many fear.

Klaus-Peter Müller, the CEO of Germany's Commerzbank, also hopes that things will turn out better than anticipated. He expects the euro to fluctuate between $1.50 and $1.60 over the next 12 months, but adds that this is "not very optimistic."

But many observers take a completely opposite view of this outlook. They call it highly optimistic.

DIETMAR HAWRANEK, ALEXANDER JUNG, ARMIN MAHLER, CHRISTIAN REIERMANN, WOLFGANG REUTER, GABOR STEINGART, JANKO TIETZ

Translated from the German by Christopher Sultan