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Why The Dollar Can't Continue To Drop

Throughout the week, Clay Risen, the managing editor of Democracy, will be covering economic developments for us on The Plank. 

Reuven Brenner had a good piece in yesterday's Wall Street Journal about the need for Washington to shore up the falling dollar. Some argue that the credit crisis is a more important beast to slay at the moment; to the contrary, Brenner posits that the slide in the U.S. currency since early this decade was in fact a critical part in the ability of global credit to expand beyond all rational limits. Therefore, any real cure to the credit crisis would include shoring up the dollar's ongoing drop.

Even if you disagree with Brenner on that point, there is still a strong case for acting on the dollar, either unilaterally or, as the Reagan administration did, in multilateral concert. Why? Because the weak dollar is becoming a major drag on global growth. China is already predicting slower expansion over the next year because so much of its reserves are held in dollars; that's likely true in other places as well. And while cheaper dollars do mean cheaper exports and a reduced trade deficit at home--which, right now, is a rare but important economic bright spot--that's helpful only to a point, after which U.S. imports become noticeably more expensive, driving up inflation.

But the broadest cast one can put on the dollar dilemma is this: For 60 years the U.S. currency has been, as Brenner puts it, the "agreed-upon unit of account in terms of which trading partners could price every contractual agreement"--in other words, the stable dollar provided a common denomination for international finance and trade. Contracts could be written in dollars, central reserves could be built on dollars. Now, thanks to American neglect, that system is out of whack. In 20 years, the euro could well replace the dollar as the global currency of choice. And given the way this country manages its house, maybe the euro should. But the reason it hasn't, the reason so many central banks and businesses stick to the dollar nevertheless, is that the costs of such a transition would be incredibly painful. It's not a switch you can flick, a general policy you can implement. It would rain havoc down on long-established trading sectors, not to mention central banks. But without U.S. action, it's also probably inevitable.

--Clay Risen