World stuck with the dollar, more’s the pity

By J Saft
March 27, 2009

jimsaftcolumn5– James Saft is a Reuters columnist. The opinions expressed are his own –

The dollar is, and will remain, the U.S.’s currency and its own and everyone else’s problem.

The idea of creating a global currency, as espoused by China earlier this week, is interesting, has a certain amount of merit and is simply not going to happen any time soon.

U.S. desire for free access to the cookie jar that being the world’s reserve currency represents will be too strong, especially given its need to finance huge amounts of debt reasonably cheaply. As well practicalities are fearsome, even if consensus was more or less there.

Chinese central bank head Zhou Xiaochuan on Monday called for the creation of a new “super-sovereign” global reserve currency, advocating building on an International Monetary Fund instrument called Special Drawing Rights.

Zhou echoed a call by Russia last week, when it indicated it would raise the issue at the upcoming Group of 20 meeting in London on April 2, saying the idea had support from emerging market economies including Brazil, India, South Korea and South Africa.

There is no doubt that the current system breeds instability, but it enjoys the great advantage of entrenchment and sticking with it allows the U.S., and others, to avoid making hard choices and paying true market prices for their economic decisions.

No surprise then that President Obama knocked the idea down in blunt terms. “I don’t believe that there’s a need for a global currency,” Obama said, terming the dollar “extraordinarily strong right now.”

Exactly. Too strong by some margin, especially when one considers the coming effects of both quantitative easing and a massive long-term need to fund the costs of the debt binge that exploded and the ever increasing bailout to clean up the aftermath.

In fact you could say the dollar’s “extraordinary” strength can only be fully explained when you take into account the fact that foreign central banks keep piling up huge reserves of the thing and that it is the international medium of exchange for commodities and energy, well really for global trade and financial intermediation.

Treasury Secretary Timothy Geithner said on Wednesday the U.S. dollar is still the world’s reserve currency and will remain so for a long time, but expressed openness to greater use of IMF SDRs.

The dollar’s central role has two main implications, both rather ugly but also very seductive for those involved.

For the U.S. it’s a bit of a free ride as far as debt financing goes. People buy and hold treasuries more and the U.S. gets cheaper financing that would otherwise be the case. Of course that’s a bit like an alcoholic bartender getting a discount at work; a real benefit, but not a true one.

It also means that even if the U.S. has the will to take away the proverbial punchbowl or drive the dollar down, it doesn’t always have control, as what it does at the short end of the interest rate curve can be confounded by foreign purchases that keep the long end and financing costs down and the dollar up.

SOVEREIGN OVER US ALL?

The U.S. reserve status also opens up the opportunity for mercantilist countries, like, say China, to keep its own currency cheap, building up huge dollar stocks and force-feeding the American milch cow with cheap credit with which to buy imported goods.

That may not work any more anyway, as all of the cow’s stomachs are full and the milk’s gone thin.
There is a temptation also to build up reserves as protection against bad times and bitter IMF medicine.

Many Asian leaders seem to have vowed after 1997 that they would do what was needed, which often included building up dollar reserves, to avoid having to meet an IMF director’s plane at the airport and accept the accompanying prescription.

That rather indicates that the old system, with the U.S. as global reserve currency, is dying, but I doubt it will do so without a fight and with cooperation among nations willing to cede part of their sovereignty, even for a greater good.

It is amazing and encouraging that China speaks of ceding control of a portion of its foreign reserve assets to IMF management, but I have a hard time seeing it happening widely soon.

So, we will have to get through the next year or two without a super-sovereign currency and with global imbalances being worked out, or around, under the current system.

My best guess is that things actually go in the right direction, more or less. The dollar should weaken as a result of U.S. policy even without a deliberate push downhill from the Chinese. Asian exporting nations will see slowing reserve growth generally, which should translate into diminished flows into the dollar and Treasuries.

That’s going to be painful all around. The Chinese and others will see their investments dwindle, even as they have to resist the impulse to sell into the fall. For the U.S. the process of implementing monetary policy and paying for fiscal policy will be made that much more difficult.

So, goodbye and perhaps good riddance to dollar hegemony, but don’t expect a stable system of global cooperation to rise easily and quickly in its place.

