What's Behind the Falling Dollar?

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What's Behind the Falling Dollar?

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You wouldn't know the dollar was falling and oil was about to reach $100 a barrel from this morning's news program on ABC. Instead, the “big news” was that Neil Diamond's famous song “Sweet Caroline” was inspired by Caroline Kennedy, daughter of the late President Kennedy.

My local newspaper, the Lansing State Journal, did not enlighten me either. But thanks to the Financial Times of London, I am aware of the ongoing international financial crisis aggravated by the millions of people defaulting on their mortgages and the consequent fall in the value of the U.S. currency.

For me, this recent financial news was very much a case of déjà vu.

It took me back 40 years to when I worked in a British bank. On the third Saturday night of the month, television programs were interrupted to tell the nation that the British currency, the pound sterling, was to be devalued by 14.2 percent. In comparison, the American currency dropped in value by 16 percent in just a few weeks in November.

Forty years ago currencies had a fixed value, only fluctuating one or two cents either way. Shortly after the devaluation of the British pound and partly because of it, fluctuating currencies became the norm, with values changing daily. In reality they can and often do change every second.

A British news item from 40 years ago may not seem all that important today—but there are lessons from it that resonate in today's world news headlines. To understand this fully, we need to go back in time a little further.

A lesson from history

A century ago the British currency, the pound sterling, was the international trading (or reserve) currency. A reserve currency must be stable. That's the only way other countries can depend on it when doing business.

Prior to World War I, if, say, China wanted to buy goods from France or Germany, the payment would have been determined in pounds sterling, not in their own national currencies. Only the pound could be relied on to maintain its value from the time of purchase until the time payment was received.

Helping with this international standing of the pound was the fact that the currency was on the gold standard. That meant pound notes could be exchanged for gold. The Bank of England guaranteed this, and Great Britain had the gold to back up the currency, no matter how many people might wish to convert paper into the precious metal.

At the time of the Great Depression the British had to take their currency off the gold standard. However, sterling still continued as a major trading currency. By this time, the dollar was also in use for international trade.

Britain was greatly impoverished by World War II. However, even after the war the British currency continued to be used for trade within the sterling area. This consisted mostly of countries that had been British colonies—roughly one quarter of all the world's nations—and that were still doing a great deal of trade with the mother country and with each other. The system was advantageous to Britain, as the various nations maintained substantial financial reserves in London.

By 1967 Britain was still having serious financial difficulties. Manufacturing had declined. To boost the manufacturing sector, the Labor government at the time decided to devalue the currency, thereby making exports cheaper and more competitive.

Those behind this decision did not foresee that it would lead to the death of the sterling area and the end of the British currency as an international trading currency.

Could the status of the dollar change?

Here we find lessons for the United States today. Since World War II, the American dollar has been the world's main trading currency. When Ghana, in West Africa, buys oil from nearby neighbor Nigeria, the oil is priced in U.S. dollars and payment is made in the American currency, not in the Ghanaian cedi or the Nigerian naira.

Neither of these currencies can be used for international trade. They are known as soft currencies—they cannot be changed over a bank counter anywhere in the world. Most national currencies are like that—they are soft currencies not accepted outside their own nation's borders.

Only a few currencies are known as hard currencies. They can be changed almost anywhere in the world. Included among these are the American dollar, the euro, the British pound, the Canadian and Australian dollars and the Japanese yen. One reason they are hard currencies is that they generally maintain their value and can therefore be relied on.

Besides being a hard currency, the U.S. dollar is the world's reserve currency. Many commodities, including oil, are priced in U.S. dollars. This is to America's advantage. If the American media is anything to go by, few people in the United States realize the consequences of this changing. But it almost happened the weekend of Nov. 18.

OPEC countries meeting in Saudi Arabia heard some of their members calling for oil to be priced in euros or a “basket” of other currencies. Only the intervention of the Saudi delegation stopped this from happening.

