The dollar’s Tinkerbell moment

By J Saft
July 7, 2009

James Saft (James Saft is a Reuters columnist. The opinions expressed are his own.)

Repeat after me: “I believe in a strong dollar as the primary global reserve currency, I believe in a strong dollar as the primary global reserve currency.”

Better hope it works, because the current debate over a far-in-the-future new monetary system may bring on a here-and-now dollar selloff and a whole new leg of the crisis.

Sadly, what worked when the children espoused their faith in Tinkerbell may not for a currency backed by the full faith and credit of a debtor nation which has socialised its banking system’s risk and needs to sell trillions in further debt to pay that and other bills.

Russia, India and, most significantly, China have all questioned the U.S. dollar’s central role in global trade and currency reserve management in the run-up to this week’s meeting of the Group of Eight industrialized nations in Italy. The future, it seems, is not greenback.

Russian President Dmitry Medvedev termed the system based on the dollar “flawed.” Suresh Tendulkar, a top Indian economic advisor said he was telling India to reduce the dollar’s weighting in setting the value of the rupee, comparing the situation to the classic “prisoner’s dilemma.”

It’s a good comparison, and as such makes his advice, and his choosing to make it public, puzzling. In the prisoner’s dilemma, two people are held for a crime and, being held apart, must decide whether to rat the other out. If both remain silent, they each get six months’ jail time, if one implicates the other he goes free and the other gets ten years, if both turn on one another they both get five years.

If holders of U.S. dollars can somehow maintain confidence in the currency, the value of their reserves will be protected, but the temptation to get a first mover’s advantage and get out while the getting is good may be overwhelming, though it will only work for that individual if everyone else more or less keeps faith.

Because, if they don’t the selloff could be so disorderly and damaging to the global economy that it will make concerns over the value of reserves look silly.

China, for its part, seems to be furiously paddling in both directions at the same time; saying that the dollar will retain its central status for “years to come” while also doing things like setting up a system to allow companies to settle cross border trades in yuan.

Writing in a newspaper published by the Chinese central bank, Li Ruogu, Chairman of the state-run Export-Import Bank of China said that Special Drawing Rights (SDRs), a unit of account used by the International Monetary Fund, could be molded to serve as a more representative global settlement unit, based on a basket of currencies. This echoes suggestions made by Chinese officials in March and can leave little doubt that the Chinese are preparing for a very different future.

“The financial crisis caused the global economy to suffer heavy losses and it also let us clearly see how unreasonable the current international monetary system is,” Li, a former central bank vice governor, said.

WHAT’S THE ALTERNATIVE?

He’s right, the old set up under which China kept its currency weak and U.S. borrowing rates lower than they otherwise would be made it too easy for the U.S. to load up on debt and almost surely was the fundamental underlying driver that led to the sub-prime mortgage crisis. It created conditions under which the huge risk management failure within banking was more likely. After all, when money is cheap and people are desperate for a bit extra yield, bad loans will begin to look safe.

Of course there are no credible current alternatives to the dollar at this point; not the euro, which might fracture or grow, or the yen or even the Chinese yuan.

And there is the danger: the very knowledge that the current dispensation is under review, and for extremely sound reasons, means that there is a small but dangerous chance that it unravels, that holders of dollars and buyers of U.S. debt lose faith leading to an uncontrolled fall in the dollar and in dollar-based assets.

It is all very similar to the banking crisis. A bank is only sound so long as we believe it to be, and the dollar, given the U.S’s weak fundamental position is only strong and worth holding so long as holders keep faith.

Really all we are observing is the continuation of the banking crisis on another plane. Last year the world lost faith in the U.S. banking system. The U.S., feeling it had no alternative, stepped up as effective guarantor of its banks and its financial system.

Well and good, and here’s hoping it works. It only will succeed however if faith in the U.S. and its dollar remain.

(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.)

30 comments

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Don’t forget the Obama factor. Few Americans are incapable of seeing him for what he truly is, but non americans know what he’s about. They know he’s here to destroy America…..

Posted by Cyn | Report as abusive

to Mr. Wang
….the alternative currencies are tangibles today, raw resources, oil, natgas, precious metals, semi precious metals, agricultural foodstuffs, and etc a large list. One has to stop thinking in terms of pseudo wealth and think in terms of actual wealth. Real wealth is grown, mioned or extracted, and then manufactured or given value added from the previous two. Aqll else is wealth rearrangment, wealth skimming, wealth punditry, wealth “governance” and so on.

