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How much longer will the US dollar be the global reserve currency?

Posted on 11 January 2012 with 6 comments from readers

To replace the US dollar as the global reserve currency there has to be a credible alternative. At the moment no contender exists with the barely a decade-old euro showing signs of falling apart rather than getting its act together as a competitor.

Go back 33 years and this author can recall his first visit to the United States to stay with a pen-friend, who remarkably has just gotten back in touch after three decades. Then as now everybody was down on the US dollar and thought it was only a matter of time before the dollar’s reserve currency status would end.

Strong dollar policy

It did not happen. Inflation purged the debts of the Vietnam War and Reagan and Volcker then purged the inflation out of the system. However then started the build up of fresh debts that have brought the US dollar to a crisis point again, except that its major competitor the euro is in even bigger trouble with its interminable sovereign debt crisis.

Hence the US dollar is the asset class of choice for the sober Pimco (click here) and many other investors this year. It’s the least dirty shirt as Bill Gross says.

So the dollar’s day of reckoning is not going to come until the eurozone is past its crisis. How long will that take? Will the eurozone bring the rest of the world down with it in a financial crash? George Soros certainly thinks so (click here).

What would the central banks’ response be in such a crisis? Printing money seems all they can do. They all fear the deflationary liquidationist policy of the 30s and will do anything rather than that.

This takes us to a more extreme version of what happened in the 1970s: a burst of much higher inflation with supermarket trolleys and gas bills hit hard, and a major bust in the bond market with interest rates heading much higher.

The US will then have no alternative but to cut its public spending because the facility to pay for it with borrowed money will be gone. Asset prices will first deflate sharply but then begin to rise again as money from the Fed finds its way into the system.

Righting the sinking ship

Eventually the system will be righted with the debt burden eroded by inflation and debt paydowns, and the always latent entrepreneurial genius of the US people will begin to surface with the pressure on the public and not the private sector.

In thirty year’s time will the dollar be the global reserve currency? We think it will survive because of the absence of a competitor, though by then the currencies of the emerging markets will be much stronger and some will be de-pegged from the dollar.

Could the euro yet come from behind and grab the dollar’s crown? It seems unlikely. The current crisis is a major set-back and will make expansion far more difficult in the future.

Posted on 11 January 2012 Categories: Banking & Finance, Bond Markets, Global Economics, Gold & Silver, Hedge Funds, Investment Gurus, US Dollar, US Stocks

6 Comments posted by readers:

Comment by TomtheMon - 11 January 2012

30 years time?

I suspect a real world currency by then of some name unknown. All the then major players sitting round a table to determine the make-up of it and fixing it to some peg to an asset (or basket) that cannot be created out of thin air.

Comment by Bill in Slidell - 11 January 2012

I can’t see the euro replacing the dollar unless Europe unifies into the Unites States of Europe with a single government. Even then, we must remember that the population of a significant fraction of European countries is actually decreasing. (The UK is an exception which is why they are fighting over where to put the high-speed rail line out of London. Or maybe they are getting ready for the Continentals to adopt the Tobin tax, with the subsequent influx of investment professionals.) A stable population is one thing. A falling population is a different matter altogether. A high ranking Chinese official once said, “We have to get rich, before we get old.” That is the result of their one child policy. Urbanization will only reinforce the trend. So no, China will not take over the world. The Chinese economy will become larger than the US economy simply because they have 4X the population. But they may not stay the largest forever. The US added 2.1 million people to its’ population in 2011. That is almost half the population of New Zealand. And if we ever allowed unlimited immigration, billions of people would pour in from all over the place. Look at Australia. People brave the Indian Ocean cyclones to try and get in. Many drown or get sent back, despite having paid people smugglers their life savings.
Think how long the British pound remained dominant. Only the debts from WW I & II along with the loss of the empire, finished it off. The US economy was far larger before the dollar took over. Also we can’t forget the virtual destruction of an entire generation of young Englishmen in WW I. That weakened the country and contributed to the decline of the pound.
The fact that the Commonwealth still retains such close cultural contacts with former subjects is quite remarkable. The crowds to see the Queen in Australia were quite large. She hit several cities down there. (I wish I was as healthy as that woman!) Representatives from 54 countries just met in Perth for the Commonwealth Heads of Government meeting.
I was amused by a picture of Iranians changing their money for US dollars. And we keep rescuing them from the ocean. I never knew we had Coast Guard ships that big. And the Coast Guard is building a new port facility next to the NASA plant in New Orleans. What is that all about? The Mississippi River isn’t big enough? Chavez building a blue water navy?
Then again, the Army did just build a billion dollar 8.3 meter high flood wall to protect the plant from hurricane storm surges. They did it right after Katrina did 100 billion in flood damage. Funny thing, a year before Katrina hit, I wrote them a letter warning that the flood walls along the outfall canals should be strengthened, and that the levees along the Mississippi River Gulf Outlet canal were too low. The flood walls failed and flooded the western part of the City when hit by a very small storm surge from Lake Pontchartrain. The storm surge from the Gulf of Mexico was exactly the height, 18 feet (5.5 meters), that I wrote should be the height of the raised levee in the eastern part of the City. I told them to raise the existing 14 foot (4.3 meter) high levee along the canal (since sealed off from the Gulf of Mexico) to 18 feet (5.5 meters). The 4 feet (1.2 meters) of over-topping flooded the east side of New Orleans. They never wrote me back. I’ll bet they didn’t save that letter, like the French do. It is amazing how ofter I hear Katrina referenced on national TV over here. It makes me glad I’m at 20 feet (6.1 meters) above sea level now. And the State is building a 1.5 meter high wall down the center of Interstate 12 as part of the widening project. It is between me and potential storm surges from Lake Pontchartrain. Hey, it can’t hurt. And people around here find ways to cross medians, no matter how wide, and slam into people driving on the other side.

Comment by Aaron - 11 January 2012

Hi tomthemon

I believe that the global currency that you describe will likely be the same global currency which has been used for over 2 millennia. A return to a gold standard is something that central bankers will revere, as this takes the power out of their hands to create debt and print their way out of it.

Eventually the supporting nations will revert back to the thought that gold and other fixed/physical asset classes are the only means of unmanipulated wealth management.

I come from south Africa, and besides being in the top four producers of gold, we also boast wealth in diamonds, coal, oil, iron ore, uranium and and and

It is countries like this that will use these commodities to back their currencies again and walk away from the influence of other nations.

Well that’s just my thoughs.

Comment by davie1003 - 12 January 2012

Yes, gold will be the numeraire (look it up) for the international currency. The only reply one can have for this lead article (and 100’s similar, posing, but not answering, questions) is “what are you smoking?”

Comment by boatman - 12 January 2012

i do not see the politicians giving up the power to print without a veryyy painful econ reset and a ‘demanding’ of sorts from the people for sound money.

i see the first happening but not the latter.

they will just want American Idol to come back on the TV.

PM’s the best investment as inflation and debt writedowns sink everything else.

Comment by obewon - 12 January 2012

When we consider:
a) the motives of the world’s power elite,
b) the continuing global debt crisis, and
c) continued US imperialism,

. . . nothing could challenge the USD as the world’s reserve currency, save for the ridiculous IMF and their “special drawing rights” (SDR) paper. So the US government continues to “get away with murder.”

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