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(The Economic Times) - In the United States, half a million jobs evaporated last month, over 1.2 million were lost in the last three months. Businesses are closing down every day. Banks are afraid to lend, credit market continues to be tight.

Consumer confidence is dwindling. Most forecasts suggest that the US gross domestic product will decline by 4% to 5% on an annualised basis in fourth quarter of 2008, and the economy will continue to experience a decline in GDP in 2009.

Every expert and non-expert has declared that the US economy is in the worst recession since the 1929 Great Depression. But the US dollar is unfazed; it continues to enjoy strong confidence in a world economy shaken by financial turmoil. The greenback is getting stronger every day just as the US economy is plunging deeper into recession.

Since August, the dollar has appreciated 17% against the rupee, 23% against the euro, and 34% against the British pound. Couple of weeks ago, the dollar strengthened somewhat even against the Chinese currency, renminbi. News reports suggest that the recent decline in export orders is putting pressure on the Chinese government to allow the renminbi to depreciate against the dollar — by five or even 10%.

Dollar’s resurgence is a puzzle when compared with how currencies of other countries collapsed in national or regional financial crises in the past two decades. The Argentine peso depreciated 75% against the US dollar during the Argentine economic and financial crisis during 1999-2002. In the 1994 Mexican peso crisis, the Mexican currency fell 55% against the dollar.

During the 1997 Southeast Asian financial turmoil, Thai bhat, Indonesian rupiah, Korean won experienced huge depreciations as did the currencies of Malaysia, the Philippines and other Southeast Asian economies. Financial crises in these countries not only caused substantial depreciations of their currencies, but also flight of foreign, and sometimes even domestic, capital. So far there is no shine off the value of the dollar, nor any major flight of foreign capital from American shores.

What’s with the greenback? Against all odds, how has it regained in the past four months what it lost against most currencies in the previous three years? Clearly, the dollar has benefited from the fact that it continues to be the international currency of exchange, trade and reserve. The strengthening of the dollar is also helped by the fact that Japan and the economies of the euro zone are as deeply sunk in recession as is the American economy and growth in China and India is projected to be lower than it had been in the previous few years.

Most of all, fright in world financial markets has sent investors running away from risky assets towards the US dollar and US treasury bonds. In the worst financial crisis since the Great Depression, the dollar has regained almost half of what it lost in the past six years. Consequently, American businesses are becoming less competitive as compared to foreign businesses.

This will dampen demand for American exports and increase its imports. American multinational corporations will also find that returns to their investments abroad decline, when expressed in dollars. American travellers, who have suffered erosion in their purchasing power abroad during the past seven years will, however, benefit from the current strengthening of the greenback.


How will the dollar fare once the full impact of the US government’s $700-billion bailout package becomes known is not clear. Will investors start shunning US treasury bonds once they realise the full import of US fiscal deficit? Will foreign investors’ confidence in the US economy fade with the prospects of its future economic growth? If the answer to these questions is yes, then it is clear that the ‘global’ economic recession has not yet led to the much needed correction in the global financial system.

While the world economy is looking towards Asia, in particular China and India, for economic growth in the coming five years, Asian economies in turn depend heavily on US consumers. The recent depreciation of the Chinese yuan, said to be triggered by the slackening of export orders, is an indicator. A weak Chinese currency is expected to keep US demand for Chinese goods buoyant, while the recession in the US would dampen it.

However, if the US economy remains in a prolonged recession, it would be foolish to expect that somehow the US would continue to increase its purchase of goods from the rest of the world to keep the world economy going, and it would be foolish and even dangerous to keep financing American imports through debt.

If China continues to use its reserves to prop up the dollar, it will seriously weaken its own position and reduce its policy options. Any future dollar depreciation would only result in a decline in the value of Chinese reserves.

China can keep its economy growing at double digits by using its $2 trillion reserves to bring prosperity to its people, by creating more jobs and paying workers higher salaries. China can also provide its own people consumer goods at low prices, same as it has been doing for American consumers for decades.

China can redeploy its reserves to increase investment in other Asian economies. The Chinese government has announced a $600-billion initiative to boost its economy over the next two years. The boost constitutes 14% of China’s GDP, and can help China maintain its potential economic growth even with slackening of US imports.

According to the most recent forecast of the world economy by the International Monetary Fund, advanced economies will experience almost a one percentage point reduction in their GDP in 2009. It is clear from these forecasts that world economic growth in the next two to three years would heavily depend on Asian economies.

Asian economies have to creatively invest their resources in productive activities instead of parking them in US treasuries. That’s the only way Asia can bring the world economy out of recession.

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