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The Dollar Crisis Examined

The other day I published a post about the recent dismal performance of the U.S. dollar against other currencies and the potential harm that could arise from a declining dollar. Last night I came across a superb article in Time by Jeremy Siegel, the Russell E. Palmer professor of finance at the University of Pennsylvania’s Wharton School and author of Stocks for the Long Run and The Future for Investors. In “Investing: Greenback Mountain,” Siegel points out the following facts regarding U.S. dollar holdings overseas:

The numbers are stunning. Governments around the world hold nearly $5.5 trillion dollars in reserves—an amount greater than the gross national product of any country except the U.S. China has by far the largest horde, with over $1.3 trillion in the till and almost one-quarter of the world’s total. But the rest of Asia is far from poor: Japan holds more than $900 billion, Taiwan and South Korea together own over $500 billion and India’s reserves crossed $200 billion this year, up more than 30% from a year ago. About two-thirds of these reserves are denominated in dollars and about 60% of those are in U.S. government treasuries—meaning that more than half of America’s publicly held national debt is now owned by foreign governments.

And why are some out there, myself included, concerned about the huge concentration of U.S. dollars overseas? Professor Siegel explains that:

Not surprisingly, these huge dollar holdings are a source of considerable anxiety for capital markets. Any hint that Asian countries in general—and China in particular—are going to sell their dollars causes the greenback to sink and sends treasury rates higher. There is evidence that governments are worried about the size of their caches. Foreign holdings of dollar-based assets doubled from $1 trillion to $2 trillion from the end of 2001 through to the spring of 2005, but since have increased less than 10%. China, which must continue to buy dollar assets if it wishes to keep its currency from appreciating too rapidly, has switched out of treasuries into more promising investments, such as Blackstone, the giant U.S. hedge fund that recently went public.

Siegel points out the consequences of overseas investors losing their appetite for U.S. dollars:

… And if foreigners turn away from dollar investments, the economic repercussions will be severe. Without overseas buyers, stock and bond prices in the U.S. will fall and the dollar will continue to slide. This will drive up the price of imports, especially oil, worsening inflation and reducing consumers’ income.

Next week I’ll be looking overseas for the latest signals showing a waning interest in the U.S. dollar. Make sure you check back with Boom2Bust.com for my findings.