Economics And Globalization of Global Financial Markets

Abstract

This paper describes the various reasons for the fall in the value of the dollar. It also highlights the implications of this downfall in the U.S. economy and the global economy. The downfall in the value of the dollar has not only had a negative impact on the economy of the U.S. but also on the global economy. The fall of dollar is a simple financial matter but a drastic event that has reduced the reserves of the world’s central banks and has decreased the value of U.S. assets in the international market. This paper cites ten sources in the Harvard writing style.

Outline

1. The beginning of the downfall in the value of the dollar
2. The causes of the downfall in the value of the Dollar
3. The Effects of the downfall of the dollar on the US economy
4. The impact of the downfall in the value of the dollar on the global economy

The beginning of the downfall in the value of the dollar

The downfall in the vale of the dollar has begun and it is impacting all the economies of the world in a negative manner. The most drastically effected economy due to the dollar downfall is the US economy. This downfall in the value of the dollar has made it loose it’s original value as the major currency of the world and has caused a series of reverse effects. The financial market experts do not take the fall of the dollar as a merely technical matter but have highlighted its adverse effects of the global economy as the they state that the downfall of the dollar has reduced the reserves of the world’s central banks and has marked down the value of all US assets on the international marketplace.

The financial analysts are conducting studies and they reveal the grave fact through the results of their studies that this fall of the dollar would not only be unfavourable for the US economy but it would also generate an alarm in the markets which would further lead to a ‘global financial meltdown’. Although the US financial administration is taking keen steps to stop the further implications of this financial hazard, it is strongly feared that the decline of the dollar value would be the major reason of the following:

 -Destabilizing the power of the United States

-Reorganizing global markets

-Shifting strategic power in the international system

There was a time when the dollar was the major currency of the world with the highest value. Its value was far above the Euro from the year 1999 and to most of 2000. The sudden downfall in value of the dollar started in the year 2001 and this downfall continued constantly through mid-2003, which caused it to loose more than a quarter of its value against the euro.

After this brief competition between the dollar and the euro, the dollar is continuously backing away in the competition, which is expected to still continue. The panic rose continuously as the pace of the dollar downfall increased continuously after April 2002. The Financial Markets Centre’s 2nd Quarter 2002 publication ‘Flow of Funds’ emphasized on the fact that the US economy growth was dependent on ‘an uncomfortable degree on ever-increasing inflows of foreign capital’ and it even declared the hypothesis that the decrease in this dependence would cause other negative events such as higher interest rates, debt defaults, and economic stagnation.

There have been various studies conducted on this decline of the dollar and the reason found by most of the financial analysts is the rising trade deficit of United States on its ‘current account’, which comprises of the following:

-Goods and services

-Income payments such as interest and dividends

-Unilateral transfers such as foreign aid and worker remittances as mentioned at ‘fall of the Dollar’

The following graph depicts the deficit of US trade that has caused the downfall of the dollar:

Source: US Department of Commerce, Bureau of Economic Analysis, 2006. [Online image]

The causes of the downfall in the value of the Dollar

According to the various studies that have been conducted to investigate the reason for the downfall in the value of the dollar the major reason has been found to be the high rate of deficit in the trade of United States. It has been observed that the imports of United States are greater than it exports in the area of goods and services. The US consumers have a strong inclination for the following import items:

-Japanese automobiles

-Chinese clothing

-German machinery

-Finnish mobile phones

Another popular item that US import’s in large quantities is oil. In contrast to the large quantity of US imports, US companies do not have the capacity to export products and services of the same value. Although there are companies such as Microsoft, Coca Cola, Boeing and Hollywood, which make huge earnings and are highly noted as major US exports, but they cannot make up for the foreign products and services purchased by US companies and consumers. In the year 2002, the amount for imports of goods and services was approximately $1,652 billion, whereas exports totalled only $1,203 billion.

