Should You Bet Against the Dollar?

WSJ ^ | 08 July 2009 | Brett Arends

[BGHater]

Foreign currency funds can protect you from a dollar decline, but they might not be necessary.

This week's G-8 meeting in Italy has kicked off with the traditional warm-up event -- yet another debate about whether the dollar will, or should, lose its place as the world's reserve currency.

This time the governments of China, Russia and Brazil all plan to raise the issue. In keeping with recent tradition, any demands that the dollar be toppled will, of course, be accompanied by soothing remarks that they are demanding no such thing.

For the rest of us, this debate raises three simple questions.

Is the dollar doomed?

Does it matter?

And what can you do about it?

Expectations of dollar decline are long established. The U.S. has been running massive federal budget and current account deficits for years. The government is now flooding the system with trillions of extra dollars – through deficits and purchases of Treasurys – in response to the crisis. Once, Uncle Sam would hardly have cared what China, Russia and Brazil said about the dollar. Today, those nations own more than $1 trillion worth of Treasurys.

So far, so bearish for the greenback. But currencies are like political parties -- they look awful until you consider the alternatives. Europe, say many analysts, may face even deeper financial crises and banking problems than the U.S. will.

The European Central Bank, furthermore, still lacks the structure and flexibility necessary to function as easily as the Federal Reserve does.

Meanwhile Asian currencies are, mostly, politically managed. They also lack liquidity. Right now they can't function as reserve currencies either.

The bear case for the dollar, if it materializes, may take generations.