U.S. recovery gets setback as countries dump dollar reserves

Many Americans have been led to believe that the worst of the financial crisis is over, but last week the U.S. economy was dealt another heavy blow that may signal further disaster is still to come.

The Financial Post reported last Wednesday that "...the U.S. dollar slid against most major currencies... hitting a five-month low of US $1.3775 against the euro..." The day after, Florida's BankUnited FSB was seized by Federal regulators in the largest U.S. bank failure so far this year.

The sudden dollar decline and seizure of Bank United is a flashback to the U.S. economic turmoil of late 2008, and a brutal reality check for many who thought the worst was over.

Last week's dollar drop was apparently in response to a comment by the president of the Federal Reserve Bank of Boston, Eric Rosengren, who warned America's economic recovery could be "slow."

There is also a great deal of concern surrounding the U.S. triple-A credit rating, which many speculate will be downgraded along with Britain's triple-A rating. Such a move would signal a decline in America's position as a reliable borrower on the international market.

Lee Hardman, a foreign-exchange strategist at Bank of Tokyo-Mitsubishi UFJ Ltd., certainly believes a downgrade will happen. But Bill Gross of Pacific Investment Management Co. is less pessimistic, telling Bloomberg that the U.S. losing its triple-A rating is "certainly nothing that's going to happen overnight."

In early May, the Obama administration increased its federal deficit forecast for 2009 to $1.84 trillion. When the government has a large deficit it needs to borrow more money, which in turn increases both the risk of a credit score downgrade and the likelihood of runaway inflation.

Many analysts cite increased investor confidence as a cause of the dollar's decline. As investors become more willing to play stocks again, they are taking money out of the U.S. dollar because it is losing its status as a safe-haven currency.

Ashraf Laidi, chief market strategist at CMC Markets, recently cautioned that we are at the start of a "serious case of dollar damage," adding that his organization "long warned about the day of reckoning for the dollar emerging at the next economic recovery."

Laidi's prediction may not be too far off. Russia has ditched the dollar in favor of the euro, Pravda reported last week. The Vedomosti newspaper confirmed this, reporting that, "The dollar has ... lost the status of the basic reserve currency for the Russian Central Bank."

Other nations are apparently following suit. The Financial Times quotes top Brazilian officials as saying that Brazil and China are also working toward "using their own currencies in trade transactions rather than the U.S. dollar..." This scenario, says economic commentator Peter Schiff, is "not only a possibility, it's inevitable."

But Schiff, one of the few to predict the housing market crash, thinks this change in the long-standing status quo should be welcomed, not feared.

"When [the U.S.] decouples, the world will thrive," Schiff told CNBC. "The world doesn't need our consumption, we need their production. The global economy is fine without propping up the U.S. economy."

Adam Abrams is a British-American blogger, currently working as an intern at Haaretz.com

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