Dollar Loses Its Luster As Reserve Currency The U.S. dollar has fallen more than 12 percent from its recent peak. Amid worries that it will continue to weaken, some central banks are keeping more of their reserves in euros and yen. There has even been talk of finding an alternative to the greenback as the world's major reserve currency.

Dollar Loses Its Luster As Reserve Currency

Dollar Loses Its Luster As Reserve Currency

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An employee of an Indonesian money exchange counts currency in Jakarta. Bay Ismoyo/AFP/Getty Images hide caption

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Bay Ismoyo/AFP/Getty Images

An employee of an Indonesian money exchange counts currency in Jakarta.

Bay Ismoyo/AFP/Getty Images

The U.S. dollar, which has been trending down this year, managed to rebound a bit Friday, and the price of gold fell after setting new highs three days in a row.

But the greenback remains weak and gold is still very pricey, with the overnight movements doing nothing to reverse the trend of the past few weeks. Gold's rise is the mirror image of the dollar's decline as investors look for a hedge against the inflation and dollar depreciation they fear will come from big U.S. deficits.

In March 2008, before the financial crisis, the dollar was at historic lows against a basket of currencies. Then, when the financial storm struck, the dollar strengthened as investors rushed to the safety of U.S. Treasury securities.

Now that the worst of the crisis appears to have passed, the dollar is under pressure again. It's down more than 12 percent from its recent peak. Fred Bergsten of the Peterson Institute for International Economics says sentiment about the dollar has now turned negative.

"Some private investors worry that the dollar may weaken systematically over time because of the big budget and trade deficits, so there's a search for alternatives to the dollar," he says.

A Search For Alternatives

For some investors the alternative is gold. For others, like some central banks around the world, the alternative is keeping more of their reserves in euros and yen. In fact there's been renewed talk in some quarters of finding an alternative for the dollar as the world's major reserve currency — and, also, pricing oil in something other than dollars.

The Dollar's Ups and Downs

Dollar chart

Those ideas, while not unthinkable in the long term, aren't likely to happen anytime soon. Bergsten says to counter the loss of confidence in the dollar, the Obama administration needs to take policy actions to shrink the huge U.S. budget deficits, which are projected to be over $1 trillion a year for the next decade.

"Social Security reform would be a perfect example, where you could decide to change the benefit formula, increase the retirement age," Bergsten says. "All of that would phase in over a period of time. It would be sizable and credible, but it would not dampen the recovery from the recession."

Bergsten also says the U.S. economy will bounce back from the recession more quickly than expected, which could strengthen the dollar.

Talking Up The Dollar?

But former Treasury official David Malpass, who now heads the financial firm Encima Global, disagrees. He predicts the U.S. currency will continue to slide unless the Obama administration shifts the way the U.S. government talks about the dollar.

"You'd get quite a bit of change, upward movement, and more prosperity for Americans, more capital flowing into the United States if the president would say he'd like the dollar to be stronger."

Malpass says the current formulation, which is "a strong dollar is in the national interest of the United States," has lost its meaning. He says while that's been the U.S. mantra for the past 15 years, the dollar has steadily weakened for almost eight years. He says some past U.S. administrations have been comfortable with a cheaper dollar because they think it makes the U.S. more competitive in world markets. Malpass argues that's not true.

"The currency keeps getting weaker; jobs keep moving overseas because that's where the capital is. Money wants to go to where it can get a steady return in real money, not in funny money. And in many ways the dollar is becoming the funny money currency for the world and that's not good for our competitiveness."

Malpass says the change in rhetoric about the dollar could have a positive effect immediately, even if it weren't backed up by big changes in U.S. policy.

"There wouldn't need to much backing. It would come as a shock; the markets would then fall into line and start strengthening the dollar."

Malpass argues that eventually the shift in rhetoric by the president would lead to changes in government policy that would support the goal. But, it's safe to say the consensus is that rhetoric won't be enough, and that credible efforts to reduce deficits will be needed to restore confidence in the dollar.