Global economy has no substitute for falling dollar

Irwin Stelzer

Let’s see. The Chinese are cross because the falling dollar means the stacks of American IOUs they have in their vaults will be paid back in a devalued currency. The Americans are cross because the Chinese refuse to allow the renminbi to rise in value and this means goods made in Chinese factories will continue to displace made-in-America products, and provide jobs for Chinese rather than American workers. The Europeans are cross because the strong euro aborts the export growth on which they are depending to fuel their economic recovery. The British are cross because the weak pound makes it expensive to buy anything abroad, and suggests that a spurt of inflation is just around the corner. In short, everyone seems to be terribly unhappy with developments in the currency markets.
Well, not terribly. The Chinese might be unhappy that the dollar is declining in value, but are delighted that their policy of pegging the renminbi to the dollar is keeping their export machine humming — they need millions of new jobs to prevent their poor masses wondering whether some other form of political organisation might provide a better life. The Americans might be fearful that further declines in the dollar will dethrone it as the world’s reserve currency, but the Obama administration is hoping that a cheap dollar will make imports more expensive and exports more competitive, creating jobs. European exporters might be groaning about the growth-stifling effect of their high-flying currency, but eurocrats are secretly delighted that the euro is proving a source of strength in these difficult times.

Other players are also trying to cope with the falling dollar. Brazil has tried to stem the rise of its currency, which has appreciated more than 40% against the dollar since March — to no avail. Oil and other commodity producers are raising prices to make up for the declining value of each dollar they receive. But these are minor players compared with the geopolitical players who see an opportunity to replace the dollar as the currency in which the world does business, to cut America down to size — think China, Russia, Venezuela, Iran.

It is one thing to want to replace the dollar, quite another to find a suitable substitute. The renminbi cannot be the chosen currency so long as it is pegged to the dollar, for its value will move with the dollar. The rouble is not a candidate, since there is not enough of the currency around to handle the volume of world trade and, besides, it is not the sort of money on which you can rely to hold its value, especially if oil prices collapse. Which brings us to the euro.

As has been pointed out by Jean Pisani-Ferry, director of the Brussels-based Bruegel think tank, and Adam Posen, a fellow at the Peterson Institute for International Economics in Washington: “There is no sign of a move to the euro as a global currency. The share of dollars in global reserves remains almost three times that of the euro.”

The reasons for this failure of the euro to advance further as a global currency seem to be rooted in the failure of the EU to encourage economic growth and to develop better systems of economic governance. Talk about pricing oil in euros instead of dollars remains just that — talk. And in the recent crisis it was the Federal Reserve Board that was called on to provide currency to meet emergency needs for liquidity — that means dollars.

Still, doubts about the dollar’s future persist. Its recent decline may be consistent with its performance in previous currency cycles. And the drop might be due to a willingness by investors to take on more risk now that the recession seems to be ending, rather than to a lack of faith in the safety of the dollar. But investors remain worried that the dollar’s decline, so far acceptably gradual, will turn into a rout, perhaps not next year, but in 2011.

Ben Bernanke, Federal Reserve Board chairman, says that this can be avoided if two policy steps are taken. First, the American government must make “a clear commitment to substantially reduce federal deficits over time”. Second, Asian countries must boost domestic demand so that they don’t have to rely so heavily on exports to America, and allow their currencies to appreciate against the dollar so that the US trade deficit continues to fall as a percentage of American GDP.

What Bernanke did not say, perhaps because he was playing the discreet central banker, is that neither of these things is likely. The Obama administration has already pencilled in eye-watering deficits for a decade and more, and is in the process of adding perhaps another $1trillion to the US deficit by “reforming” healthcare — claims of savings are somewhere between delusions and lies. It will then turn its attention to the energy sector, and the subsidies required to fund its green revolution.

Meanwhile, the Chinese are unlikely to allow their currency to appreciate in value, and other Asian nations will continue to intervene to prevent their currencies from rising against both the dollar and renminbi. Trade imbalances will, therefore, persist.

Which puts the ball right back in the Fed’s court. Unless Bernanke drains liquidity from the financial system, and shrinks the Fed’s balance sheet by winding down $2 trillion in support programmes — and does so precisely when the recovery takes hold so as not to cause a relapse by moving too early — the dollar’s decline will accelerate, shattering confidence in its long-term value. One well-respected expert tells me that in two to five years the dollar will no longer be considered safe enough to be the currency in which the world does business. Its replacement: separate deals in local currencies — the Chinese paying for Brazil’s oil in renminbi, which the Brazilians use to purchase stuff made in China — and the International Monetary Fund’s drawing rights, bits of paper backed by a basket of currencies, including but not limited to the dollar. That would mark the end of an era which has seen world trade flourish and millions emerge from poverty. Sad. (Irwin Stelzer, The Sunday Times)

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