By: Dr. Hadi Mahdaviyan

The US dollar has always been considered a dominant currency in the world economy and fluctuations in its parity rate are followed closely. The hegemonic role of the dollar was revealed more after the end of World War II. During 1970s, changes in foreign exchange system of the world caused the dollar to lose its central position, so that, instead of solely relying on the dollar, the world economy became reliant on a number of major currencies. However, the dollar continued to be the most creditable currency in international markets. This does not mean that it is valuable as an asset, but due to its hegemony, it has more applications in global transactions. Of course, after introduction of the euro, this role of the dollar has been put to a serious challenge. But we must see why the dollar is the world’s most creditable currency.

One reason is that the United States has the world’s biggest economy. Although the country has only 5 percent of the world population, it accounts for 25-30 percent of international economy. It is the world’s biggest economy in terms of everything: in terms of production added value, in terms of international monetary markets it hosts, in terms of the sheer size of its economy, in terms of exports, in terms of transactions as well as in terms of agricultural and industrial products. The country is also a hub for monetary and financial markets of the world.

Another reason for the importance of the dollar is that in addition to the United States, Canada and a large part of the Latin America carry out their transactions in the dollar either directly or indirectly. There are some countries and islands in that region where the US dollar is official money. That is, they have established a powerful link between their national currency and the dollar. Adding the above countries, the region dominated by the dollar will account for 40-45 percent of the world economy. Other big economies lag far behind that of the Americas. For example, although Southeast Asia is a big economic region, but financial and monetary relations in that region are not such coherent as to be able to replace its currency for the dollar. Of course, the case of the European Union is somehow different. The Union introduced economic reforms since 1950s and 1960s and started to merge its commerce and economy. European Union countries started to change their tariffs and customs duties and, finally merged their currencies to give birth to a single currency, that is, the dollar. However, euro is still far from being a final substitute for the dollar.

Therefore, study of the recent fluctuations in the value of the dollar is of high significance even for Iran. Various internal and external factors with different degrees of influence have brought the current changes about. The first factor is performance of the US economy. During the recent years when the dollar has sometimes lost ground in the face of other currencies, the American economy has had a poor performance. Poor performance means that recent economic policies adopted by the US government have caused major budget deficits and deficits in the US trade balance. Under George Bush Jr. the balanced American budget has given way to considerable deficit. The consequences of 9/11 terror attacks including wars in Afghanistan and Iraq have made the government to adopt expansionary policies which have caused budget deficit and deficit in balance of payments. Therefore, other currencies have gained ground in the face of the dollar.

Another factor which has led to devaluation of the dollar is the situation in the housing sector. Up to 2-3 years ago, American banks handed out low-interest facilities to those who wanted to purchase a house. Therefore, considerable assets were created in the balance sheet of banks, which were not of high quality. As the trend of interest rate was reversed during recent years and those loans were given at floating rates of interest, installments of housing loans suddenly surged. Therefore, bank customers were not able to pay the installments while, on the other hand, increased interest rate has caused their debt to exceed the value of the mortgage. Therefore, many people who had taken loans from banks preferred to return their property to the bank because the benefit and principal were of higher value than the housing unit they had purchased. This crisis in the mortgage market of the United States caused the US central bank (Federal Reserve Bank) to change its policy to reduce interest rate and also decrease the cost of repayment of loans. On the whole, these two internal factors worked to devaluate the dollar, but another external and international factor was also influential.

Since the dollar is a reference currency and other countries conduct their transactions in the dollar they prefer a less expensive dollar. During 1997-98, a financial crisis swept Southeast Asia before moving up to Russia, Turkey and Latin America. A major reason for that crisis was a powerful dollar. Those countries had taken hefty loans from international institutes and then the dollar’s parity had suddenly increased. Therefore, they had great difficulty for the repayment of those loans. But when the dollar is less powerful, other countries will be better able to repay their loans. Many countries that faced major challenges in the financial crisis in late 1990s shored up their economies in recent years and overcame that crisis. If the dollar had not devaluated, those countries would not be able to recover so soon. Therefore, the world and especially indebted countries welcome a devaluated dollar.

It should be noted that countries with considerable surplus foreign exchange do not follow this rule. Countries like member states of the Organization of Petroleum Exporting Countries, Hong Kong, China or Russia are sensitive to fluctuations of the dollar. Countries with natural resources suffer when the dollar devaluates. Therefore, they would try to replace the dollar with other assets like gold. However, South African and Southeast Asian nations welcome inexpensive dollar, so that, they would be able to repay their debts more easily. Of course, the United States is one of the most liberal world economies. The future and present situations of the dollar is determined by the balance between supply and demand. Foreign exchange market is totally competitive and due attention should be paid to factors that regulate supply and demand before analyzing that market.

In conclusion, a brief reference should be made to the effect of devaluated dollar on the rial. The rial has been pinned to the dollar during the past years. Although our officials do not like this situation and have tried to adopt policies to reduce dependence of the rial on the dollar, it is not easy for the Iranian economy to totally cut its ties to the dollar. In addition, we export oil and our dependence on oil revenues has been increased. Petrodollars now account for a bigger portion of the budget pie. Also, imports have greatly increased in order to keep prices down. Therefore, the link between the rial and the dollar has been made more powerful because nominal stability of the rial against the dollar has led to a form of stability in pricing and economic behavior and has had positive effects on prediction of economic factors. That nominal attachment to the dollar has worked as a stabilizing factor for the Iranian economy.