Further De-valuation of the USD

[Elle]

So I just learned today that Ecaudor and Panama use the USD as their official currency. This isn't new, but it suprised me.

The Ecuador scenerio is the one I read about and it appears they are using US paper money but are minting their own "US" coins. So my question is, does their minting of a few million dollars in "US" coins per year hurt the value of the USD? And why would the United States agree to this?

[scottkursk]

They really don't effect us or our USD at all. The centavos are in theorry equivalant to the us coins and if I remember they actually look a bit like our coins but they have Ecuadorians on the coins. (Oh to get FDR off of my coins....)

Of course, holding the coins still subjects you to the same risks that were associated with the Sucre. I was in Columbia with a bunch of Ecuadorians a few years ago after they did the switch. One one side they hated losing a bit of national pride but they loved ditching some of the inflation.

As for the USD being held en masse overseas, I seem to remember that 50 or 75% of physical US dollars are held overseas. In fact the fed wholesales them to overseas banks.

So I just learned today that Ecaudor and Panama use the USD as their official currency.  This isn't new, but it suprised me. 

The Ecuador scenerio is the one I read about and it appears they are using US paper money but are minting their own "US" coins.  So my question is, does their minting of a few million dollars in "US" coins per year hurt the value of the USD?  And why would the United States agree to this? 

[Jay P]

I don't know about the specifics of Ecuador or Panama, but I have heard of countries other than the US being on a "US dollar standard". If I'm not mistaken, Argentina was on such a standard until a few years ago.

Being on a US dollar standard means that the local currency is exchangeable for US dollars at a fixed rate (not necessarily 1 to 1). So just as under a gold standard, a holder of the currency would be able to demand gold for it, under a US dollar standard, a holder of the currency would be able to demand US dollars for it.

The idea is that the local currency will have value by virtue of its being able to be exchanged for something else of value. This may sound strange, since after all, today's US dollar is not backed by anything, but in much of the world, the US dollar has much more stable value than any local currencies.

Note that the foreign government (or other entity that decided to issue currency backed by dollars) does not actually print or mint US currency. (I'd be very surprised to find out I was mistaken on this point.) What it prints instead are units of its own currency, which it's then obligated to redeem for US currency. So it creates no obligation on the part of the US government, or indeed on the part of any holders of US currency.

For example, if I am owed a debt in US currency today and somebody offered me Ecuadoran money as payment, claiming that it's "just as good", I could refuse to accept it. (Presumably the Ecuadoran government could force Ecuadoran citizens to accept it, but that's another issue.)

Using US dollars as a "reserve currency" like this creates more demand for them, so if anything, it would tend to make the dollar more valuable. And I don't believe the US government could do anything to stop it even if they wanted to. After all, if US dollars are owned by foreigners, it's up to the owners of those dollars to use them as they see fit.

Note that if a government goes on a US dollar standard, it is then limited in how much currency it can issue, since if it issues too much, it won't have the dollars to pay out when holders of the local currency demand them. So it's a brake on local inflation, in a somewhat lesser way than the gold standard was. It definitely makes the value of money less subject to the whim of politicians.

However, there's always the question of whether the government will stay on the dollar standard. That is, they could at some point in the future decide by fiat that they'll no longer pay out dollars. Or that they won't pay out as many. Devaluation, in other words. I believe this is what Argentina did a few years ago, with the result that holders of Argentine currency were not given the US dollars they'd been promised. (Exactly analogous to the Devaluation of the US dollar in the 1930's: FDR decreed that holders of dollars would not receive as much gold as they'd been promised. The difference is that in one case, the US dollar is the entity backing up something else, and in the other case, the US dollar is the entity being itself backed up.)

[scottkursk]

I don't know about the specifics of Ecuador or Panama, but I have heard of countries other than the US being on a "US dollar standard".  If I'm not mistaken, Argentina was on such a standard until a few years ago.

Panama and Ecuador acually abanoned hopes of a local currency. They just set an exchange rate and said on such and such date that the old currency was non-existant. Other countries like Argentina and China now have freefloating currencies that trade at whatever ratio the market will bear. Many countries artificially peg their currencies to the USD so that they can artificially lower their rate of inflation.

Naturally the peg rate would float to a market defined level if it had a chance but the way the governments of the pegged countries work is that contracts have to be denominated at the pegged rate. That forces people to accept the peg rate for the most part. Of course there are ways around it....

For example, if I am owed a debt in US currency today and somebody offered me Ecuadoran money as payment, claiming that it's "just as good", I could refuse to accept it.  (Presumably the Ecuadoran government could force Ecuadoran citizens to accept it, but that's another issue.)

