Why the Dollar Could Collapse
The euro could replace the dollar as an international currency. Between Q1 2008 and Q4 2010 (most recent report), the value of euros held in foreign government reserves increased from $393 billion to $1.35 trillion, a 240% increase. During this same time period, dollar holdings only increased 11%, from $2.77 to $3.1 trillion. Dollar holdings only represent 61% of total measurable reserves, down from Q3 2008, when dollars comprised 67% of reserves. Since the percentage of dollars is slowly declining, this means that foreign governments are slowly moving their currency reserves out of dollars.(Source: IMF, COFER Table)China is the largest investor in dollars. As of January 2011, (most recent report) it held $1.1 trillion in U.S. Treasury Securities. It periodically hints it will reduce its holdings if the U.S. doesn't reduce its debt.(See China May Reduce Debt Purchases) However, its holdings continue to increase.
Japan is the second largest investor, with $886 billion in holdings. It buys Treasuries to keep the value of the yen low, so it can export more cheaply. However, its debt is now 200% of its GDP. Some are concerned it may be forced to sell some of its holdings to pay for an estimated $250 billion reconstruction cost from its earthquake/tsunami/nuclear disaster.
Oil-exporting countries (and the Caribbean banking centers that often serve as their front) hold $381 billion. If they decide to trade oil in euros instead of dollars, they would have less of a need to hold dollars to keep its value relatively higher. For example, Iran and Venezuela have both proposed oil-trading markets denominated in euros instead of dollars.
Why the Dollar Won't Collapse
Many say the dollar won't collapse because- It's backed by the U.S. Government, making it the world's safe harbor currency.
- It's the universal medium of exchange, thanks to our (still relatively) sophisticated financial markets.
- The major oil contracts are still priced in dollars.
Many in Congress want the dollar to decline because they believe it will help the U.S. economy. A weak dollar lowers the price of U.S. exports relative to foreign goods, making our products more competitive. In fact, the decline in the dollar improved the trade deficit in 2008. (See U.S. Trade Deficit)
Outcome
Although the dollar has declined dramatically over the last seven years, it has not yet created a collapse. It's not in the best interest of most countries to allow this to happen, since it would decrease the value of their dollar holdings.Regardless of the outcome, be prepared. Most experts agree that the best hedge against risk is with a well-diversified investment portfolio.
Ask your financial planner about including overseas funds. These are denominated in foreign currencies rise when the dollar falls. Focus on economies with strong domestic markets, such as Japan and Europe. Also ask about commodities funds, such as gold, silver and oil, which increase when the dollar declines. (Updated April 12, 2011)
