Wednesday, January 26, 2011

Dollar as reserve currency

I received an e mail from a friend asking about the status of the dollar as the world's reserve currency.

My reply is below:

Great to hear from you and you flatter me - we all have opinions and I am not certain mine is worth any more than anyone else's - particularly predications of the future. I suppose the recent Businessweek article might lead to reasonable questions about the future of both the value of the dollar and the status of the dollar internationally.

That said, in the immediate and intermediate term there is little chance that the US dollar will lose its status as the world reserve currency.

1. What is the alternative? The problems in Europe, particularly in the areas you outline in debt and inflation potential are more severe than in the US.

2. Political and economic stability. While the US faces grave threats, the stability of our institutions is far greater than any other country in the word. Douglass North makes a convincing argument for this in Violence and the Social Orders.

In 2009 the FT had a nice piece that observed

http://www.ft.com/cms/s/0/9df9b2c0-4eda-11de-8c10-00144feabdc0.html#ixzz1C3AzPOaE

A leading Chinese financial official on Monday rejected suggestions the US dollar could be replaced quickly as the global reserve currency, as US Treasury secretary Tim Geithner arrived in China on his first official visit.

“In the short term I don’t think we can find another currency to replace the US dollar,” said Guo Shuqing, chairman of China Construction Bank and former head of the country’s foreign exchange administrator. “The US dollar is the main currency because their economy is number one in terms of competitiveness, in terms of innovation.” Speaking in an interview with the Financial Times, Mr Guo also raised doubts about a proposal from China’s central bank governor, Zhou Xiaochuan, to replace the dollar with a “super-sovereign reserve currency” based on special drawing rights issued by the International Monetary Fund.


3. Ironically, the large levels of US soverign and private debt held by foreign holders - both states and private companies and individuals provides a strong incentive to retain the dollar. Any movement away from reserve status would so devalue the dollar as to reduce the value of these US denominated assets (and in the short run would be a huge windfall for the US government).

Longer term - the dollar will be replaced just like the dollar replaced the pound, the pound replaced gold, and gold evolved over time. The question is when is the long term and no one knows. The pound was the reserve currency for over 100 years, gold for 4 centuries so perhaps the 65 year run of the dollar is nearing a conclusion. But see comment 1 above - there is no replacement and holds of wealth and liquidity are loath to move to a new currency unless there are strong compeling reasons - negative for the dollar and positive for the new currency.

Last year UYS Today (they actually do a nice job of short summary) did a nice piece

http://www.usatoday.com/money/economy/2010-03-12-dollar12_CV_N.htm

For a more detailed overview that I see as objective and with which I tend to agree

http://www.investorsinsight.com/blogs/forecasts_trends/archive/2009/10/20/will-the-us-dollar-lose-quot-reserve-currency-quot-status.aspx

I'll turn it around, if you are the leader of Saudi Arabia or the dictator of China - which currency would you hold if not the dollar?

Now, the debt issue to which you refer, this is the major threat to continued US economic growth and the difficulty that our elected officials have had over the past 20 years in formulating a response is of much greater concern to me in the short and intermediate term. I know you are familiar with Pete Peterson and the Peterson Institute and his research agenda and advocacy should be heard and considered by Americans and our elected officials. The failure to do so echoes the late stages of the Roman and Ottoman Empires and inertia will make life very, very challenging for our children.

No comments:

Post a Comment