Dumping the Dollar

Posted On Wednesday, Apr 01, 2009


For many decades, the US dollar has been the world’s reserve currency, the one by which all others are measured, and the currency most used for international trade. Over the past six to nine months, as the worldwide recession has deepened, the US Dollar or the ‘greenback’ has been the currency of last resort and has therefore maintained more than its value. However, there are several reasons that may lead to the decline of the greenback.

      • The U.S Government is piling up loads of debt in an effort to bail out the economy out of deepening recession. This increasing debt would surely put downward pressure on a nation’s currency value.

      • The U.S government has opted for printing (more) money, a time-honored means to relieve some of the debt problems. However, this always leads to an inflation problem in the long term, which again places a declining bias on a nation’s monetary unit.
      • U.S. interest rates are at exceptionally low levels. This will reduce the appeal for international investors of holding Treasury Bills, bonds and notes once the need for "safety" starts dissipating.

What is clear, however, is that the economy of the reserve currency of the world is currently facing structural problems, which have been described as serious and unsustainable, and are causing worldwide concern, particularly at the policy level. The low savings rate, the large current account deficit and now also the large budget deficit are the familiar issues, and associated with these is the question of how willing are those economies with surplus savings to continue financing those deficits.

The world has been relying on the dollar as a reserve currency which has to preserve its value, but America, in order to solve its own economic problems, has to now print (more) money, which will devalue the currency in the long term. So there is an essential contradiction there.

There’s some light in the tunnel.
Is it the end of the long tunnel or a train fast approaching?

The issue of the world currency reserve is expected to be raised at the April 2 summit of the G20. A U.N. panel recommends that the world abandons the dollar as its reserve currency in favor of a shared basket of currencies. There are strong voices like China and Russia backing the thought. China called for a replacement of the dollar, installed as the reserve currency after World War II, with a different standard run by the International Monetary Fund. China and Russia are calling for the creation of a new world reserve currency amid fears that the Federal Reserve`s quantitative easing policy (printing additional money) might cause hyperinflation, leading to the eventual collapse of the economy.

China’s version of new reserve currency

Top officials from China used strong language as to enforce the fact that they would want to see a new world reserve currency replacing the dollar. They said: "The global financial crisis reveals flaws in the international monetary system". "An international reserve currency should not be tied to the interests and economic conditions of any one country". People`s Bank of China Governor Zhou Xiaochuan suggested the IMF`s Special Drawing Rights, a currency basket comprising dollars, euros, sterling and yen, could serve as a super-sovereign reserve currency, saying it would not be easily influenced by the policies of individual countries. Some analysts say the move demonstrates China`s growing discontent with American dominance of the world economy. Russia is also planning to propose the creation of a new reserve currency, to be issued by international financial institutions. IMF managing director Dominique Strauss-Kahn said that talks on a new world reserve currency to replace the US dollar were "legitimate" and could take place "in the coming months."

Chart: Special Drawing Rights

Special Drawing Rights

Source: Bloomberg
* SDR rate is quoted as the number of dollars per SDR

Special Drawing Rights (SDRs)

One solution China is offering to reduce currency-value uncertainty is expanding the use of an instrument called Special Drawing Rights (SDRs). These were devised by the International Monetary Fund about half a century ago. They are based on a basket of currencies. Widespread use of SDRs never really caught on because the system continued to work fairly well with the greenback at the top of the heap. But now, with greater financial sector regulation in the air and an overhaul of world financial markets likely upcoming, there are starting to be some calls for a re-examination of currency markets as well.

What does History indicate?

We have had a long history of reserve currencies which reflects an interesting fact that the position of a country as a super power of the world (whose currency acts as a reserve currency) tends to rotate in a natural cycle of around 100 years.

Will History repeat itself?

SupremacyFromToNo. of

Source: Content provided by Hongkong Monetary Authority
*U.S Dollar still remains the world reserve currency. No. of years calculated upto 2009

The above table indicates that we may be near or just few years away from the climax. Historically, as other currencies have dominated as a reserve currency for a cycle of nearly 100 years, it could be true for the dollar too.

"Can SDR serve as a reserve currency?"

SDR is a combination of the U.S Dollar, Yen, Euro, and the British Pound i.e currencies of different nations.

As we are all aware, each of the economies whose currencies are mentioned above are going through equally difficult times as the United States. Then, how their combination would be different from the U.S dollar. It still is a paper bag of paper currencies which is just the problem we all suffer from.

There seems to be no practical solution.

With paper currencies and the power to print it at will, inflation is inevitable.

The only super rescuer out of this financial mess and the coming inflation is Gold.

Above article is authored by Quantum.

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