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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What do we do when the price of gold becomes outragiously high to the dollar?

Posted by Ara Horasanian | Report as abusive

The biggest problem with a world currency and a mega-strong IMF is who will be in charge after all, whom will the IMF be responding to? Without democratic supervision, IMF may turn into the worst type of Frankensteinian monster ever created. And let us keep in mind that IMF is actually ruled by the US.

Posted by Cristi Barbu | Report as abusive

The US Government has been exploiting the status of the Dollar as a global reserve Currency to the hilt. The low Interest and quantitative easing Policy followed is ensuring that the pain of US fiscal profligacy is spread to Countries and people across the World. These people are a lot poorer and can ill afford to subsidise American consumption of Global resources.
In the absence of alternatives,might is right. The ramifications of the US throwing more

Posted by F.Daruwala | Report as abusive

The world is littered with examples of reserve currencies being toasted – a simple look at history will tell you that…

Posted by Evaluator Speculator | Report as abusive

Sorry for the earlier truncated posting!

The US Government has been exploiting the status of the Dollar as a global reserve Currency to the hilt. The low Interest and quantitative easing Policy followed is ensuring that the pain of US fiscal profligacy is spread to Countries and people across the World. These people are a lot poorer and can ill afford to subsidise American consumption of Global resources.
In the absence of Currency alternatives,might is right. The ramifications of the US throwing more Money at Wall Street to cover their gambling Losses is fraught with danger and bound to fail as a Tiger cannot change his colour nor can a Gambler change his habits. Such opportunistic decisions are unethical,fiscally irresponsible and morally hazardous. That the Costs of this folly will be mostly borne by the poor and innocent across the world is both sad and disturbing.
Be prepared for a drastic drop in American influence across the World and very tough times for American citizens. The ordinary peace loving,tax paying American citizen may not want to remain a serf forever.

Posted by F.Daruwala | Report as abusive

One of the only convincing reasons I have ever read about the real motives behind the Bush administration to invade Iraq; (ignoring all the BS about the threat of WMD’s or to foster democracy in the region and Saddam gassing his own people with nerve gas originally supplied the the US) + (ignore all the radical liberal charges that the US wants to control Iraq’s oil reserves where that may be a component of a long-term foreign policy or not); the theory that made the most sense was that Iran, Iraq, Venezuela, and some other minor players were going to refuse payments for oil in USD and only except Euros instead. Indeed Saddam’s regime already had done this while at the same time dumping massive amounts of USD and trading for Euros where he made a very handsome profit as the Euro having been worth less than the dollar rocketed past it between 2000 and 2003. Saddam tried to lead by example I suppose. Look what happened to him. Any other takers on that move? Indeed the US would obviously not give up the role of reserve currency without being dragged away kicking and screaming. As entrenched as the dollar is, I fail to see how that could be possible without a systemic collapse. Are we there yet?

Posted by J | Report as abusive

James, and at what point do you expect the Amero to replcae the US dollar?

Posted by Joe McTavish | Report as abusive

It’s high time for US to get sober. It is only possible when there is some sort of global currency. Then US will consume liquor as much as it can afford; not, as of now, by merely printing more dollars.

Posted by Sajid | Report as abusive

Of course Geithner, the one holding the reserve currency is gonna say that it will exist forever but in the end it’s not the one to decide.

China is in a Faustian situation in which buying more dollar treasuries could be suicide in the end but not buying will harm the dollar as well. That’s why they’ve come up with an idea to get them out of this Faustian trap.

But as long as the dollar is in a “still value” situation this will not be done lithely. This situation will change when the dollar really loses it’s value which will make the discussion about a new world currency much more easier.

Posted by Youri Carma | Report as abusive

It is true that there is nothing alternative to dollars. Certainly, the world is not going back to gold and silver exchange.Also, there is not any other country has good credibility. Every country is a trouble. So go dollars go. who has power to prevent you. Your are powerful trade machine. Dollars, dollars and dollars

The fact that so many countries around the globe are questioning the validity of maintaining vast reserves of the US$ is not a promising sign for the once mighty greenback. My guess… withing 2 years or less, the Euro will become the world’s reserve currency as the US$ is now beginning the slide down it’s self induced slipery slope. Pretty difficult to spend your way out of this.

Posted by W. Finn | Report as abusive

Yes, It’s true the gold and silver standard will not come back, but there is a new currency out there. It’s called the Amero. This could be why the U.S. is in this spending frenzy. Print as much paper money as possible. Flood the market with paper which value comes from the “faith” of it’s people. Cause ungodly inflation, which will enflame the people which will be the vehicle to the Amero!! U think?

Posted by JB | Report as abusive

Special Drawing Rights are derived from “Paper Gold” In other words,gold has intrinsic value,not papers. Gold is a precious metal as silver,copper et al. I have reason to believe that the price of gold is going up especially in Asia when folks have the tradition to value Gold as the standard of wealth. Currency is usually paper and papers are papers per se!

