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12/26/2004 06:18:00 AM | Nikhil

Decline of the Dollar
The Center for American Progress has a fairly good overview of the dollar's decline and its possible consequences:
That is a question over which there is sharp disagreement within the economics community. Some people argue that the Japanese, Chinese and others have no choice but to continue to buy dollars or their economies will be devastated. Some refer to this as "the balance of terror." Others argue that the current direction of U.S. external debt is unsustainable and that eventually the dollar will fail and might well take the global trading system down with it. Because no nation in the modern economic era has played such a dominant role in the world economy as the United States, and no nation has ever had anything like the amount of debt that the U.S. now owes, we are in totally uncharted territory.

There are, however, some disturbing precedents. Most global depressions have been rooted in currency problems. The depression that began in Europe in the 1920s and quickly spread to the U.S. was directly tied to the fact that trade was carried out in gold and the United States had been so dominant in transatlantic trading that a huge portion of the world's gold ended up here. Just like a monopoly game when one player ends up with all the money, the game ends. Europe's inability to buy American products meant that we had invested in far more capacity than we needed and Wall Street suddenly realized that American stocks were grossly overvalued.

The column contains a simple but useful summary of how currency exchange rates are formed for those without Economics 1 or 2.




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