Yes, the dollar is showing its age. But it’s a tough old geezer and it may hang on longer than you expect -- indeed, longer than we can easily afford.
The value of the U.S. currency has dropped by more than a third over the past decade (see right), as America fought two wars and embarked on a massive borrow-and-consume binge. With the Federal Reserve now buying U.S. debt for the sake of propping up, um, domestic consumption – one of the vices that got us into our fix in the first place – it is no secret that the greenback’s best days are behind it.
“We don’t have a world of U.S. hegemony any more,” says Jonathan Lewis of Samson Capital Advisors in New York. “It’s only natural the financial system should reflect a more multipolar world with a less prominent role for the dollar. The question is what.”
But contrary to popular belief, the end of the dollar’s reign isn't in sight. For all the posturing about Fed laxity and American decline, the rest of the world is just as addicted to cheap dollars as we are -- a fact that won't make it any easier to put the global economy on the road to a sustainable recovery.
China, for instance, is often mentioned as the economic superpower that will unseat the United States. Yet it is piling up trillions of dollars of depreciating Treasury debt. Why?
Not out of some abiding loyalty to Americans, swell as we are, but because buying dollars keeps the Chinese currency cheap, makes Chinese goods affordable and puts millions of Chinese to work. Kicking a habit like that is no easier in Beijing than it is in Washington.
What’s more, as ridiculous as the current system is we are years from even considering an alternative, let alone putting one in place. There's gold, but so what. Strategic drawing rights? Sorry, back to the drawing board.
“You can’t replace a free market system with one that isn’t free,” says Lewis, who runs the Samson Multicurrency Plus strategy. “You need free capital flows and deep local markets, for starters. The yuan as a reserve currency is an idea on a whiteboard.”
The dollar is dead. Long live the dollar.
That’s not to say alternatives to the dollar won’t develop over time. Once the Europeans pull themselves together and deal with their bailout problems, the euro may look more like a viable second reserve currency. The Chinese will take their time to put market reforms in place, but they may have opened things up sufficiently in a decade or so that the yuan too look more plausible.
That sounds unnerving, but a move away from the current system could actually be good for America. Much of the fretting about a shift away from a dollar-centric world centers on the fear that the United States will see its borrowing costs soar.
But Fred Bergsten, a Carter administration Treasury official, says that shift could be a blessing in disguise, by forcing disciplline on policymakers who have been distinctly lacking in that characteristic. By cutting our borrowing, we could force exporters like China to shape up as well, by rebalancing their own economies. This could help prune the global imbalances that have vexed the world economy in recent years.
Of course, this rosy view hinges on Congress breaking its addiction to ever-higher spending, which is anything but a given. But just maybe we will wake up to the error of our ways before it's too late. Hey, a guy can dream.
“If the United States stopped running large trade deficits and acting as the consumer of last resort, many countries would be forced to rebalance their growth strategies to expand domestic demand instead of relying on exports,” Bergsten wrote in a 2009 commentary. “Other countries should be careful what they wish for when they propose dethroning the dollar.”
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