Francis Shieh, a lifelong student of economics to search for knowledge and wisdom and to add Gold for its intrinsic value as known to all folks. March 27, 2009

Skilled labor isthe source of wealth. When people have a marketable skill,they can earn income and accumulate wealth. “The Wealth of Nations” may be the people with skills as human capital or human resource to be the

factor of production i.e. labor.

“Keys for Economic Understanding” http://www.Amazon.com online book catalog may be a useful reference to learn the true wealth of an individual or a nation or a human capital in the global economy.

March 27, 2009

That China is beginning to phase out of dollars is a good thing. This trend will end a number of problems. The first is the inability of the US Congress and the US consumer to spend within their means. It will end the failed notion of the US being able to dominate the world militarily, since funding its military at its current size will become ever more difficult and unstainable. By moving to a basket of currencies approach, we will also see the demise of the foreign currency markets as they will be largely unnecessary since central bankers/governments will keep the mix of currencies within narrow ranges for political reasons. This is a good thing, as foreign exchange markets have been little more than extortion rackets for a long time, where exorbitant tolls have been extracted by money changers for international trade.

Although the Chinese may seem as though they have a lot of dollars that will become worthless if they do phase out use of their dollar reserves, they will actually have an equally large gain in the appreciation of their own currency. For a country like China, which will soon overtake the US as the world’s largest economy and where they are heavily dependent on manufacturing, this will be a good thing as their own currency will buy more raw materials. In the near term, the Chinese can grow their economy by growing their domestic economy by using their dollar excesses, which should quickly wind down their dollar portfolio. Inflation will only be much of a problem in the US, which has decided to base its economy on further oil consumption and on shifting its negative assets from one asset class to another. Although Obama has a strategic vision to get the US out of its current quandry, their are too many republicans who own a disproportionate share private capital and as a consequence they will be able to block sufficiently rapid progress for the strategy to work, even though the average American will suffer greatly for the obstructionism.

The notion that Americans can continue its profligate spending because others are trapped into supporting it through the dollar is illusory. As the global dollar phase out begins, it will rapidly change the international monetary order. Although the IMF is currently dominated by the US, as the dollar wanes, the Chinese and others will be calling the shots as only they will have money to pump into the IMF to support it. Again, they will be able to liquidate their dollar valued assets for their contributions. In 5 to 10 years time, the glut of dollars problem will be resolved, although the internal domestic consequences for the US will only then begin to command the attention of the American political classes.

Posted by sgp | Report as abusive

Good for you James Saft. Not many mainstream journalists are willing to bring up the description of the style of the emperor’s missing clothes. My understanding is that there is not much actual US$ currency out there. At the rate that it is being diluted, how can it possibly stay strong? Especially now that the emperor’s naked body comes into view and it is covered with infected wounds and cancerous tumors. We begin to understand why the Fed does not share much information about its internal workings. Bernanke may have made a big mistake in trying to transform it into a Fantasia where everything is done with the best interests of the American people and the American economy. This banker’s club has used the good professor’s elevation to conceal it’s coup of the world economy.

Posted by Jonathan Cole | Report as abusive

A query about the disclaimer
“”"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 –”"”

>> Does’nt our friend Saft have USD currency in his pocket ?

:)

Posted by karuna | Report as abusive

@ karuna
LOL
GOOD POINT!

Posted by PwlM | Report as abusive

It is clear to much of the world that US has got drunk the past decade, and is drinking even more now trying to get out. Significant *further* depreciation of the USD in the next few years is all but guaranteed. The irresponsibility demonstrated by the US means it is unsuitable for managing a world reserve currency. Russia, China, BRIC, and (silently) oil producers have decided it is time to create a competing reserve currency beside US & Euro.

Whether this will happen is mostly a function of these countries, not the US. They are the ones who must propose a workable model for the IMF SDR, and implement that model. They are the ones who must then transfer a suitably large chunk of their reserves to the SDR, and let the IMF manage it. They are the ones who must trade and settle using the SDR.

A good start is to make the SDR substantially non-fiat. Base it on a basket of commodities in addition to the major currencies. This will give it some real meat, and function as a meaningful reserve currency.

While the US will fight tooth and nail for the USD as reserve, failure is good for its own sake. Because the country has got drunk over it, addicted to the free lunch economy as a result. But holders of USD also bears major responsibilities – because they too got addicted to holding USD and the ‘free’ trade benefits as a result. In the end, this is a question of will power.

Posted by The Real Thing | Report as abusive

CreditCrunch!Finacial Crunch!! the latest economic terror unleased by the American Market economy.To stae the truth the system was not based on morals and is doomed to die. There is an ethical crunch in their system and in its hypocritical advocacies.Americans have a penchant for consuming beyond their means all these years which I should say in no uncertain terms that they have just sucked the blood of the less priviliged of world under the guise of elitism. Please spare the world its last breath America and pay your debts and live within your means.please do not invent another malaise with your recovery plans!!

Posted by mohamed ayub | Report as abusive