Good riddance to dollar hegemony
James Saft is a Reuters columnist. The opinions expressed are his own.
HUNTSVILLE, Ala. — While the U.S. will fight it kicking and screaming, the dollar’s upcoming fall from its central global role will be a blessing all round.
The World Bank on Tuesday predicted that the dollar will lose its place by 2025 as the principle global reserve currency, to be supplanted by a multipolar world where it, the euro and the yuan will share top billing.
First off, things have come to a sorry pass when the dollar is going to lose out to two currencies of which one, the euro, many people worry may cease to exist, and the other, the yuan, isn’t even properly convertible.
But beneath the ignominy lies a simple truth: being the world’s main reserve currency is a bit like being a pop star; there are lots of fringe benefits but it is very easy to end up in financial rehab.
There are several supposed central benefits to being the world’s principal reserve currency; lower funding costs, a home-field advantage in financial intermediation and better control over one’s own monetary policy. All three have been a mixed blessing, at best, for the U.S. and may yet turn out to be mostly malign.
“Countries whose currencies are key in the international monetary system benefit from domestic macroeconomic policy autonomy, seigniorage revenues, relatively low borrowing costs, a competitive edge in financial markets, and little pressure to adjust their external accounts. It has also produced a potentially destabilizing situation in which (a) the world’s leading economy, the United States, is also the largest debtor, and (b) the world’s largest creditor, China, assumes massive currency mismatch risk in the process of financing U.S. debt,” according to the World Bank’s report titled “Multipolarity: The New Global Economy.”
“Another shortcoming of the current system is that global liquidity is created primarily as the result of the monetary policy decisions that best suit the country issuing the predominant international currency, the United States, rather than with the intention of fully accommodating global demand for liquidity,” it added.
Because people must buy dollars to make many financial transactions, and central banks choose to hold dollars as a store of value, the dollar is too strong, borrowing in dollars is too cheap and there are inadequate controls on unsustainable behavior such as running current account deficits.
IT’S BAD TO BE KING
The U.S., both as a nation and a collection of individuals, would surely have borrowed less and arguably would have invested more if lower demand for the dollar had made real interest rates higher. It has been all the easier to believe fictions like the idea that we can all grow rich by buying each other’s houses when money was so cheap. There is then a direct line between dollar supremacy and the serial bubbles.
That brings us to monetary policy and the supposedly huge benefits of being free to run it the way you see fit. This of course has not always been true, Chinese buying of dollars and Treasuries has meaningfully impaired the Federal Reserve’s ability to control the economy.
Even beyond that, being able to run unimpaired monetary policy is akin to allowing small children to decide exactly what they will eat; they are going to tend to overindulge in sweets and get sick. Now part of that is due to the “heads, asset holders win, tails, they get bailed out” policies of the Fed, which has concentrated wealth and rewarded people for taking on too much risk. It is impossible to know how the Fed would have acted if the dollar were not king of the hill, but it’s a fair guess to say they would have placed less faith in the benign powers of debt and consumption.
As for having a competitive edge in financial markets, this perhaps has been the real disaster, as America has financialized itself into a place with greater structural risks (think too big to fail), greater income and asset inequality and a hollowed-out manufacturing base.
Now, if you want to know why the world will become financially multipolar you simply need to look at the growth projections the World Bank made for developed markets between now and 2025 — 2.3 percent annually — and the same figure for the emerging world — 4.7 percent. Power and centrality will follow the money.
The new world will not be perfect either. If China opens its economy fully we will see a huge bubble as capital floods in to make money. And if you are not in one of the main currency areas you will face new and complicated issues of volatility and risk.
The key point is that this transition must happen gradually. If the dollar’s reign does end the hard way, all of a sudden in a currency crisis, it will be in large part because of temptations inherent in being number one.
(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.)