Cuba just did that with the USD. Publicly, it was to wean the people off of the greenback that was the backbone and go to a "patriotic" currency. Their is an official 1 for 1 exchange rate. Domestically, it did have that rate and still does since the USD's are extremely illegal. Of course, outside of Cuba they are a joke and the Cuban govt became positively flush with hard currency. They traded toilet paper for dollars. Mexico has done this a couple times by recalling the peso and hosing anyone hold peso denominated bonds or equity.

Using US dollars as a "reserve currency" like this creates more demand for them, so if anything, it would tend to make the dollar more valuable.  And I don't believe the US government could do anything to stop it even if they wanted to.  After all, if US dollars are owned by foreigners, it's up to the owners of those dollars to use them as they see fit.

The peg rate countries do effectively use the USD as a gold standard except more easily convertible. Much to goldbugs chagrin, the USD is more liquid than gold. Yes gold is pretty and shiny and makes that ting! when you clank two ingots together but you just can't spend it. It has uses just like any other mineral like bauxite, phosphorous, helium. The problem with pegged currencies is that if the foreign central bankers want to print money, they just modify the peg rate or in some cases keep the official peg rate the same and just print away. Just like anything else no matter how shiny and pretty the peg is.

[Yes]

All of this occurs due to the fact that we are no longer on a precious metal standard.

[visaplace]

The issue of the devaluation of the US dollar is serious. However the finanical media do not seem to care much nor do the economists etc. The twin deficits virtually gaurantee the continued decline in the US dollar. Is anyone listening? Does anyone care? The US standard of living will fall with the dollar.

[Tom Rexton]

The issue of the devaluation of the US dollar is serious. However the finanical media do not seem to care much nor do the economists etc. The twin deficits virtually gaurantee the continued decline in the US dollar. Is anyone listening? Does anyone care? The US standard of living will fall with the dollar.

Actually, it is evident in many economic articles from several economic websites and magazines that the deficits are major concerns for the US economy (not to mention the world economy).

The problem is that economists have been "crying wolf" for years that the USD will fall and thereby cause a global depression, the worst of which will be suffered by Americans. It hasn't happened yet. The USD has so far been GRADUALLY devaluating, not freefalling as prophesied.

Of course, it is most likely that some time in the near future, there will be a panic that will cause the USD to devaluate rapidly, leading to the worst US financial disaster since the Great Depression.

What you shold be worried about, however, is not so much your living standards, but how the government will react.

[wishbone]

The dollar has fallen considerably in the last year or two. It is unclear if it will fall further.

Just as the US has been acting in ways that devalue the dollar, other countries (notably China and Euro-land) could do the same. So, the dollar may even appreciate in terms of those currencies while falling against commodities, like Gold.

[Ed from OC]

Larry Kudlow argues that the problem lies with Euro deflation, rather than dollar inflation.

"Is there too much panic about the so-called dollar decline? You bet there is.

Most of the recent drop in the U.S. currency has come against the euro. But Europe has dug itself into a deflationary hole in recent years. The volume of euros is way too scarce, and taxes, government spending, regulations, and unemployment are way too high. Why anyone would want to invest in Old Europe’s socialist policies is beyond me. Surely it isn’t worth deflating the U.S. economic recovery, or the dollar, just to play Europe’s perverse game.

The dollar, in actuality, isn’t really weak. A broader dollar index of 26 currencies published by the Federal Reserve paints a much stronger picture. Since February 2002, the dollar has fallen 14 percent from a greatly overvalued position that deflated the U.S. economy into recession. However, over the last 10 years, this broad-dollar index is basically unchanged. The dollar is at nearly the same point today as it was in 1994. During this period the average inflation rate in the U.S. was 1.8 percent."

Read the rest of the article here.

[wishbone]

Larry Kudlow argues that the problem lies with Euro deflation, rather than dollar inflation.

I'm not a Kudlow fan. I find him to be more of a Republican cheerleader/spin-doctor than an unbiased observer of reality.

Most of the recent drop in the U.S. currency has come against the euro.

This is true. All it means is that the Dollar has fallen against the Euro, but it has not yet fallen against the asian currencies. If one looks at Gold (the favorite yardstick of objectivists) the dollar has fallen a huge amount.

While I am no expert in this field, the opinion of experts I trust can be summed up thus: the dollar has fallen against gold and euros, but not against the dollar. The fall against the euro may be overdone, and the dollar may rebound relative to the euro. These investors I trust believe that the dollar's fall against asian currencies is yet to come.