The economist magazine has an essay on whether the dollar could lose its reserve status. The article makes a number of good points, although no surprises to most Austrians. Hazlitt forecasted the end of the Bretton Woods system in an inflationary crisis 40 years ago. The unravelling has been postponed by a series of magic tricks and fortuitous accidents. But now,
- One big difference is that under the original Bretton Woods system America ran a current-account surplus and the value of the dollar was officially pegged to gold. No wonder, perhaps, that today’s “system” is already starting to creak as some Asian central banks start to worry about the value of their dollar reserves. To sustain the current arrangement, they will have to keep buying more and more dollars as America’s current-account deficit widens. Asian central banks are already exposed to enormous potential losses in local-currency terms should their currencies appreciate against the dollar. It would be prudent for them to diversify their reserves, but that could send the dollar tumbling. Larry Summers, a Treasury secretary under President Clinton, calls this the “balance of financial terror”: in effect, America relies on the costs to Asian central banks of not financing its deficit as assurance that financing will continue indefinitely.
- Where the dollar has failed is as a store of value. Since 1960 the dollar has fallen by around two-thirds against the euro (using Germany’s currency as a proxy before 1999) and the yen (see chart 1). The euro area, unlike America, is a net creditor. Never before has the guardian of the world’s main reserve currency been its biggest net debtor. And a debtor may be tempted to use devaluation to reduce its external deficit—hardly a desirable property for a reserve currency.
Those bearish on the dollar are asking why investors will want to hold the assets of a country that has, by its own actions, jeopardised its reserve-currency position. And, they point out, without the intervention of central banks, which have been huge net buyers of dollars, the dollar would already be lower. If those same central banks were to begin to sell some of their $2.3 trillion dollar assets, then there would be a risk of a collapse in the dollar. However you look at it, America is likely to find it increasingly hard to finance its huge current-account deficit.
{ 6 comments }
i like to compare foreign bankers holding american dollars to a bank that has let a poorly run business get into debt over its head with the bank’s money. the bank has to eventually decide to cut off the loans to the business and eat its’ losses now or continue to loan and suffer a bigger loss later. is this an accurate analogy in your opinion?
“the value of the dollar was officially pegged to gold” is such an unfortunate and confusing phrase. People get hung up on the price-fixing connotations, which superficially seems anti-liberal. The “value” of the dollar is not fixed. It fluxes with each individual. It is the amount of dollars that is fixed, preventing the fraud of devaluation, and for that any object of value is suitable, although gold is favored.
ebert: I believe your analogy is good, except that a bank has shareholders to whom it is responsible for providing returns. To whom is the Chinese central bank responsible? Who in China is in a position to complain from losses at its central bank?
Hadn’t the main euro zone economies -Germany, France, Italy- been held back so strongly by its welfare statist policies of high taxes and excessive regulations (Compared to them the US economy is still a free market haven), the euro would have already taken over the dollar’s role as the world’s reserve currency.
Shostak argues that the euro should be valued even lower than the dollar in terms of the quantity of euro currency that has been created by the central bank. It is difficult to see which fiat currency should be the reserve currency in this system.
The currency debate is often based on ideology rather than fact … the choice to hold dollars is a free one … the Chinese, Germans, Koreans, etc. choose to hold dollars for one reason … they do not want to buy US products … the growth strategies they employ are export driven … This creates the imbalance … we can talk all day about gold standards and miss the simple fact that trade must be two way in the long run … currency is a holding medium
Correct me if I am wrong, but is the USD’s recent woes a direct result of the current account deficit that the US is presently confronted with? The Euro area actually has a trade surplus; would’t the USD decline represent the market correcting for previous Federal Reserve created distortions. I understand the point that more Euros have been created (out of thin air) than USD, but the European consumer hasn’t been quite as profligate as his American counterpart. Isn’t the real issue the balance of payments?
Comments on this entry are closed.