Is the US dollar crumbling?

With the deepening of the financial crisis on US Wall Street, global financial markets are going through a big shake never before in history. In a very short time period, global markets no matter stock markets, oil, gold or other commodities, prices are having big fluctuations. Such big concussions in the financial markets means that the international monetary and financial systems using US dollar as the dollar settlement unit is having its greatest test since the Bretton Woods Agreement.

About this current financial crisis cause and the future developments, there are many discussions and many think that the main cause is that US provided too much US dollar liquidity.

Bretton Woods Agreement was signed on July 1944. It established the US dollar's global reserve currency leadership status. From then on, global trades, commodities market and other global trading markets all used US dollar for settlement. Such US dollar based international trading and financial system in the United States provides support for the US as a strong global leader. But at the same time, the US dollar also poses a deadly irresistible temptation for America.

According to David Ricardo's theory, even if a country could produce everything more efficiently than another country, it would reap gains from specializing in what it was best at producing and trading with other nations and thus achieve developments in the country. The hegemony of the US dollar as the trading dollar settlement unit in global trading gives US slight advantage over other countries. When other countries are busying producing various products and resources, US can easily print more US dollars and it can engage in global trade and buy other countries products for its own consumption. To anyone or any country, such convenience is an irresistible temptation. Hence, as the US dollar supports the hegemony of US, it is also causing laziness in US and in the past few decades, US manufacturing have largely moved out of US and US have become from a big manufacturing country into a big financial country deeply engrossed in consumption. US is loosing in a lot of areas of leadership after the 2nd world war. US is also becoming from a biggest creditor into a biggest debtor.

But the problem for US is that such dependency on the US currency for support cannot continue on. The basis for the US dollar as the global trading currency is based on US credits. When the US dollar is printed too much and exceeds US credibility limits, it will be the end of the happy days for US. As the manufacturing industry continues to be lost and the financial services industry sector continues to increase its foothold, US credibility will be shown more in the real estate, financial assets and so on. When the sub-prime crisis starts and the US housing prices and financial assets prices starts to decline greatly, US credibility will also start to follow and fall which will affect the US dollar global reserve currency status.

What is more worst is that the US government's actions to help with the current sub-prime crisis is continuing to print more US dollar and draw more overdraft on the US credibility. For many years, in order to maintain their decent lifestyles, the US government and the US citizens continues to borrow, causing the continuous increment of trade and fiscal deficits. The end result is the flooding of US dollars and asset bubbles, which is one of the root cause of the current sub-prime credit crisis. At the current sub-prime credit crisis, although by issuing more bonds by the US government can help alleviate the problem on hand, but it will not totally resolve the problem but instead plant a seed for more trouble in the future.

Recently Bush government announced a 700 billion USD plan to save the market. The purpose of the plan is to ease the market fear caused by the collapse of Lehman Brothers, Merrill Lynch being taken over and stop the domino effect caused by the sub-prime crisis. However, it has done a major impact to the US dollar's credibility.

In order to proceed with the plan, the US government has asked to increase the limit allowed for US treasury bonds from current value of 10.6 trillion USD to 11.3 trillion USD in order to leave some spare for the implementation of the plan. The limit put on the US treasury bonds was originally put in place to enforce within a workable range an unbreakable line of safety. Now that the US government easily changed it to resolve the current financial market crisis, it is equivalent to giving the market dangerous signals that the US dollar will further weaken.

On 22 September 2008, the New York Mercantile Exchange November crude oil price raised by 6.62 USD and closed at 109.37 USD, a 6.44% increment. At the same day, New York Mercantile Exchange gold futures price also raised by 44.3 USD closing at 909 USD per ounce, a 5.1% increment. Crude oil and gold's continuous big increment has obvious relations to the plan that the US government is going to implement.

Such continuous injection of the US dollar into the financial market is a continuous act of abuse of the US dollar credibility and will enhance the weakening of the US dollar. When the other countries cannot tolerate any more of US acts of excessive overdraft on the US dollar, they will not lend money to US, start to give up on the US dollar and US dollar's credibility will then crumble.

Of course, US credit crisis can be passed on to other countries through the international commodity prices and international monetary and financial systems causing world's major economies difficulty to protect themselves from it. The rest of the world will be forced into a dilemma.