The dollar's days may be numbered
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Associate Editor
David Stevenson Mar 27, 2009
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If you've been on holiday abroad recently, you'll be all too aware how expensive everything has become if you're paying in pounds.
Sadly for travellers, and also for importers, our national economic woes mean there's little sign of sterling recovering much in the near future. But the pound's not the only currency with problems.
With various parts of the eurozone near-bankrupt, the euro is under pressure, while Japan's recession means the yen doesn't look too hot either. And the Swiss franc – a traditional safe haven – has been deliberately crushed by the Swiss central bank, keen to prevent deflation.
Still, there's always the dollar. It might be massively indebted, but America is still the place where everyone runs to put their money when things start looking shaky. The dollar is still the world's reserve currency.
But perhaps not for much longer...
Sterling's in a mess right now - but so is the rest of the world
Unless you have a secret stash of dollars or euros you can press into service when the need arises, travelling outside the UK these days has become awfully pricey. The currency swap shops will give you less than $1.40 per £1, while you're lucky if you can beat 1:1 on euros.
While exchange rates may improve again one day, you only have to scan the horrendous headlines about our economy to realise this isn't likely to be any time soon.
But sterling's main saving grace is that the world is in a mess too, particularly the US. Right now, the dollar is the world's "reserve currency", which means that many other countries hold large amounts of dollars in their foreign exchange reserves – 65% of the total, at the last count. That means the Americans are in pole position to set the global economic agenda – effectively they run the racetrack.
But the trouble is, as we discuss in MoneyWeek magazine this week (Can America's latest rescue package really work?, if you're not already a subscriber, get your first three issues free here), the US has gone on a spending spree like no other in history. That means they're running up debt like no tomorrow - $11 trillion and counting, if you include social security obligations. In fact, if you want to see something really scary, check out the US National Debt Clock and keep hitting the 'refresh' button. The numbers just ratchet up while you watch in horror.
This means humungous levels of US borrowing, and probably lots more new money being minted, for years to come. That poses some big question marks about the greenback's long-term future.
Are the dollar's days numbered?
So anyone who holds US dollars could be forgiven for getting a bit twitchy about the value of their holdings. And the Chinese have started the ball rolling. Central bank governor Zhou Xiaochuan has called for a "super-sovereign reserve currency" that would be run by the International Monetary Fund (IMF). Russia, Brazil and India have backed the idea as well.
Now people have been predicting the end of the dollar's status as reserve currency for years. But it's easier said than done. Having the global reserve currency is the main reason that America has been able to rack up the debts it has. Losing that position might be healthier for the global economy in the long run, but it wouldn't be a very comfortable adjustment for the US.
And then there's the status issue. If you no longer control the world's main "go-to" currency, it rather suggests you've lost your position as the world's most important country. Hence the long tradition of Presidents and Treasury Secretaries pretending that the US has a "strong dollar" policy, regardless of what's actually happening on the ground.
So it's no wonder that markets were shocked when on Wednesday, US Treasury Secretary Tim Geithner said that America is "quite open" to the Chinese proposals, sending the dollar plunging. "This apparent policy shift amounts to an earthquake in geo-finance", says David Bloom at HSBC, according to The Telegraph.
Dramatic stuff. It didn't take very long for Mr Geithner to "clarify" what he meant, i.e. that there was no policy change and that "the dollar would remain the world's dominant currency" – though that's not quite the same thing – but by then the cat was out of the bag. "If there's a lesson from today", says Chris Turner at ING Capital Markets, "it's that the dollar's on thin ice and any loose talk will be quickly punished."
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How would a global currency work?
So how would a global super-currency work? At the moment the IMF runs on Special Drawing Rights, which are a basket of the world's major currencies. "The IMF would be groomed as the planet's central bank", says The Telegraph's Ambrose Evans-Pritchard, "and the SDRs would gradually become an accepted means of payment - call it the 'globo'."
This could have some benefits. It would mean a new monetary start for a world racked by deflation, and maybe inflation again soon. The managers – the IMF - would be independent of national governments. That means countries wouldn't be able to 'inflate' their way out of debt by de-basing their currencies.
But as the problems of the eurozone show, monetary union is easier said than done. Trying to set pan-eurozone interest rates is hard enough. Doing it on a global basis would be nigh-on impossible.
And more to the point, any basket of currencies used to back the 'globo' would include a far smaller number of dollars than central banks currently hold in their reserves. That would mean a big plunge for the dollar and serious upheaval for the global financial system.
So you won't be able to swap your pounds for globos any time soon. "This is obviously not something that's going to happen for quite a long time", says Morris Goldstein at the Peterson Institute. But Geithner's 'slip' means the door has been opened to a future without the dollar. As Goldstein puts it, "the crisis does raise a lot of fundamental issues, and the reserve currency is one of them".
China holds almost 30% of the world's entire dollar reserves, says Mr Bloom, so "what they say matters". If the dollar starts dropping in earnest, and the Chinese really get fed up with losing so much money, don't bet on some form of the world super-currency not happening.
And in the meantime, we've said it before, but we'll say it again – gold looks like the only currency worth having.
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