Business | Banking
Dollar gloom could spell doom
Repeat after me: "I believe in a strong dollar as the primary global reserve currency, I believe in a strong dollar as the primary global reserve currency."
- euters
- Published: 23:02 July 12, 2009
Repeat after me: "I believe in a strong dollar as the primary global reserve currency, I believe in a strong dollar as the primary global reserve currency."
Better hope it works, because the current debate over a far-in-the-future new monetary system may bring on a here-and-now dollar sell-off and a whole new leg of the crisis.
Sadly, what worked when the children espoused their faith in Tinkerbell may not for a currency backed by the full faith and credit of a debtor nation which has socialised its banking system's risk and needs to sell trillions in further debt to pay that and other bills.
Russia, India and, most significantly, China all questioned the US dollar's central role in global trade and currency reserve management in the run-up to the meeting of the Group of Eight industrialised nations in Italy last week. The future, it seems, is not greenback.
Russian President Dmitry Medvedev termed the system based on the dollar "flawed".
Suresh Tendulkar, a top Indian economic advisor, said he was telling India to reduce the dollar's weighting in setting the value of the rupee, comparing the situation to the classic "prisoner's dilemma".
It's a good comparison and as such makes his advice, and his choosing to make it public, puzzling. In the prisoner's dilemma, two people are held for a crime and, being held apart, must decide whether to rat the other out.
If both remain silent, they each get six months' jail time, if one implicates the other he goes free and the other gets ten years, if both turn on one another, they both get five years.
If holders of US dollars can somehow maintain confidence in the currency, the value of their reserves will be protected, but the temptation to get a first mover's advantage and get out while the getting is good may be overwhelming, though it will only work for that individual if everyone else more or less keeps faith.
Because, if they don't the sell-off could be so disorderly and damaging to the global economy that it will make concerns over the value of reserves look silly.
China, for its part, seems to be furiously paddling in both directions at the same time; saying that the dollar will retain its central status for 'years to come' while also doing things like setting up a system to allow companies to settle cross-border trades in yuan.
Writing in a newspaper published by the Chinese central bank, Li Ruogu, chairman of the state-run Export-Import Bank of China said that Special Drawing Rights (SDRs), a unit of account used by the International Monetary Fund, could be moulded to serve as a more representative global settlement unit, based on a basket of currencies.
This echoes suggestions made by Chinese officials in March and can leave little doubt that the Chinese are preparing for a very different future.
"The financial crisis caused the global economy to suffer heavy losses and it also let us clearly see how unreasonable the current international monetary system is," Li, a former central bank vice-governor, said.
He's right, the old set-up under which China kept its currency weak and US borrowing rates lower than they otherwise would be made it too easy for the US to load up on debt and almost surely was the fundamental underlying driver that led to the sub-prime mortgage crisis.
It created conditions under which the huge risk management failure within banking was more likely. After all, when money is cheap and people are desperate for a bit extra yield, bad loans will begin to look safe.
Of course there are no credible current alternatives to the dollar at this point; not the euro, which might fracture or grow, or the yen or even the Chinese yuan.
And there is the danger: the very knowledge that the current dispensation is under review, and for extremely sound reasons, means that there is a small but dangerous chance that it unravels, that holders of dollars and buyers of US debt lose faith leading to an uncontrolled fall in the dollar and in dollar-based assets.
It is all very similar to the banking crisis. A bank is only sound so long as we believe it to be, and the dollar, given the US's weak fundamental position is only strong and worth holding so long as holders keep faith.
Really all we are observing is the continuation of the banking crisis on another plane. Last year the world lost faith in the US banking system. The US, feeling it had no alternative, stepped up as effective guarantor of its banks and its financial system.
Well and good, and here's hoping it works. It only will succeed however if faith in the US and its dollar remain.
Share this article
Popular in Business
-
Budget travel
Airlines in the region
Take a pictorial look at some of the budget airlines in GCC
Business Editor's choice
-
New law to protect investor rights
Dubai land department is studying legislation to protect property purchasers
-
Global Village
Revamped layout featuring four cultures to greet visitors this season
-
Cloud computing is here to stay
Managing security effectively is critical when sharing data over the internet
