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The U.S. Dollar Losing its Luster?

Washington D.C.
VOA News

Many analysts contend that the dollar's decline has tarnished its reputation as the world's soundest currency. Many countries, including the oil-rich states of the Persian Gulf, are increasingly eyeing alternatives to the dollar. But other experts counter that American economic leadership and the dollar's dominance as the principle reserve currency are likely to last for many years to come.

When news spread in September that Saudi Arabia, the world's biggest oil producer, might not peg the riyal to the dollar, the dollar declined in world markets. Oil-rich Kuwait had already freed its dinar from the dollar, tying it to a basket of stronger currencies. The United Arab Emirates and Qatar hinted they might soon follow. Many experts say that because most Persian Gulf states hold large dollar reserves, any change in their monetary policies could weaken the dollar further.

Most of the countries in the Persian Gulf, including Saudi Arabia, the United Arab Emirates, Kuwait, Qatar, Oman and Bahrain, tied their currencies to the dollar years ago. Local currencies gained credibility from their link to the dollar and it helped the region reap the benefits of America's strong dollar policy throughout the 1980s and 1990s.

U.S. Monetary Policy

But many experts contend that U.S. monetary policy no longer meets local needs. They say the booming economies in the Persian Gulf, where oil prices have quadrupled during the past five years, need higher interest rates to fight inflation. But the U.S. has taken looser monetary action aimed at fending off recession.

David Taylor is a Middle East expert with Oxford Analytica, an international consulting firm, headquartered in Britain. "Their economies and that of the U.S. are increasingly out of sync," says Taylor.

"The falling U.S. dollar and the cuts in U.S. interest rates are designed for an economic cycle in the U.S., which is totally different from the economic cycle in the Gulf," says Taylor. "Also, they are being obliged to defend the peg and to discourage speculation more or less following the U.S. interest rate cuts, which isn't what they need at all. And that's the basis of the problem and the main deleterious effect is the fact that it is helping to push up inflation."

Pressure on Persian Gulf Economies

According to the International Monetary Fund, most Persian Gulf economies are experiencing their worst inflation in years. Last year, inflation averaged 12 percent in Qatar and about ten percent in the United Arab Emirates. In Saudi Arabia, it doubled to about five percent.

Debate is growing across the Persian Gulf over the dollar's slide, which is diminishing oil-export earnings and raising the cost of imports from Europe and Asia. The pinch is being felt by business and consumers. The erosion of local currencies has also heightened tensions among the large number of immigrants working in the region's expanding construction sector who send their savings home to countries such as India and Pakistan.

Oxford Analytica's David Taylor says some of the Persian Gulf states still have strong political and economic reasons to peg their currencies to the dollar. He says Saudi Arabia, the largest economy in the region, for example, wants to protect its large dollar investments abroad.

"If it did break the peg, it might well cause a loss of confidence in the dollar, which would diminish the value of these assets. There are also some question marks about causes and effects. I think quite a lot of the inflation is actually domestically generated and therefore would not necessarily be affected by a change of this sort," says Taylor.

"The other thing is the United States guarantees the security of Saudi Arabia," says Peter Morici, who teaches international economics at the University of Maryland. Saudi Arabia is a very sparsely populated country, which can hardly defend itself. And the Saudi royal family looks to the United States to sustain its stability. It's not about to tweak the United States by endorsing a basket of currencies. Those kinds of choices and discussions are as much political and ideological as they are grounded in sound economics," says Morici.

The U.S. Economy and the World

Morici adds that the U.S. economy is the locomotive that pulls the world. "If we are losing our edge, why are Asian markets panicking right now? The answer is: They rely on the Americans for leadership and when the Americans misstep, which we have done, they get very frightened. If the dollar is no longer a reserve currency, then Asian markets would view the recession in the United States as 'ho-hum,'" says Morici. "People who invest worldwide are frightened about the future of the U.S. economy, which itself is an indicator of its importance."

According to Christian Weller, an expert on international finance at the Center for American Progress in Washington, "Countries, because of the slide of the dollar, have experienced the painful adjustment in their reserves and they would like to diversify into other currencies."

"The problem is always where would they go? You want to invest in a country that actually has a transparent, large, liquid financial market and financial system. I think that makes it harder to invest in China or to invest in India, where the markets are fairly small and very illiquid markets. You can go to the euro, but there is no one euro market," says Weller. "You can buy euro assets in Germany, in Italy, in Denmark, but there is no one market. And I think that speaks very much for investing in the U.S. because it is the largest and the most liquid financial market."

Furthermore, argues Irwin Stelzer, a senior economist with the Washington-based Hudson Institute, the U.S. economy, unmatched in size and vitality, is well equipped to weather any slowdown.

"We have learned how to manage monetary policy. We have learned how to manage fiscal policy and we have an economy that is enormously varied and resilient -- where people change jobs, where they move from depressed states to states where there are more opportunities, or capital moves around the system with great speed from industries that are dying to industries that are growing," says Stelzer.

Many experts, including Stelzer, say that America's economic preeminence rests not on the value of its currency, but its ability to lead regions like the Persian Gulf to a stable and sustainable 21st century global economy.

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