By Alexander Bolton - 10/08/09 10:05 AM EDT
New waves of concern are rippling through Congress over the state of the U.S. dollar amid record budget deficits.
Lawmakers say there is a real danger of foreign investors losing faith in the dollar as a secure instrument if the nation’s debt continues to mount and the Federal Reserve fails to reabsorb trillions in commitments to help the economy and restore lending.
But his words failed to quell anxiety.
Bernanke told lawmakers that he had checked with finance ministers of other G-20 countries and promised there is “no cabal” to replace the dollar, according to a senator who attended the meeting. The source also said that Bernanke acknowledged that the dollar could face a threat in the future.
“He said the way to avoid this situation is for the country to get its fiscal situation in order,” said the senator, making reference to the problems that record deficits pose to the dollar's strength.
“Brazil, Russia and China have been working among themselves to bring a global discussion of whether the dollar ought to be the reserve currency,” said Sen. Chuck Grassley (Iowa), the ranking Republican on the Senate Finance Committee.
“If we keep increasing federal spending by 8 to 9 percent a year and if the Fed doesn’t start mopping up money, there’s a real worry,” he said.
Grassley is one of 30 co-sponsors of legislation that would direct the Government Accountability Office to audit the Federal Reserve and its member banks. He also attached an amendment to housing legislation that became law in May that gives the GAO limited access to the Federal Reserve’s records.
Democrats have also voiced concern.
“I don’t think we understand all the ramifications but the general feeling is that it can’t be good for the U.S. So we have to be concerned,” said Sen. Ben Nelson (D-Neb.).
Worry about the status of the dollar has spread in the wake of two recent developments. Last week, World Bank President Robert Zoellick warned that the “United States would be mistaken to take for granted the dollar’s place as the world’s predominant currency.”
Then on Tuesday of this week, currency markets whipsawed after a British newspaper, The Independent, reported that oil-rich countries around the Persian Gulf were in negotiations with Russia, China, Japan and France to replace the dollar with a basket of currencies in pricing oil.
Most economic experts view the threat to the dollar’s position as a reserve currency as a long-term problem, but one that is becoming more serious with higher deficits.
The annual deficit is projected to reach $1.6 trillion this year and the total U.S. debt is expected to rise beyond $12 trillion.
John Williamson, a senior fellow at the Peterson Institute for International Economics, said the dollar will not be replaced overnight but that “in the long run, it’s inevitable.”
“I think there will be a world currency, or several currencies in that role,” he said. “I think the chances of the dollars remaining the unique currency in the world [are] very slim.”
Williamson said the dollar could reign as the dominant currency for the next 20 years but warned that span would shrink if federal deficits continue to soar.
“Big deficits are going to continue in the medium term and that’s going to undermine confidence in the dollar,” he said.
At a meeting Wednesday afternoon, Senate Republicans discussed the prospect of the dollar losing its status as the world’s currency.
Sen. Jim DeMint (S.C.), chairman of the Senate Republican Steering Committee, said he would invite economic experts to the group’s lunch meeting next week to make presentations on the issue.
“There’s growing concern about our ability to pay our debt and in the long-term value of our currency,” said DeMint. “I think it’s very alarming and I’ve been making calls and my staff has this morning about the issue.”
Rep. John Tanner (Tenn.), a leading centrist Democrat in the House, warned that if nations move away from using the dollar as the world’s central currency, “people won’t be buying much of our paper.”
The U.S. has been able to finance debt by selling U.S. Treasury bills. China holds $2.1 trillion in foreign currency reserves, most of it in dollars. If China and other countries did not want to buy the U.S. currency, it would make it harder for the U.S. to finance deficits without a significant hike in interest rates.
China also has a self-interest in a strong dollar, however. It would see its currency reserves drop in value with a weaker dollar, and it would also make it more difficult for U.S. consumers to purchase goods from China’s export-dependent economy.
Some Republican lawmakers are concerned about the national security threat posed by rival nations such as Russia talking up the prospect of replacing the dollar as part of a strategy to undermine U.S. economic stability.
Other lawmakers think their colleagues’s concerns are overblown.
“In the middle of the economic collapse last fall the dollar increased in value because the perception of the world was that with all of the world economic problems, the dollar was the safest place for the dollars,” said Sen. Byron Dorgan (N.D.), chairman of the Senate Democratic Policy Committee.
“There’s been all sorts of predictions about the demise of the dollar. I think this country is going to have a strong economic future.”
Dorgan says lawmakers should be willing to cut Democratic and Republican priorities alike.
“There are some on the floor day after day saying you have to send 40,000 more troops [in Afghanistan]; how are they going to pay for that?” Dorgan said. “Are they going to charge it like they charged the cost of the Iraq war?”