Unseating the Dollar's Reserve Currency Hegemony Still a Long Shot

October 20, 2009

The dollar has not performed well in 2009, and market chatter has been full of speculation about whether orderly depreciation might mutate into a disorderly rout.   Market players want to know if the dollar’s dominance in the international monetary system might be replaced or get shared.  This is not the first year that such questions have been asked, yet the dollar’s hold on reserve asset portfolios is still essentially unchallenged.  Currency market analysts for the most part, myself included, do not anticipate major changes anytime soon.  It was suggested by Beijing officials that synthetic currencies like IMF Special Drawing Rights be elevated into such the major reserve asset role.  That was indeed an envisaged possibility when SDRs were invented, but it became clear as years passed that a currency or commodity that is not readily exchanged in everyday commerce would not be trusted to assume the function of chief international store of value.  Likewise, currencies whose convertibility are limited, like the Chinese yuan, are not true candidates for a reserve currency role.

One of the reasons behind the dollar’s solid grip on reserve asset portfolios is the scarcity of good currency alternatives to challenge its dominance.  Sterling was a hegemon before the First World War and is associated with extremely well developed capital markets, but the British economy has too many liabilities for the pound to reassume such a role.  The U.K. suffered with double-digit inflation during much of the post-war era, and its public deficit and debt problems are just as large relatively speaking as America’s.  Sterling’s prognosis looks very shaky. 

The yen has been well-bid, in contrast, but a funny thing happened on Japan’s way to global economic domination after 1990.  Although that economy is still the world’s second largest among nation states, it now is prone to price deflation and has among the G-7’s weakest trend rates of growth. 

Only the euro seems to be a truly viable candidate, but it too has serious drawbacks.  One is that the euro has only been around for around eleven years, which is too brief an interval for such a pivotal function in world commerce and wealth holding.  That shortcoming only begins to explain why the euro is not ready to challenge the dollar.  I strongly recommend an article in Tuesday’s Financial Times by Jean Pisani-Ferry and Adam Posen entitled “Why the euro is not the next global currency” for a detailed rundown of other impediments.  By process of elimination, the TINA defense (There Is No Alternative) will prevent the dollar from getting usurped as the world’s main vehicle for invoicing trade and storing value.

The past forty years have established beyond little doubt that being the world’s major reserve currency does not shield the U.S. currency from fairly chronic debasement. The pace of depreciation would almost certainly accelerate initially if the dollar were to abdicate that role, but remaining king of all currencies provides no immunity against selling pressure.  It only lessens the collateral damage that is associated with depreciation and exports most of the unwelcome consequences of an eroding dollar to economies whose currencies are appreciating.

Copyright Larry Greenberg 2009.  All rights reserved.  No secondary distribution without express permission.



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