The dollar: Sunrise or sunset?

Many analysts have been proclaiming the U.S. dollar is in terminal decline, and that it is due to be replaced by another currency, perhaps the Chinese Renminbi (a.k.a. Yuan) or a new Asian or Mideast regional currency akin to the Euro. The Bearish story can be summarized thusly: interest rates are so low in the U.S. that global capital is flowing to higher interest rates in the Eurozone (hence the strength of the Euro).

Additionally, the enormous Federal deficits will exceed the appetite for U.S. Treasury bonds, requiring the Federal Reserve to print money to buy the bonds -- a measure widely presumed to be inflationary and thus a negative for the dollar. As valid as these bearish points may be, they don't address every issue at hand.

From another point of view, it may be sunrise for the U.S. dollar rather than sunset.

Ultimately, a currency is a reflection of the economy that issues it. Thus the dollar bears are implicitly or explicitly reckoning that the Eurozone and Asian economies -- particularly China -- will be stronger, more profitable and more stable than the U.S. That may well be a bad bet, for the following reasons:

1. As poor as transparency may be in the U.S. financial system (you know, all those "mark to fantasy" derivatives and credit default swaps (CDS) are still floating around off-balance sheet), it is even worse in Asia and yes, in some nooks and crannies of Europe as well.

2. Despite recent attempts at reform, China's banking system remains opaque and risk-laden. China's large banks are still under the effective control of the central government. So when the government orders the banks to loan out billions of Yuan in "economic stimulus," they do so, even though the risks of adding to their already stupendous bad debts are very high. Please see my essay China: An Interim Report: Its Economy, Ecology and Future for more on this subject.

3. Japan's banking sector and national balance sheet has been chronically ill for two decades, and demographics and the global recession are only worsening that nation's hidden financial ills. Please see my essay Japan's Runaway Debt Train for a more detailed explanation.

4. European banks face their own debt implosion, one that is poorly understood and largely opaque: the big Eurozone banks have huge exposure to loan defaults in the rapidly sinking Eastern European nations. The major Eurozone banks in effect made "subprime loans" to entire nations, not just homeowners. The losses have barely begun to be reported or booked.

5. Interest rates, especially in the long-run, are rising in the U.S., and this will make dollar-denominated bonds more attractive to global capital. To buy U.S. bonds, you need to own or buy dollars; thus demand for bonds translates into demand for dollars.

6. Despite a lot of talk about trading oil in currencies other than the U.S. dollar, the dollar continues to be the currency of the oil trade. Thus in one sense the dollar acts as a defacto oil-backed currency. To buy oil, you first have to buy dollars. That sets a certain demand floor for the buck globally.

7. Recent upticks in the Hong Kong, German and French economies mask the underlying reality that all the major Asian and Eurozone economies are still export-dependent. Once the positive effects of their domestic stimulus spending plans wear off, Asian and Eurozone economies will find their growth drops off, too.

Despite all the talk about domestic demand in China and the EU, these economies are structurally dependent on massive exports for their growth and profits. Without exports, their economies will be mired in recession. The U.S. is also a major exporter, but it is significantly less dependent on exports than other trading nations.

8. The U.S. remains the sole global "Empire" and thus the advantages worthy of an Empire accrue to it alone.This statement is not triumphalism, but simply a reflection of the reality that the U.S. maintains a global commercial, diplomatic and military presence which is unmatched by any other nation or regional alliance like the EU.

Literally every nation above postage-stamp size is a "region of interest" to the U.S. The majority of globally active U.S.-based corporations' profits are earned overseas, American diplomacy is active in every corner of the world, and the U.S. maintains military bases in 63 countries and has military missions in over 150 nations.

While the U.S. is clearly stumbling through a severe mortgage and financial crisis, some of its key global institutions and policies are quite forward-thinking. The value of this global reach and influence is easily overstated, but it is also easily understated.

Holding a currency or a bond denominated in a currency is in effect a bet on the future value of the issuing nation's economy and the soundness of its policies. Its growth, profitability, transparency, resilience, productivity, resources, innovation and ability to ride out crisis are all at stake.

It may well turn out that the great challenges and crises facing the U.S. -- the very issues that currently weigh so heavily on the dollar -- are partly a reflection of greater (though far from perfect) transparency. Other nations face even greater structural challenges in demographics, energy, food, water, innovation, and policy, but many are more adept at masking their tremendous bad debts and fundamental problems than the "let it all hang out" U.S.

Perhaps as the global recession mutates into a structural interplay of chronic crises, global capital will conclude that "the devil you know" -- the U.S. dollar -- is indeed preferable to the devil you don't yet know.

Charles Hugh Smith writes the Of Two Minds blog and is the author of numerous books, most recently "Survival+: Structuring Prosperity for Yourself and the Nation."

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