     The history depicts the fact that United States did not always lack trade as it does today. Even when there were disasters like the World War II US operated large trade surpluses. With the passage of time the trade balance was reallocated, as foreign investments began to surge into the US and as US consumers got more inclined and purchased more foreign goods and services. In the 1960s, imports of Japanese cameras and European cars rose whereas on the other hand jet aircraft increased the pace of US tourism overseas. The series of quivers to the value of the dollar began when during the Vietnam War; there was a huge pressure on the US payments position, which compelled Washington in the year 1971 to defer conversion of the dollar into gold.

This quivers to the value of the dollar continued to the 1980s, with the growth of the global trade and the resettlement of manufacturing from the US to lower-cost lands. This trade deficit of the US economy grew when low-cost export areas such as Mexico, Malaysia and China initiated their imports. China has greatly emerged as the most low-cost and huge exporter of the world. There is a huge variety of items that China exports around the world and it alone accounts for over $100 billion of the deficit.

Chinese exports are becoming more and more favourable and China possesses the maximum quantity of exports to most of the countries of the world, which is earning it huge amounts. Be it household items such as electronic appliances, computers, printing machines, garments China is undoubtedly leading the export market whereas it is low on imports. People around the world have become much familiar with the ‘Made in China’ label for a wide range of imported things they use.

Other than the trade deficit there are some other reasons that have caused dollar downfall. Some of these are the accounting scandals at Enron, Tyco, WorldCom and many other company’s revealed serious weaknesses as mentioned at ‘fall of the Dollar’.

The Effects of the downfall of the dollar on the US economy

The downfall of the dollar has had the most drastic effect on the US economy. The different aspects of the US economy are being affected such trade and investments with this decline of the dollar. It is feared that this impact will become fiercer with the passage of time and as more competitor companies like China and Japan enter into the export market. The US economy has been affected by the dollar downfall, as its imports are greater than its exports, which when referred to the subject of economics is described simply as loss.

The economic growth in the United States has continuously risen from the growth rate of its major trading partners, so U.S. consumers have become more inclined towards buying more imports than foreigners have been buying U.S. exports. The following chart depicts the fact that most of the export demand for U.S. products comes from countries whose economies are growing more at a rate that is more slow in pace than the U.S. economy as mentioned at ‘The Evolution and Implications of the U.S. Current Account Deficit’.

Source: Federal Reserve Bank of Atlanta [Online Image]

The trade deficit is the most contributing factor towards the fall of the U.S economy. The current account deficit of United States is nearing to US$600 billion this year and the federal deficit running at $450 billion. To prevent the negative effects of this account deficit the economy of United States is required to magnetize approximately a net $5 billion of funding every working day and the major portion of it from overseas. That makes five percent of US gross domestic product (GDP) in nominal value. Assuming money velocity at a conservative multiple of five, foreign fund inflow supports twenty five percent of the US economy. It is being revealed that the fall in the value of the dollar will apparently make it easier to meet the funding requirement for the U.S economy as mentioned above.

This would further help to cut down the trade deficit with the method of reducing the cost of exports cheaper and increasing the costs of import. On the contrary, the fall in the value of dollar lessens the net yield of foreign-own dollar debts, which produces incentives for foreign holder of US bonds to sell. There have been a number of negative effects of the downfall in the value of the dollar, of different nature.

Studies have revealed that around 3 million private-sector jobs in the last two years have been lost in the U.S; long-term unemployment has reached the speed where it has more than tripled; the unemployment rate has also increased. United States has a $4 trillion national debt, 1.4 million Americans have lost their health insurance, middle-class families are not able to send their kids to college because they lack money to do that, bankruptcy cases have increased by a record-breaking twenty three percent, business investment is at its lowest level in more than fifty years as mentioned at ‘America’s selective strong dollar policy’.

It is feared that the recovery of the US economy is improbable until the drastic effects of the dollar decline diminish. While the US economy is struggling to recover, the struggle of companies by discarding the excess quantity of their production by reducing prices and downsizing jobs and workweeks are making the situation more worse and the chance to recover more impossible. If this negative situation that is being caused due to the decline of the dollar value continues to get worse, it is only the federal government, which holds the power to ‘direct’ the US economy in a positive direction. John Maynard Keynes states the task that is used to accomplish this ‘to get the money moving again’.