When Rafael Correa, the president of Ecuador, stated that “Opec needed to sell its oil in a 'strong currency', he summed up the discontent widely shared by other Opec members and expressed most volubly by Iran and Venezuela. 'If we continue to trade it in a weak currency [the dollar], . . . we will need to sell more of our oil to buy the same amount of goods and services'” (“Opec Looks at Switch to Strong Currency,” Financial Times, Nov. 19, 2007).

If oil were priced in euros, it would cost Americans more to buy it. Further, if the dollar should ever become a soft currency due to its unreliability, the United States would have to actually pay in euros. That means America would have to sell sufficient goods to Europe to buy oil from the Middle East.

Americans have had the luxury of enjoying cheaper oil partly because the precious liquid was priced in dollars. Other countries have seen wild fluctuations and shortages of supply because not only have they had to contend with price increases in dollars, but they have also had the problem of coming up with dollars in the first place.

The United States could soon have that problem with euros. Where would the euros come from? Especially now, when, according to Fareed Zakaria in Newsweek, “the United States is the only major country in the world to which travel has declined amid a tourist boom.” He adds: “Every American who has a friend abroad has heard some story about the absurd hassle and humiliation of entering or exiting the United States” (“America the Unwelcoming,” Nov. 26, 2007).

What's the root cause?

The root cause of the problem can be summed up in one word: debt. Americans have been overspending for decades, both at the governmental and personal levels. More recently, that debt has been financed by other countries.

Only the United States could do this, precisely because the dollar is the world's trading currency. Other countries would accept U.S. dollars as payment for goods and were happy to bank those dollars
to pay for their own future needs.

But this is no longer the case. Increasingly of late, there is a realization around the world that those dollars are decreasing in value. Consequently, countries want to divest themselves of their U.S. dollars, but they want to do it slowly to avoid a panic that might wipe out the value altogether.

That's exactly what China, holder of billions of dollars of U.S. debt, is doing—diversifying into other currencies.

Debt is the primary reason for the present crisis. The subprime mortgage crisis was the trigger, itself a reflection that too many Americans were over their heads in debt.

Banks have made it possible, through credit cards and personal loans, for people to live way beyond their means, buying things they want regardless of whether they can really afford the items.

Faced with mounting numbers of people filing for bankruptcy to get out from under credit card debt, banks launched a major campaign to have the U.S. Congress change the law so that it would be harder for Americans to avoid their accumulated debt. This, along with the tremendous increase in adjustable rate mortgages, has backfired on the banks, which are now finding that people struggling to pay their credit card bills and ever-larger mortgage payments are ending up in foreclosure.

America is not the only country affected. According to the BBC, after the United States the United Kingdom and Australia are the next two countries with the highest amounts of personal debt. All three countries seem set to weather some rough financial storms in the near future!

Most Americans seem blissfully unaware of the dollar's decline or of the possible repercussions for them on a personal level. At the very least, the fuel they need to get to work may well again substantially increase in cost. This will, in turn, affect the prices of nearly everything, since nearly everything we buy must be transported somewhere.

Ironically, neither energy nor food costs are included when the government reports the core inflation rate, often used to determine annual cost of living increases. Life seems set to get harder for most Americans in the months ahead!

This also gives the U.S. Federal Reserve Bank a headache. Wall Street is calling for a further drop in interest rates, which are set by the Fed. However, the rest of the world wants to see interest rates either held or raised so as to stabilize the dollar. This dilemma led to the following front page headline in the Nov. 17, 2007, Financial Times: “Fed and Markets Set to Clash on Rates.”

It will be interesting to see whether the Federal Reserve chooses to try to preserve the dollar and maintain its global role as the world's reserve currency or bows to domestic pressure for relief for debt-strapped Americans and for increased corporate profits. By the time you read this, you may know the answer—and you'll have a better understanding of the long-term consequences of the choice.

Bible prophecy foretells the rise of a new dominant geopolitical power just prior to Christ's return (see “The Coming European Superpower”). And, sadly, it also foretells the decline and fall of the nations descended from Great Britain, including the United States and Australia (see our free booklet The United States and Britain in Bible Prophecy to learn more).

The Good News will continue to report on relevant news stories in these regards—and, more importantly, where events are headed. GN