He who laughs last, laughs longest. In the current financial crisis, that could be Uncle Sam. But it could also be the last time the US manages to play the practical joke of tanking its own currency.
Uncle Sam laughing, how come? Surely, given the rapid-fire series of aneurysms on Wall Street, he is crying. Well, not quite. The collapse of the dollar means the US has a pretty effective way of making the rest of the world cry and putting at least half a smile on its own face.
The US Federal Reserve Board’s cut, cut and cut again approach to interest rates is fuelling inflation. That’s one reason the greenback has been plummeting. Now we have the Fed-orchestrated bailout of Bear Stearns Companies Inc.—combined with US treasury secretary Hank Paulson’s assurance that he’ll do what’s needed to shore up Wall Street. That has put further skids under the dollar.
The US itself isn’t suffering too badly. During the long binge years, it borrowed vast sums from the rest of the world—particularly the Chinese, Japanese and Arabs. If it had been a normal debtor country—such as, say, Mexico in the 1990s—it would have been required to borrow in hard currency.
But the dollar has traditionally been seen as a hard currency, indeed the world’s reserve currency. So the US was able to borrow in its own currency.
The result is that, unlike a typical debtor country, the US cannot go bust. If push comes to shove, it just ramps up the printing press and churns out more dollars.
Foreign investors may have nothing they can do, in the short term, to protect themselves from Uncle Sam’s folly. All they can do is run from the dollar.
In the longer term, though, actions do have consequences. Foreign investors, who are partly to blame for not holding the US to account during the bubble years, are unlikely to forget this wealth destruction. The dollar’s status as a reserve currency could be irreparably damaged. The next time Uncle Sam needs to borrow, he may have to issue bonds denominated in renminbi, roubles or euros. If he binges then, he really will be crying.