– At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund –

84 comments

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someone said that the US spends only 4% on the military… that is patently false.

US military/defense spending was 21% of the federal budget (as of 2008), but that number is likely higher now, because of the ongoing wars.

notably, the US government spends about the same amount, around 20% each, on social security and health care.

that budgetary pie is gonna have to get a lot bigger (which we now know is not ecologically sustainable) OR the portions become much smaller, if we are to continue to advance and maintain a decent standard of living.

i know this… those military dollars, in the hundreds of billions, would sure come in handy at HOME right now… in this time of recession.

The IMF in advocating continuing adherence to the US Dollar, as the de facto monetary standard, is essentially saying that this to will pass and it will be return to business as usual, perhaps with new rules and regulations.

A reality check shows that the US is not what it once was. It may be have been the world’s biggest economy but now its built on a foundation of sand. For example, (1) the extent to which real estate and the financial sector contributed to its GDP; (2) its knowledge economy (whatever that is) is not built on/a generator of jobs … Bill Gates once told India’s entrepreneurs that jobs are to be found in manufacturing, i.e. creating the goods that people need (3) US government’s debt (federal, state and municipal) and the deficit in the current account are long past being sustainable.

The Chinese and others are right, its time for a new monetary standard; one with an appropriate regulatory framework around it, one that would, for example, eliminate arbitrary valuation of local currency by states; provide for multilateral control; and not afford bias to any particular state. The US, Canada and others others have been arguing that the Chinese are undervaluing their currency for market purposes but perhaps they are simply factoring in parity with the underlying value of the US dollar.

It is a house of cards that has to tumble.

I said military budget is 4% of GDP. Don’t mistaken GDP for Federal Budget.
4% of GDP == 21% of Federal Budget.

Actually military spending is good for economy. These money goes to weak US manufacturing rather than to China.

Japan promise $100BIL to IMF, EU another $100BIL. I just wondering about remaining $800BIL. May be Russia or Kazakhstan?

Zimbabwe can lend $100,000,000,000,000,000,000,000,000.00+ with easy but in Zimbabwe dollars.

I glad to see World Currency thats nothing to do with USD.
But reality is:
World Currency will be backed by USD at least on 50%-60%. Essentially World Currency and USD will be hardwired. In this case I don’t want China or EU making decisions that affect US economy.

Lets make 19 of 20G put in $40BIL-$50BIL and US puts the rest. In this case it is going to be real ‘World Currency’.

Posted by SKV | Report as abusive

The problem is not the USD per se but
a) it’s a single national currency (as de Gaulle said – it has a home) that has and will be managed for the benefit of the issuer and the determent of the issuers’ creditors and
b) that self-interest will result in an increasingly unstable global economy and
c) the Bretton Woods agreement, which by default gave the USD it’s privileged position, no longer applies – in any sense.

The problem with the IMF and it’s SDR is that it is a thinly-veiled surrogate for the USD and will, in its current form, suffer from the same problems as the USD. The new world realitiy is that more than 60% of the world’s population and ? of it’s remaining cash is not to be found in either the USA or the IMF.
As the IMF will have to, increasingly, turn to non-members for funding; these countries (China, Russia, Brazil and India) will, justifiably, want a say in how these funds are to be allocated. Will the Washington Consensus relinquish its power? I don’t think so. So an entirely new body with an entirely new international “currency” will eventually be called for.
A real NEW World Order will have to include, in positions of power, the following economies: China, EU, USA, Russia, Brazil and, if they can ever agree, some Gulf common market structure. A “currency” based on a basket of these economies would provide for a more balanced and less vexatious global economy.
The days of the US dictating how the global economy will be shaped ended in September, 2008 and, just like the British and French found out in the 19th and 18th centuries; those days will not come back. History moves on.
I just hope that a new currency can be found fast because the most recent display of deliberate mis-management of the world’s reserve currency by the US (which has a pathetic record of economic mis-management going back to 1973); fills me with dread. Why? Just ask yourself how will commodities such as oil and food be priced when the US finally manages to provoke a hyper-inflation event in the USD? The rise in both last year (oil @ USD149, all food up +50%) was just a foretaste of the possibilities.

Posted by dhome | Report as abusive