What’s the Worry? The world is moving at a rapid pace. Debt is increasing. North Korea is pushing into the nuclear arena. Iran is on the brink of democracy!!! Arguably the world is in a state of flux not seen for 40 years. Investors have new found concern over what could happen to the U.S. in the midst of a potential economic meltdown. What is happening with the dollar? Will the US. be downgraded? What if the dollar is no longer the currency of favor in foreign markets? I recently came across an article by Liz Ann Sonders, Chief investment strategist for Schwab, that answers many of these difficult questions. One section I wanted to focus on is the dollar and its importance in the world markets. If you would like to read the entire article I have included the link.

Enjoy the read- From the Article by Liz Ann Sonders…. The dollar’s not going anywhere ... ... and China knows it, too. "In the short term I don’t think we can find another currency to replace the U.S. dollar," said Guo Shuqing, chairman of China Construction Bank and former head of China’s foreign exchange administrator. "The U.S. dollar is the main currency because their economy is number one in terms of competitiveness, in terms of innovation." Although the financial crisis may be accelerating the balance of power shift toward China, this change will likely remain gradual.

Oh, and China is still buying. China increased its Treasury holdings by $272 billion in the second half of 2008 and continued to buy U.S. Treasuries throughout the first quarter (although more recently at the short end of the yield curve). The last month China was a net seller was February 2008. And it’s not just China. Foreign central banks (FCBs) continue to buy U.S. Treasuries and are absorbing some of the increased supply. In fact, FCBs have purchased more Treasuries ($215 billion this year through May) than the Fed.

This supports the view that U.S. debt is unlikely to get downgraded anytime soon, a worry that developed after Standard & Poor’s revised its outlook on the United Kingdom’s sovereign debt rating from "stable" to "negative." The dollar remains the world’s reserve currency, accounting for 64% of global foreign exchange reserves (versus the euro’s 26%). Also, imagine any private company maintaining an AAA rating when the dominant global reserve country has a lower rating? It’s simply not practical.

What about China’s yuan? Asks our former Schwab colleague Sheldon Engler in his Global Risk Monitor: "Can a non-convertible currency in a country where an authoritarian government fixes interest rates and where capital markets are infantile really be considered a serious contender to the dollar?" Good question.

The fix ... it’s the economy, stupid Most reasonable folks will concede that in the longer term, we won’t get ourselves out of our debt crisis through spending and taxation. The only way to solve the problem is to grow GDP faster than debt and to adopt vigorous fiscal discipline. So, will aggressive monetary and fiscal policy be sufficient to restore economic growth and the vitality of the financial sector?

Let me play "angel’s advocate" to the consensus bearish view: There is a non-calamitous way out of our present mess. Let’s start with the premise that we’re not the first country to get into a financial pickle and run up large deficits in order to bail itself out. In fact, many countries have run disturbingly high debt-to-GDP ratios but have seen them come back down over time and without calamity.

We even have our own example: The U.S. total debt-to-GDP ratio was 125% after World War II, but had come down to 25% by 1980. Another example would be Japan, which has maintained a high ratio of 150%–180% for the past decade (not that I’m suggesting theirs is a model for us to follow).

The only way to manage our debt is to concentrate on both components of the equation—keep spending in check and maximize economic growth, which in turn reduces the debt ratio by increasing tax revenues. In other words, rising economic growth helps both numerator (debt) and denominator (GDP). We also believe that the private sector’s deleveraging is a longer-term story, meaning savers’ demand for Treasuries will remain high.