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.