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The Buck Drops Here

It's easy to see the decline of the dollar as an event far removed from day-to-day deal making. Maybe the champagne for the closing is a bit more expensive now, but otherwise what does it really matter?

Some economists say the dollar's decline may be part of a global shift away from the greenback that could be important to real estate investors, whether their assets are in the U.S. or overseas.

For American investors, the consequences could be serious and include permanently higher interest rates at home and higher prices for property abroad.

If the dollar loses its status as the favorite currency for global trade, or reserve currency, it could affect the economy in a variety of ways. If oil exporters decide to price oil in euros rather than dollars, U.S. companies would lose out twice when oil and the euro rose at the same time.

Also, if central banks begin buying more of other kinds of debt rather than Treasury bonds, the federal government might need to borrow money from foreign investors at higher rates.

Enter the euro

The composition of foreign currency dollar reserves has declined from 70.9% in 1999 to 65.8% in 2005, while euro holdings grew from 17.9% to 25.8%, reports the International Monetary Fund. To boot, China, Russia, and a number of oil-exporting countries with high dollar holdings have all expressed interest in shifting at least some of their reserve accounts out of dollars.

What's kept this shift from being more apparent is that foreign central banks, particularly China and oil-producing Middle Eastern countries, continue to buy huge quantities of Treasury bonds in order to keep their own currency from being overwhelmed by their trade surpluses with the U.S., according to Brad Setser, a fellow in geoeconomics at the Council on Foreign Relations, a New York think tank.

Global central bank reserves in all currencies have grown by $1 trillion over the past year, says Setser, creating more demand for dollars than would have been there. If those central banks decide to plow less of their next trillion into dollar-denominated debt, it could be extremely bad for real estate.

Real estate has boomed on the back of low interest rates, stemming partially from central bank demand for U.S. bonds, says Setser. If the appetite of central banks' drops, interest rates would have to rise to compensate, making foreign property purchases less attractive.

And not just our rates: If Middle Eastern oil-producing countries make good on threats to cut their currencies' fixed-dollar exchange rates, Setser says, their interest rates would rise, dragging down their markets too.

Say goodnight, George

But is the dollar's weakness a short blip or a more fundamental shift? In September, one ex-dollar defender, Alan Greenspan, said that he believes it is absolutely conceivable that the euro could either replace the dollar as a reserve currency or become just as important as the dollar.

Greenspan told a German news magazine that the euro's growing use as a reserve currency “without any doubt contributed to the current economic growth,” by leading to a lowering of interest rates in the euro zone.

Others aren't so sure that the euro will take over. “It would be extremely difficult for the euro to supplant the dollar as a hegemonic currency,” says Stephen Jen, Morgan Stanley's chief currency economist. Jen thinks currently the dollar is very undervalued relative to the euro.

Over the long haul, however, even the more optimistic Jen believes that the dollar's place in the world is changing. The story is neither about the euro nor the dollar, but a reflection of the growing strength of several emerging markets.

Until recently, real estate transactions in Russia were often priced in dollars. Now, more deals are frequently priced and paid in their local currency, says Jen. “They're growing up. It's a natural consequence of globalization.”

Bennett Voyles is a veteran commercial real estate reporter and National Real Estate Investor's Paris correspondent. For questions or comments, e-mail [email protected].

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