The Falling Dollar

An index of the value of the American dollar against has decreased by 15% in the past half year, from 89.11 on March 5th to 75.24 on October 20th. Because the American dollar has been described as a “safe haven” in the investment market for a long time, the simplest explanation of the currency’s decline is based on the increasing value of risky assets, lowering the demand for the dollar to hedge. But this hardly constitutes an outright collapse, nor is it necessarily cause for concern.

Worries about the dollar are hardly new. The current-account deficit of America has increased since the 1980s, implying the pressure on depreciation. Some may argue that the U.S. dollar’s dominance is due to America’s position as a superpower, which is, however, now seriously challenged by the emerging countries. Moreover, these emerging countries, like China and Russia, who hold a large portion of their reserves in dollars, have recently called for the need to shift the world’s currency reserves out of the greenback. All of these factors cause the weakness of the dollar.

The weakness of the dollar has also revived fears of a currency crash. However, this kind of concern is going too far. Depreciation, if it continues in the future, will be a gradual move instead of a sharp crash. That is because its liquidity ensures the dollar’s irreplaceable position as the settlement currency of international trading and the main currency reserve for most central banks. It is clear that no other currency can compete with the dollar in terms of the amount in circulation, maintaining demand for the greenback. In fact, the financial crisis actually caused a flight to dollars as a safe-haven, proving that the dollar is still considered a safe asset, and the recent weakness merely reverses the previous risk aversion.

Responses of countries with floating exchange rates to the dollar’s slide vary. To ease appreciation of the Brazilian real, Brazil’s government directly reintroduced a tax on foreign purchases of equities and bonds this week, causing the real to fall by 2% and Brazil’s stock market to drop by 3%. Instead of similar direct measures, the Canadian government has resorted to “talking their currency down,” saying that the strength of the Canadian dollar would offset the good news in the past three months. The foreign-exchange market responded to the statement immediately, leading Canada’s currency to fall by 2% against the American dollar. In general, since the recovery is uneven between different regions, countries with stronger trading relationships with Asia, such as Australia and Japan, are relatively sanguine about a weak greenback.

The lesson we have learned for the past year is that the dollar is that during the financial meltdown the dollar was still a currency to flee to, not from, showing that a dangerous collapse in the greenback is unlikely. But since the American budget deficit is expected to last for years and the world’s trading imbalance cannot not be solved in the short term, all governments may have to prepare to face a weak dollar for a long time.

Current Account Deficit: Magic or Disaster?

For those who believe China’s huge current account is the root cause the financial crisis, this is good news- their surplus is finally shrinking. In the first half of this year, the surplus narrowed to $130 billion, one-third lower than a year earlier, and barely half its level in the second half of 2008. The narrowing surplus can help China’s government to ease the pressure on the Yuan to appreciate, and also reduce imbalances in the world economy. China’s statistics, however, are notoriously tricky, and this is why some analysts still hold a skeptical attitude toward these figures.

Being one of the primary components of the balance of payments, the current account is the sum of the balance of trade, net factor income and net transfer payments, illustrating how capital flows across borders. When a country has a current account deficit, it means that people in this country spend more than they have earned, resulting in the decrease of the country's net foreign assets. Based on IMF data, the following map is the accumulated current account from 1980 to 2008, telling us a vivid story about how the capital has “traveled” around the world over the past two decades: The hard working Asian spend much less than they’ve earned, and saved the rest of it in the way of buying all kinds of financial products issued by the private or public sector, like American Treasury bonds, hedge funds, etc. With all this hot money flowing back to the U.S., Americans have been buying or investing in things they cannot really afford, leading to the ballooning asset prices.



If you have read the book “The Age of Turbulence: Adventures in a New World” by Greenspan published in 2007, you would be interested in his point of view on America’s current account deficit. In the book, he emphasized that mainly driven by the private sector, America’s deficit merely reflects the attraction of America’s investment environment, and therefore, it is not a problem. Securities and assets with high and stable yields are like magnets, attracting money from all over the world back to America’s investment market, pushing up the need for US dollars, and offsetting the pressure on the dollar to depreciate. This theory even has an academic name: "Pitchford Thesis." With the help of this financial magic, Americans experienced a prosperous decade in the 1990s: a high economics growth rate, low inflation rate and low unemployment rate. Some economists even called this the economic miracle of America. Now, we all know this magical story ended in tragedy, but if the world economic imbalance still lasts, then the financial crisis this time will not be the only thing we should worry about.

The narrowing current account surplus of China seems to imply the decrease of the world economic imbalance, if the statistics are reliable. But from past record, however, China’s government is not so trustworthy. Their national GDP, for example, is always very different to the sum of provincial GDPs, making the numbers lackcredibility. And the current account they reported this time is much smaller than those suggested by its trading partners’ data. Actually, if you add up all country’s trade with China, China’s surplus should be $295 billion, more than twice as much as the $130 billion surplus logged by China itself. It is no wonder that some conspiracy theorists conclude that Beijing is deliberately understating its embarrassingly large surplus.

It is almost certain that Beijing’s number is understated. But despite its inaccuracy, the crucial thing for the rest of the global economy is not the precise size of China’s surplus, but the fact that it is finally shrinking.

Education Reform

No one would doubt the importance of education. Deliberately transmitting society’s accumulated knowledge, skills and values from one generation to another, education shapes children’s characteristics and competitiveness, defining a country’s future. This explained the result of the poll conducted for the Economist, which shows that almost three quarters of Americans think that the problems facing education are at least as grave as health care. Indeed, there is an appetite for reform.

Ironically, the financial crisis offers a great opportunity for education reform. Thanks to the federal stimulus, Mr. Duncan, Barack Obama’s education secretary, find himself in an unprecedented position, holding a surplus of more than $10 billion, including $3.5 billion to turn around schools. With his $10 billion, he has said he wants to “fundamentally change the business the department of education is in.” This ambition should not be too surprising, because this statement simply echoed the Obama’s demand for change while running the campaign.

The education department has divided cash into several programs, including a $4.4 billion “Race to the Top.” This program reward states for reform in several areas. It will streamline the collection of pupil data, which can be used to improve teaching. Also, states should set internationally benchmarked standards and use teacher’s performance to determine training, pay, and promotion. Moreover, the fund will support efforts to help struggling schools.

In some respects, education reform is even more difficult than health care reform. In the latter case, the problem is clear, and the solution is there. The “only” difficulty is that Obama must persuade his people that this reform is leading the country in the right direction. The education issue, however, is more complicated since it involves so many problems including race, social structure, parent’s attitudes, etc. Actually, a higher budget can bring the school better facilities, talented teachers, and a lower teacher-student ratio, but it cannot solve school violence, the imbalance of resources between private and public, and a high drop-out rate. Despite the huge budget, change will just be formalistic without the support of parents and the whole education system.

Of course, things are always easier in a theory than in practice. That is why Rand Weingarten, leader of the American Federation of Teachers, said “implementation is where reforms die.” But Obama promises that this time, change will be different- more comprehensive and more enduring. People are now waiting to see whether he is just a dreamer or a dream practitioner.