Confidence and the overvalued US dollar: A ‘what if’ analysis

Editor: It is no secret that one can achieve wonders with a little confidence. With the United States being a world power militarily, technologically and to a growing lesser extent, economically, there is an unmatched level of confidence that serves as a buttress for the US economy. Such is the confidence that allows the US dollar to be the global currency, and incidentally the prime sort after central bank reserve: 4.29 trillion or 63 per cent of global currency reserves holding, according to IMF data 2015.{{more}}

As a consequence of global confidence in the US dollar, there is a demand for the dollar for the dollar’s sake, which makes it more valuable than it ought to be, had it been demanded for trade with the US only and not trade between any other two nations. Had that been the case, countries would hold the US dollar primarily to trade with US. However, the world is not so simple and a surplus with the US might mean a deficit with a country that has a deficit with the US, making it worthwhile to hold USD for more than trade with US. This phenomenon is prevalent in Caricom where inter-regional trade is denominated and conducted in US dollars.

The question, however, becomes: what if confidence in the US were to be severely waned to cause significant depreciation of the dollar? While this phenomenon is highly unlikely, bearing in mind the US remained strong after the 2008 mortgage sub-prime crises, fortunes change and it is always worth the while to assess the repercussion of a possibility, despite the likelihood of the scenario being near zero. Having said that, being an African from the Caribbean, my analysis focuses on the consequence thereof.

The depreciation of the US dollar will have little inflationary impact on Caricom, since, member states currencies are either pegged to the US dollar or managed float contingent on the US dollar and Caricom’s biggest trade deficit is held with the US. Consequently, the balance of payment effect of the Caricom members will therefore mirror that of the US, a consequence of the peg: US goods remains affordable subject to inflationary pressures of the consequential increased demand, while goods from Europe, UK, and Asia will become less affordable. This has implications for Caribbean tourism market, as it becomes more attractive financially for citizens of the aforementioned metropolitan countries to visit the Caribbean and the US.

Caricom member states’ competitiveness will be improved. It is no secret that the IMF continues to prescribe currency devaluation to governments throughout Caricom. Its most recent patient, Trinidad and Tobago, is yet to overtly pronounce whether such prescription will be heeded. Nevertheless, the devaluation of the US dollar is tantamount to a devaluation of the Barbadian dollar, the Eastern Caribbean Currency Union dollar and, to a lesser extent, the Trinidadian dollar. The points in the paragraph above hold: Imports from non-US nations become less affordable while the reverse is true.

What if the US dollar were to wane? The United States continues to keep a large portion of their reserves in gold. This can easily be sold to create a demand for the US dollar, which, along with increased demand for US goods and services, will be able ensure a speedy recovery. In addition, the loss associated with debt quoted in US dollars will force prudent governments and corporations to settle them promptly before they become due to further compound demand.

Severe depreciation in the US dollar can only be temporary. The US dollar has become so intertwined in the global financial market that its decline creates a demand. Caricom nations will suffer under the soaring of the dollar and strive under its decline. Perhaps the time has come to ask the IMF officials to recommend a currency devaluation to the US dollar.

Moses Davis