-Caveat Lector-

American Gangster's Wad of Euros Signals U.S. Decline (Update1)

By James G. Neuger and Simon Kennedy

Nov. 14 (Bloomberg) -- ``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 U.S.
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. This time, the U.S. currency
is on the losing side.

After declining in five of the last six years, the weakest dollar in
the era of floating currencies reflects a period of diminished U.S.
political and economic hegemony. Whoever wins the White House next
year will confront two unpopular choices: Accept the fall in U.S.
clout and the rise of new rivals, or rein in record public and
consumer debt that the rest of the world no longer wants to bankroll.

``What we're seeing is a very broad rebalancing of economic and
political power in the world,'' says Jeffrey Garten, a Yale School of
Business professor who was the Commerce Department's undersecretary
for international trade in the Clinton administration. ``The scales
are moving, and they're moving quite fast.''

The dollar blues have migrated from the halls of central banks to
images of rap musicians.

In a video for the movie ``American Gangster,'' hip-hop maestro Jay-Z
thumbs through a wad of 500-euro notes on a night of cruising through
the concrete canyons of New York, a city where the euro isn't legal
tender. The euro gained against the dollar today as European economic
growth in the third quarter accelerated more than forecast.

Nixon Genesis

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 in the U.S. For the first
time, economists are raising the once-improbable specter that the
dollar's monopoly as the world's dominant reserve currency is under

Like the British pound, its predecessor as the world currency, the
dollar has fallen victim to widening burdens overseas and economic
stresses at home. The slippage began in 1971 when President Richard
Nixon, in a stopgap move to cope with the inflationary financing of
the Vietnam War, halted the exchange of dollars for gold.

Since then, currency markets have ebbed and flowed. High Federal
Reserve interest rates and a flood of Japanese capital to finance
Ronald Reagan's deficits bred the ``superdollar'' of the mid-1980s.
The Internet-led productivity boom lured investment to the U.S. in the
late 1990s. The most recent period reflects a world awash in other

Permanent Depreciation

``Part of the depreciation is permanent,'' says Harvard University
professor Kenneth 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 bottomed at 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.

One of the main U.S. exports since then has been the dollar itself, in
exchange for foreign capital to finance trade deficits and a national
debt of more than $9 trillion. While the current- account deficit is
narrowing from last year's record $811.5 billion, the U.S. still
requires $2.1 billion a day of other people's money.

`Unstable Situation'

``We're getting into a very unstable situation,'' says Richard Duncan,
a partner at Blackhorse Asset Management in Singapore and author of
the 2005 book ``The Dollar Crisis: Causes, Consequences, Cures.''

Such a prospect unsettles U.S. allies, and concerns are mounting that
the flight from the dollar is feeding on itself and threatening a
crisis of confidence that the next president will have to address.

Kuwait, freed by the U.S. from Saddam Hussein's army in 1991, unhinged
its currency from the dollar in May, and pressure is building for Gulf
Arab neighbors to follow suit. Qatar's prime minister, Sheikh Hamad
bin Jasim bin Jaber al-Thani, complained Nov. 11 that the dollar's
drop is cutting oil and gas income, leaving less to invest abroad. The
United Arab Emirates may drop the dirham's peg to the dollar, analysts

The central bank in Iraq, a country the U.S. military has occupied
since 2003, last month said it, too, wants to diversify reserves away
from mostly dollars.

Korean Shipbuilders

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 Stiglitz, a Nobel-laureate economist at Columbia University, at
a Bloomberg 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.''

Economic Dry Spell

To be sure, the latest slump -- 6.6 percent against the euro since the
end of August, 4.7 percent against the yen --partly reflects an
economic dry spell. Credit-market turmoil led banks to cut consumer
lending, bruising the U.S. economy's main engine.

``I don't think this is a lasting phenomenon, but it will come to a
halt especially when America in a few months or at the start of next
year gets over the financial crisis,'' says Theo Waigel, Germany's
finance minister in the 1990s and an architect of the euro.

For now, the U.S. economy is a drag on the rest of the world. When the
IMF last month trimmed its global growth prediction for 2008 to 4.8
percent from 5.2 percent, it blamed the U.S., whose forecast was cut
to 1.9 percent from 2.8 percent.

Two Fed rate cuts, to 4.5 percent, have tilted the trading odds
against the dollar in the near term. While the European Central Bank
has put a planned increase in its benchmark 4 percent rate on hold,
investors still see European rates going up and U.S. rates going down.

Asia Diversifies

``I wouldn't bet against the U.S. as the world's reserve currency,''
says former Treasury Secretary John Snow, now chairman of Cerberus
Capital Management in New York. ``The dollar markets 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

Cash-rich governments are discovering the profit motive, 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 & Co. estimate as much as $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 will 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.

G-7 Action

Ultimately, if the dollar's swoon depresses U.S. stocks or threatens
global growth, Group of Seven major industrial nations may have to do
more than issue communiqués.

The last concerted international maneuver to rearrange currency rates
was in September 2000, when the G-7 sold dollars to prop up the
then-stumbling euro in a U.S. presidential election year.

For the moment, policy makers are just talking. ECB President
Jean-Claude Trichet last week called the euro's record- setting rise

Treasury Secretary Henry Paulson trotted out the 1990s mantra that a
``strong dollar is in our nation's interest'' --as long as markets
determine its rate. For the first time, Paulson had to rebut concerns
about the dollar's supremacy as a reserve currency.

`Uphill Struggle'

``At this moment I don't think that the Americans are very
disturbed,'' says former Dutch Finance Minister Gerrit Zalm, one of
the euro's founding fathers. ``Until now, the developments are gradual
with little effect on the stock exchange or long term capital-market

``There is a loss of confidence in both the dollar and the U.S.,''
said Riordan Roett, a professor at Johns Hopkins University in
Baltimore. ``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.''

To contact the reporters on this story: James G. Neuger in Brussels at
[EMAIL PROTECTED] ; Simon Kennedy in Paris at
Last Updated: November 14, 2007 10:15 EST

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