Question

We know that at the beginning of the Economic crisis in America the Dollar fell significantly with respect to the Euro. However we noticed in recent days that the value of the Dollar with respect to the Euro has risen, whilst the Economic crisis is still at its peak in America. What has caused this rise given this reality?

Answer

As you know paper currency is unbacked (by a commodity), it depends on the economy of the state which issues it.

The Global Economic Crisis began in America and the Dollar fell in value with respect to other currencies. When the crisis reached Europe it effected European economies and weakened the paper currencies in European states, resulting in a relative increase in the Dollar.

To understand this, assume that the Dollar equals to one Euro. When the crisis began in America, the American Economy weakened and the dollar fell by say 20%, so that it was worth 80% of a Euro, that is, one euro now equaled 1.25 dollars. When the crisis extended to Europe, European economies weakened and their currencies fell by say 10%, that is, one euro now equaled 1.125 dollars (90% x 1.25). The Dollar now equaled 88% of the Euro, which is as if it is had risen from 80% to 88%, whilst in reality it had not risen at all in an absolute assessment, but relative to the Euro it had risen, only because the latter has declined.

It is expected that the Dollar will return back down relative to the Euro, particularly after the initial shock of the crisis in Europe is over and measures are implemented to deal with the crisis. European economies are in a better position to cope with the crisis than the American economy.

Thus the rise is relative to the weakness of the economies of states. The greater the impact of the crisis on an economy the more its currency will fall relative to other currencies. The Crisis has affected many of the world's states. Thus paper currencies have lost their value across the board, but relative to some countries, currencies rise and fall depending on the effect of the crisis on their economies. This volatile state will remain as long as the crisis is effective.

18/02/2009

Question

The Economic Crisis is still affecting the world as a whole. America has huge loans on her which is owes to other states, China in particular. Is it not able to print dollars and pay off its debts to China, or do the regulations of the IMF prevent this?

Answer

America is able to print paper currency, with the consent of the IMF or without it. America itself is the influential party in the IMF. However printing money in such a manner leads to the decline of the value of the Dollar and, in turn, to inflation, that is, the rise of prices. Hence America would not take such a path, expect if she saw some another outweighing factor to do so.

For example, it was reported that America printed between 2 - 4 trillion dollars during the speculative oil boom in which oil price increased to almost $150 a barrel, and America itself was involved in this speculation. She printed this money in order to be able to buy a larger volume of oil, directly or indirectly, and to add it to her storage. In that she saw a benefit greater than the harm caused by inflation. She stopped doing this as the Global Economic Crisis began to deepen, as American markets could not bear more inflation due to the bankruptcy of many companies, rising debt, and declining production and consumption.

It is not possible for America now to print money without a greater economic counterpart, and this situation is likely to persist in the foreseeable future.

However the moment America sees a benefit for her in printing money without a counterweight, she will do so, for she is the lone state which controls her currency by having a large portion of it in the reserves of other states, in addition to the fact that she has overriding influence in the IMF.

Therefore it is not feasible at present for America to print money in order to pay off her debts. This is for two reasons:

First: if she does so the value of the currency will drop, because as the supply of the currency increases (without economic counterpart) its value drops. In turn, the value of the returned money will be lower, causing a problem between the debtor and creditor. If the creditor is a big state like China then such a move will effect economic relations between the two countries and will increase America's economic crisis even further. America and Europe want China to work with them to solve the crisis, not to abandon it.

Second: an increase in the supply of paper money without economic return will lead to an increase in prices within America, and American economic markets cannot afford this.

Due to these reasons it is not expected that America prints money without a greater economic counterpart, at least in the foreseeable future.

However, as we have said, the possibility is still existent. If America finds that there is an overriding benefit for it, political or economic, she will do it on the basis of the widespread American dollars in the reserves of other states and using her influence in the IMF.