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#15 - JRL 7210
Moscow News
June 4-10, 2003
We Can't Do Without the Dollar
The dollar is weak at the moment, but it remains the main reserve currency in Russia and the rest of the world
By Ilya Baranikas

In mid-May, the U.S. Treasury Department promulgated the design of the new $20 bill to be circulated in the fall of this year. In addition to green, the new bill will feature background colors never used before on U.S. paper money. On the new bill, the picture of President Andrew Jackson will not be inside an oval. The reverse will carry a different picture of the White House. The watermarks on the new bill will be more complicated to make forgery more difficult. The other anti-forgery innovations are kept secret by the Treasury Department There are plans to introduce new bills of denominations other than $20, but we only know that new $50 and $100 bills are already in the making, while the matter of issuing different $5 and $10 bills is still being considered. The $1 bill will remain unaltered because counterfeiters ignore it.

Meanwhile, the forgers have not been lazing around. According to the Treasury Department's secret service, in 1995 just one percent of all counterfeit bills were forged with high-precision digital equipment; in 2002, 40%. The forgers even know how to recast genuine bills to increase their denomination. They bleach the surface of a low-denomination bill, leaving intact the watermarks and the protective band. Then the cleaned surface is used to print a new design taken from a larger-value bill.

Weakening Dollar No Trouble?

However, the Treasury Department has more serious things to worry about than forged bills in circulation. For the $10 trillion U.S. economy, $43 million in counterfeit money (in 2002) is peanuts. What hundreds of millions of people across the world are concerned about is the dollar's dwindling value.

The greenback is nose-diving. Since January 2002, it has lost a quarter of its value against the euro. Yet the Americans remain unperturbed. U.S. Treasury Secretary John Snow recently gave his G-7 counterparts to understand that they could fret all they liked over the dollar's exchange rate, but Washington saw no reason for distress - at least for the time being. His utterance sent weak-nerved money-market-operators into a panic, and the dollar into a fresh fall.

Very soon, however, the treasury secretary's boss, the U.S. president, corrected him. In an interview he granted to the Vesti news program of Russia's RTR television channel, George W. Bush firmly declared that his administration was pursuing a policy of strengthening the dollar, and that a U.S. economic upsurge would improve the American currency's exchange rate. Bush reaffirmed his stance in an interview with France's Le Figaro.

Among the G-7 members, the most worried is Japan. Its economy is paralyzed by a prolonged recession, and an appreciation of the yen against the dollar would be nothing short of disastrous. So the Japanese central bank stages a currency intervention at regular intervals, buying up huge qualities of dollars to balance the U.S. currency's rate to the yen.

The Europeans are not making a fuss, but they are not exactly gloating over the greenback's surrender to the euro. When toward late May the euro's rate jumped to $1.19 (only to fall back to $1.17 later), currency gurus advised the European Central Bank to see to it that the euro did not hit $1.30. In fact, the European economies are weaker than the U.S. economy. Besides, European goods have to be offered at competitive prices on the world market, and an appreciated euro would be of little help there.

Competitiveness is the watchword of the proponents of a cheap dollar. But as a matter of fact, a cheap dollar plays into the hands of transnationals like McDonald's, Procter & Gamble, PepsiCo, Ford, and others of the same kind. According to the results of a recent opinion poll, 45% of U.S. companies that have no external market are optimistic about the future, expecting bigger profits in the second half of this year, and only nine percent are pessimistic.

Beware of a Japanese Scenario!

A weak dollar is capable of not only stimulating export of American goods, thereby improving the foreign-trade balance of the United States (whose 2002 budget deficit stood at $503 billion, or 5.3% of GDP). The dollar's low exchange rate also acts as a barrier to deflation: If not all U.S. companies, then those with international operations are able in this situation to jack up the prices of their products.

There is no immediate threat of deflation, but it looms somewhere on the horizon, as was confirmed in May by the United States' chief financial guru - Federal Reserve System Chairman Alan Greenspan. He puts this year's annualized inflation rate at a mere 1.7% (against 2.5% a year ago); this is the lowest inflation rate seen by the United States in the last 37 years. The whole thing is currently qualified as "de-inflation" (a cross between inflation and deflation), achieved mostly by "money hoarding" ahead of the Iraq war, when people and businesses avoided any unnecessary spending. And when buyers turn tight-fisted, sellers tend to cut their prices.

The near-zero price rise in America would have been no cause for worry if this factor had not been accompanied by low discount rates. Economists say that with the central bank's discount rate of five percent, deflation is not something to fear. But if, like in the United States at the moment, it drops to 1.25%, a "Japanese scenario" may loom large. As a protracted recession like the one in Japan is highly undesirable, the United States is going out of its way to fight off deflation. Economic growth would ensure that it does not happen.

By and large, the American economy is picking up, though very slowly. In last year's fourth quarter, its GDP rose 1.4%, and in this year's first quarter, 1.9%. After the end of the Iraq war, U.S. economic growth quickened, restoring consumer trust and somewhat lowering unemployment. The American stock exchange became livelier, with the major indexes (Dow Jones, NASDAQ, S & P) inching up.

Don't Rush to Exchange Your Dollars

Financial analysts are certain that investors will gradually return to the greenback, pushing it up. This began to happen late last week. In spite of terrorist acts, the Iraq war, business recession, scandals over corporate finances, etc., the American market remains the world's largest and most solvent, and therefore the best, marketplace for investors. Of course America is unlikely to see another seven years of miraculous growth, when the dollar's value grew 47%. Yet the dollar could experience another steep rise.

Let us look at the reasons why. First, let us see how the dollar/euro rate will be affected by the results of the June 5 session of the European Central Bank (ECB), which is expected to cut the main discount rate (it currently stands at five percent in the European Union). The ECB had persistently refrained from lowering the discount rate, although the sad state of the European economy demanded a lower rate. A lower discount rate should in principle increase the dollar's value against the euro. But no one can confidently predict what will happen, as there are too many factors affecting the exchange rate. For example, the huge deficit of the U.S. state budget, which scares away investors. This year's deficit is forecast at $400 billion, or four percent of GDP. Economists are usually wary of a "double deficit" - that of the state budget combined with that of the foreign-trade balance.

But they also point out that a "double deficit" is no problem as long as investors sink money into the American economy. However, if they turn their backs on it, share prices on the American stock exchange will fall, and discount rates will go up, making it harder for businesses to borrow money for development purposes. As a result, economic growth will slow down, precipitating the dollar slide. But despite all that, no businessperson who has a foothold on the American market would be foolish enough to quit it - it is the world's richest. That is why holders of American securities are not in a hurry to get rid of them.

We can conclude from the above that:

(1) The U.S. government will try to keep the dollar from falling below a certain level, because a dollar that is too cheap will make imported goods too expensive, thereby decreasing the purchasing power of the U.S. population and slowing down economic growth (private consumption accounts for two-thirds of the U.S. economy).

(2) The other leading industrial powers do not want to see a weak dollar either as this would make the euro, yen, and pound sterling too expensive. Consequently, imported European, Japanese and British goods of high quality would be unaffordable to most people.

Many people in the CIS have hastened to convert their dollar savings into some other currency, seeing that the "conventional unit" in quite a few Russian stores is now the euro, not the dollar. And they hark billionaire financier George Soros' prediction that the dollar will slide further. They don't realize, however, that Soros has a hidden agenda of his own, and that the dollar remains the principal reserve currency in Russia and the rest of the world.

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