Dollar Squeezed in Global Currency Marketplace

"It may be our currency, but it's your problem" was Treasury Secretary John Connally's taunt when the U.S. unhooked the dollar from the gold standard in 1971, unilaterally rewriting the rules of world business in America's favor.

Now the world is taunting back. Almost four decades after the United States tore up the monetary arrangements that governed the post-World War II international economy, the dollar's fall from grace amounts to a tectonic shift in the global hierarchy.

"What we're seeing is a very broad rebalancing of economic and political power in the world," said Jeffrey Garten, a Yale School of Business professor who was the Commerce Department's undersecretary for international trade in the Clinton administration.

The latest tailspin was triggered by the ascendance of China and India, growing confidence in Europe's common currency, record American debt and trade gaps, London's challenge to New York as a financial center and a two-year housing recession. For the first time, the dollar's monopoly as the world's dominant reserve currency is under threat.

"Part of the depreciation is permanent," said Harvard professor Kenneth A. Froot, who has been a consultant to the Fed. "There is no doubt that the dollar must sink against periphery currencies to reflect their increase in competitiveness and productivity."

The Fed's trade-weighted major currency index fell to 71.11 on Nov. 7, the lowest since the era of free-floating currencies started in 1971. Against the yen and European currencies, the dollar is now worth about a third of what it was in the days of fixed rates.

Concerns are mounting that the flight from the dollar is feeding on itself. Kuwait unhinged its currency from the dollar in May, and pressure is building for Gulf Arab neighbors to follow suit. Qatar's prime minister, Sheik Hamad bin Khalifa al-Thani, complained Nov. 11 that the dollar's drop is cutting oil and gas income, leaving less to invest abroad.

The central bank in Iraq last month said it, too, wants to diversify reserves away from mostly dollars. South Korea's central bank this week urged shipbuilders to issue invoices in won, the Korean currency, and take out more hedging policies to guard against a weakened dollar.

The dollar's share of global central banks' currency portfolios slid to 64.8 percent in the second quarter from 71 percent in 1999, the year the euro debuted, the International Monetary Fund says. The euro, used in 13 countries, now accounts for 25.6 percent.

"The global reserve system is fraying; it's falling apart," said Joseph E. Stiglitz, a Nobel-laureate economist at Columbia University, at a Bloomberg News seminar last month in Tokyo. "The change in mindset about the use of the dollar in reserves and the movement of the dollar out of reserves will continue to exert downward pressure."

Former Treasury secretary John Snow, now chairman of Cerberus Capital Management in New York, said: "I wouldn't bet against the U.S. as the world's reserve currency." Dollar markets, he said, "are so deep and so liquid and the American economy is so fundamentally advanced."

Central banks in Asia are hedging that bet. Buoyed by the fastest growth of any major economy and putting tight limits on the appreciation of its exchange rate, China has piled up the world's biggest stash of foreign currencies, worth $1.4 trillion at the end of September.

Cash-rich governments are adding to pressure on the dollar as they comb the world's markets for investments that pay more than the current 4.25 percent return on 10-year U.S. Treasury bonds. Economists at Merrill Lynch estimate that $1.2 trillion in dollar holdings will shift to other currencies in the next five years.

A warning by Cheng Siwei, vice chairman of the National People's Congress, that China would invest in stronger currencies triggered a recent stampede out of the dollar. China doesn't have to dump dollars to depress the U.S. currency, economists at UBS AG say. Accumulating them at a slower pace will have the same effect.

"There is a loss of confidence in both the dollar and the U.S.," said Riordan Roett, a professor at Johns Hopkins University. "It may only reflect the widespread dismay with the Bush administration, but it is obvious that the next administration, of either party, will have a steep uphill struggle."

With reporting by Kim Kyoungwha in Seoul, Kevin Carmichael in Washington, Kathleen Hays in New York, Massoud A. Derhally and Will McSheehy in Dubai, and Stanley White and Kazumi Miura in Tokyo.