The Dollar is Down for the count [Archive]

FloridaPoke

09-24-2009, 06:47 PM

Reserve currencies come and go. They don't last forever. International currencies in the past have included the Chinese Liang and Greek drachma, coined in the fifth century B.C., the silver punch-marked coins of fourth century India, the Roman denari, the Byzantine solidus and Islamic dinar of the middle-ages, the Venetian ducato of the Renaissance, the seventeenth century Dutch guilder and of course, more recently, sterling and the dollar.

If history of the last switch in reserve currency (from pound sterling to the US dollar) is any guide, the Chinese renminbi can be expected to replace the US dollar as a reserve currency around 2050. The UK lost its position to the US as the world’s largest economy in 1872 and the largest exporter in 1915. The switch in net debtor/creditor positions started 1914, and as the US dollar emerged as a convertible net creditor currency, its use in finance and trade widened. By 1945, the pound was dethroned. Today, the US is in a net debtor position similar to Britain after the WWI, with China being the world’s largest creditor. I believe that China will surpass the US by 2015; China is on its way to becoming the world largest exporter. So these historic parallels might imply a switch in the reserve currency by around 2050.

But in the mean time, the dollar is used in approximately 65% of all global trade, and the emerging economies are all long gazillions of dollars. China artificially holds its currency stable and does not allow it to float. If it did, the renminbi would hyper-inflate against the dollar and all of their exports to the US would collapse.

I believe there will be a global effort (in the short term) to not let the dollar fall too far as that would lead to a global depression. And in the longer term, I believe there will be a global effort to create an IMF neutral currency to be the global reserve currency. And I think that would be good for the US in the long term (with some obvious short term pain).

In a famous warning to Congress in 1960, the Belgian Yale economist Robert Triffin explained that as the marginal supplier of the world’s reserve currency, the US had no choice but to run persistent current account deficits. As the global economy expanded, demand for reserve assets increased. These could only be supplied to foreigners by America running a current account deficit and issuing dollar-denominated obligations to fund it. If the US stopped running balance of payments deficits and supplying reserves, the resulting shortage of liquidity would pull the global economy into a contractionary spiral.

For some reason, our leaders are intentionally letting the dollar fall, probably to help exports. At some point, however, irrational declines will be precipitated by irrational buying and the dollar will probably whipsaw back up.

But until we get our financial house in order, and Obama tripling the deficit ain't helping, we are in a bit of a house of cards situation. Our only saving grace is we are still 25% of the global economy.....and our consumer demand is required by the rest of the world.