The government can make efforts in this direction by adopting the methodology of taking loans from unused wealth from the private sector and then using it or dispensing it to taxpayers who will as a result, utilize the money for economic uses, which would rejuvenate business activity. In other words it can be said that federal deficits, are one of the vital components of the solution to the falling US economy. Although the use of money by borrowing will increase the national debt, but this can be handled with the renewal of economic growth as discussed by ‘William Greider’ in ‘Deflation: It Threatens the United States–and the World’.

The impact of the downfall in the value of the dollar on the global economy

The dollar has been the most dominating currency of the world for a long period of time. Hence today its downfall is not only negatively impacting the US economy but it is creating detrimental effects on the global economy as well. The value of the dollar has today decreased down fifty percent against the euro since October 2000. China is another country, which has become a leader in the export industry whereas it does not import much and is earning a lot, which makes it a significant element of the global economy.

The downfall of the dollar value is exerting new pressures on China as well. Chinese citizens are trying to exchange US dollars for their own currency, the Yuan. The pressure that China faces due to the downfall of the dollar value is that if there is an official revaluation of the Yuan, it cut into the value of their dollar savings. In Europe the downfall of the dollar has caused the Europeans to worry, as it would cause a great damage to their weak economic expansion by making their exports more expensive in the US or in other economies linked to the dollar as discussed by Francis in ‘Worldwide effects of sinking dollar’.

The drastic effects of the dollar downfall are feared to be more than what is expected. The dollar downfall is affecting the global economy as in Asia and Europe; it is an important circumstance for a prospering export economy. Talking about the global economy when we consider Germany, it is found that its economic recovery depends totally on the area of its exports. The German economy was stable in the third quarter as exports were as strong. But today, with the downfall in the value of the dollar, carmakers and chemical conglomerates are distressed with the fact they could be selling fewer and fewer products in US dollar markets in the future as mentioned at ‘Why the Dollar’s fall is bad for everyone’.

However, the Mexico and Canada still desire to ‘dollarize’ their economies. The reason why they are still willing to dollarize despite the fall in the dollar value is that United States is their biggest market and accepting the dollar would get rid of any unfavourable consequences about currency movements. They also present the fact that dollarization would save them from the consequence of ‘overshooting’ market.

In contrast to this, the countries like China and other emerging markets in Asia which largely depend on the exports area to the United States for hard currency are reluctant and find their trade balances worsening. Japan has made efforts to solve out this ordeal by trying to keep the yen low against the dollar in order to recover falling exports. The countries that indulge in less trade with the United States such as Argentina, Brazil, African countries do not fear being affected to a large extent as mentioned at ‘The Euro, the Dollar, and Their Impact on Global Manufacturing’.

The downfall in the value of the dollar has not only caused international fears. Asian central banks are being forced by the varied and serious risks to hedge their bets, not wanting to be ill prepared in the event of a disorderly decline in the dollar. Russia is making steady moves to save itself from the drastic upheaval of the dollar decline. Gradually, it is decreasing the percentage of its reserves denominated in dollars, moving towards a level of 50:50 split between dollars and euros. Russia is the major country, which is taking steps of prevention, and it is being watched by entire world. As Russia is taking keen steps to prevent this crucial disorder due to the dollar decline, the other nations are not reluctant any more to follow the same trait.

The other nations cannot afford to ignore Russia’s moves or else they would suffer at the end. Hence as Russia moves to decrease the percentage of its own holdings of dollars, so are the big Asian economies, as well as many other economies around the globe. No one wants to get burned in the event Russia moves to the euro. Moreover, as the dollar value continues to decline and crude oil continues to rise in price, having the dollar, as the preferred international currency for petro-transactions will turn into a liability, especially for the big Asian economies, which are heavy importers of crude oil as mentioned at ‘Crisis towers over the dollar’.

References

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