The smart ones are trading their soon to be worth-less digital electronic promises to pay to the less smart ones for long term access to real wealth, like in the case of china, buying up or contracting for most of productive Africa,(swapping their depreciating in value digits for the “real stuff” to the local stupid warlords) or just stockpiling what they can get now, such as the huge warehouses full of copper ingots they are stashing away by the shipload.

Tangibles rule. That’s the main lesson to be learned from man’s history.

Debt and snakeoil lie based casino bankster fraud “instruments” are such a con and a scam, including the fraudulent private Federal Reserve “note” or labor IOU, that millions of thinking people, rich and not so rich, are sliding away as fast as they can from storing their wealth in such dubious “products”.

Until there is a commodity based currency, something akin to Keynes “bancor”, not just gold backed but backed by a basket of useful commodities, which are real wealth, all these central bank notes from here or there remain suspect.

These big bankster frauds are just panicking that their old congame is being exposed for what it is.

Posted by zogg r mann | Report as abusive

The U.S. became the reserve currency by cornering the gold market when we were on a gold standard. What will be the next reserve when no currency is reliably on a gold standard?

Posted by Arthur O. | Report as abusive

I agree – we have lived in a false balloon -created by false profits – for so long we have forgotten what real wealth is … it is tangible stuff, land, gold, and houses are OK.

My grandfather had a saying that went like this, ” if you don’t have the money in your pocket to buy it you don’t need it,” never buy on credit. He kept his cash rolled up, and held together with rubber bands in old cigar boxes – he did not trust banks – I now know why.

Land was his value, and we (government) is selling it right out from under our feet. Other countries probably own more of this country than many realize, and country is only on loan to us, till we die, because we will never be able to pay-off our debts. Our founders would be ashamed of us right about now – don’t you think?

Posted by Tim | Report as abusive

The transition to a Single Global Currency can be as smooth and trustworthy as the transition in Europe from the legacy currencies, e.g. franc, mark, lira, to the euro. Preparing for such a transition will take a lot of planning and research. At some point, holders of dollars must be reassured that they will receive the equivalent value in the new currency, just as holders of the preeminent pre-euro European currency, the mark, received the correct value for those marks.

WHAT’S THE ALTERNATIVE? What about trading whitout any money involved! Iran traded oil for Thai rice for instance. A very large, very underestimated proportion of world trade is done this way. Countries who have this possibillity and don’t want to stick their necks into the “dollar guillotine” are going to increase this way of trading. But I have to agree that not every country has this possibillity but still, it’s an alternative for some countries.

Posted by Youri Carma | Report as abusive

The U.S. Dollar: created over two hundred years ago, kinda like the Earth, but only took a generation or so to turn to radioactive dust.

Faith-based economics… gotta love it!

Posted by The Bell | Report as abusive

What will the effect be of a successful Ron Paul inspired revelation of how the Fed works have on the trade-ability of the mighty dollar? It seems Ron has cobbled together a coalition of American lawmakers sick of being out-bid by the lobby-groups Obama was going to consign to history (ha-ha-ha) in Fed decision making!
Perhaps a return to the gold-standard makes more sense now than at anytime since Nixon ditched it… including when Nixon ditched it… unless of course you are the guy sitting next to the printing press!
Good to read a James Saft article, it been a while. I guess there hasn’t been much worth writing about recently?

Posted by Peter H | Report as abusive

Dear,Mr.James,
You have created lot of interests to me go thorough of your article.
I have been watching American and English economy since so many years.
Today, i firmly believed that,so many developing nations American education system and started for applying by their own set of formulas.
That works,produces good returns by standard of living,more jobs in I.T.Sectors,coonstruction activities,and very concrete methodology in financial sectors.
As on today,even world recessions gave only cautious signals to India,China,Brazil and Russia.
But America,England,Germany,Japan and some western countries had not come out from bad economic stages.
Please see the reasoning on modern terms than seeing only historical ways.
All your writings had some valuable answers from G8and from G5 summits.

Everyone get ready for a Super-Depression.
Its coming.
We will return to the age of local economies and local food supplies.
Some of it will be good, some will be bad.
Either way, its coming.

RLS

Posted by Ron S. | Report as abusive