A gamble for the dollar

The world’s financial markets are facing turmoil following the announcement by United States Federal Reserve Chairman Ben Bernanke that the Fed will buy long-term U.S. Treasuries.

The U.S. dollar has plunged in currency markets around the world; prices of gold and precious international commodities have soared; and U.S. Treasury yields have nose-dived, as expected.

The latest decision by U.S. financial authorities is a gamble. The policy resembles what Japan did during its “lost decade.” Japan wasted nearly a decade tinkering with small measures that did not touch the country’s fundamentals or bail out ailing financial companies.

The U.S. is currently spending billions of dollars to take over the mess created by its financial companies. Similarly, Japan tried to cover its deficit with Treasuries by making state-controlled financial companies take over government bonds. The situation is hardly any different in the U.S., where the Fed is playing the role taken by Japan’s state-run financial companies over a decade ago. The Bank of Japan went so far as to drive interest rates down to zero, but the impact was limited.

Solving the current crisis faced by the U.S. requires solid international cooperation. Cash-rich countries like China, Japan and oil-producing countries may have to take the risky decision to invest in U.S. Treasuries.

While they bolster the value of the greenback, the U.S. economy has to recover. But the possibility of such an event becoming a reality is somewhat remote. Chinese Premier Wen Jiabao has urged Washington to ensure the safety of China’s investments in the U.S.; meanwhile some Middle Eastern sovereign funds are about to withdraw investments in the U.S. as many of their ventures abroad and at home have soured.

We also have to gird ourselves for the worst-case scenario. The sudden weakening of the dollar would slow down recovery of the world’s major economies and trigger serious inflation. The world may experience its first super stagflation. One has to be reminded that the current global economic system based on the U.S. currency may collapse.

The weakening of the dollar would reduce the possibility for another 1997?98 Asian currency crisis. But we have to remember the oil shock that has plagued the domestic economy until recently. A severe contraction of the global market could deal a serious blow to Korea’s export-reliant economy.

The global economy is about to go through more financial triage, and Korea needs to be prepared.