People are surprised that despite the global economic crisis that was precipitated by the collapse of some US Investment Banks that had held on to worthless mortgage debt, the US dollar has continued to rise against all other currencies. If one had forecast this to happen, few of the pundits would have agreed. Furthermore when US treasury securities are yielding 1% one would expect money to flow out to countries offering higher rates and thus make the dollar depreciate more.
Well it is all to do with confidence. The whole world has confidence that whatever happens the US government will not default on its debt and therefore every country would prefer to hold assets in US dollars in preference to any other country’s security. So the Japanese and Chinese have not pulled out any money from the US and the market value of their securities have strengthened both in dollar terms and in the currency of the lending country, reinforcing the decision to hold on to these securities.
With this confidence and the dramatic fall in the prices of commodities, especially crude oil, the US is able to withstand the trade deficit it runs with the rest of the world, counterbalanced by the surplus in invisible earnings. There is no other country or currency or for that matter any asset, not even gold that can match the US treasury bonds and so while the currency remains strong, and there is no run of funds out of the US, I believe the US is the best placed to get out of the recession, faster than other countries due to its flexible labor laws, that permit quick firing in the event of company’s requiring urgent action to stem losses, so it can just as quickly take advantage of an uptick as soon as it occurs where employers are not afraid to hire because they can just as easily fire unlike in most other places.
This flexibility in the economy will hold the country in good shape, for a more speedy recovery than the rest of the world, that depend a lot on international trade. With a fall in orders for Chinese goods, some of their companies are folding, as is the case with Indian companies that depend on overseas orders including those in the computer field.
It is anyone’s guess as to what price the exchange rate will settle at, and it is all the more miserable for Sri Lankan companies that export, unless a substantial depreciation is carried out on a sickeningly overvalued currency the Sri Lankan rupee.
It is therefore important to bring back confidence, for funds to move out to more lucrative areas. A lot depends on the deflation that is taking place, and the level at which it will eventually settle at. This massive drop in international wealth as a result of the valuation in stock markets worldwide as well as the drop in value of homes, which is a greater figure to the average homeowner, has made people very cautious about spending their way out of a recession, which will therefore not happen. The downside of that is that the recession will last longer, until people are willing to invest again.
The unavailability of funds rather than the rate of interest has stopped many a company it its tracks, and this situation will not change much as people and companies have got risk averse and are reluctant to take a gamble, which they would have taken if this crisis had not erupted.
It is also worthy of note that contrary to the doctrine, the Bush administration has been deficit spending to such an extent that it will reduce the ability of a future administration to cut its budget. Keynesian economics teaches one to spend one’s way out of a recession, usually by larger increases in public spending, but I do not believe that it is the way to go, because the perception of fiscal responsibility will erode into areas not earlier considered and a run on the dollar could result. The Friedmanite way of controlling Monetary policy will also not arise due to deflation and printing more money will only mean they search for even more safe haven’s to park their funds instead of spending which will increase the amount on deposit reducing the likelihood of them being able to spend their way out of a recession as it will not work.
Massive public works programs to keep people employed while also improving the infrastructure is what has been bandied about as the only way to show some relief in the country.
While gold used to be a safe haven, it is no longer the case as investors realize its true value will only emerge in jewelery and is neither an inflation beater nor a safe investment. Cash in the form of dollars are held all over the world, cushioning the dollar further, which is still the defacto reserve currency of the world. Therefore in closing, this state of affairs will continue and those forecasters who predicted the demise of the dollar will just have to eat humble pie, now realizing the importance of this currency far further than would have been anticipated earlier.