Loading ...
Reading time: 7 – 12 minutes
Recently, representatives of China and Brazil have suggested that either the Renimbi, the Brazilian Real, or some new currency backed by the IMF be used to substitute the dollar.
An alternate 'reserve currency"?
US Treasury Secretary Tim Geithner said that this was an idea meriting consideration (but later recanted).
Columbia University economist Jeffrey D. Sachs wrote in the June 2009 “Scientific American” that the Chinese proposal had “much to commend it” and that “Geithner’s first reaction was right”.
Does this mean that the dollar’s role as the global reserve currency is doomed? Can the economists, central bankers, and IMF band together and decree some alternative “world currency”?
Probably not. Here is why.
What importers and exporters want
The main purpose of a global reserve currency is to serve as the means of payment in international trade.
The key decisions regarding international trade are not made by central bankers, the IMF, or economists.
The real decision makers are importers and exporters.
Foreign trade is a two-way street: goods flow one way; money flows in the opposite direction.
Both importers and exporters must agree on the goods to be exported and the kind of money to be paid in exchange.
Exporter and importer
Availability of trading currency
Furthermore, the importer must actually have available the kind of money that the exporter wants in exchange for his goods — this is a key point.
How many importers in the United States or Europe are holding fat balances of Chinese Renimbi or Brazilian Reais in their bank accounts? Not many. Fewer still have balances worth mentioning in Mongolian Togrog or Algerian Dinar.
If it were possible to change the means of international payment by decree to a currency (or basket of currencies) other than the dollar, the immediate result would be a sharp decline in world trade — a depressive effect similar to the tariff wars of the 1930s — simply because not enough importers hold enough of these alternative currencies to sustain world trade.
Governments would fall.
It just ain’t goin’ happen!
The shortage of non-dollars
Now I know that some people think that if you need to get some Chinese Renimbi or Brazilian Reais you just go down to the local bank and buy some.
An alternative currency?
The only unlimited suppliers of Renimbi or Reais are the central banks of China and Brazil.
Otherwise, you have to buy these currencies from off-shore residents that have accumulated them as a result of international trade, investment, or tourism.
The problem is that both China and Brazil — and almost every other country in the world except the United States — have a tacit or explicit policy to encourage exports and discourage imports (neo-mercantilism).
Brazil, for example, has an implicit tariff of about 100% on imports.
This means that, other than dollars, most currencies held in foreign hands are in relative short supply.
Global reserve currencies (from Wikipedia)
For the Brazilian Real to become a world trading currency, the government of Brazil would have to remove economic protection from local industries — so that foreign goods would become competitive on the local market.
At the same time, the Brazilian government would have to somehow find a way to convince foreign suppliers to receive payment in Brazilian currency.
If you know how this could be done, please leave a comment on this article.
The Anti-Gresham’s Law of global currency
Sir Thomas Gresham
Sir Thomas Gresham stated in the time of Tudor England that “Bad money drives out the good”. But this is only true if both currencies are required to be accepted as legal tender at a fixed ratio.
There is no “legal tender” in international trade that binds exporters to accept a certain currency that importers may offer in payment.
Instead, there is a free market in which exporters prefer to be paid in what they perceive as the “best” currency, not the weakest.
Electing the “best” currency
Exporters elect the “best” currency based on their own practical experience, observance of the market, and commonsense:
- In how many other countries will exporters accept a certain currency?
- How safe are bank deposits in the country that issues this currency?
- How well do the laws of the country that issues this currency protect the property rights of foreigners?
- For how many decades has this currency been widely accepted in international commerce?
- Over the last few decades, how well has the central bank of the issuing country protected the value of this currency, compared to other currencies?
Weighing the 'best' currency
- If the exporter (due to problems in his own country) were to move to the country of the other currency, how well would he be received? Would he and his family be comfortable living there? How well does the issuing country receive foreigners?
- How stable is the political and economic system of the issuing country relative to alternatives?
Try to answer each of these question, not in absolute terms, but in terms relative to other currencies — remembering that the currency selected must be issued by a country that is large enough to run a substantial trade deficit to supply enough currency to be relevant in the world economy — without putting the issuing country at risk.
So far, there are only two issuers of currency that even come close to meeting these requirements, the United States and Euroland — and Euroland doesn’t want to run a trade deficit.
How about the IMF?
So far, there have been no serious suggestions that the IMF issue legal tender meant to be accepted by exporters throughout the world and that would be widely available in bank checking accounts or by credit card.
Is 'symmetry' a criteria?
Instead, we have various suggestions that only are relevant to dealings between central banks.
An importer can’t pay an exporters in a check issued in SDRs, nor can the exporter uses this “currency” to pay for a trip to Disneyland.
Professor Jeffrey Sachs (in the above-mentioned article) seemed to like the Chinese proposal for “a more symetrical monetary system, in which nations peg their currencies to a representative basket of others rather than the dollar alone”.
However, this would require abandoning the free market, ignoring the “votes” of real-world importers and exporters, and surrendering national sovereignty to a small international body of over-paid, non-elected economists.
Not very likely to happen any time soon.
Too soon to give up on the dollar
The Crash of 2008 was undoubtedly a world-changing event that severely shook the position of the US dollar.
It also brought about the inauguration of one of the least inspiring (in economic terms) governments since Jimmy Carter.
With wild, irrational spending by the Pelosi-Reid Congress combined with quasi-nationalization of the US auto industry and proposals for massive tax increases to fund medical nirvana and a mystical green, “carbon-free” environment — it is not surprising that the Chinese, Brazilians, and other holders of dollar reserves are nervous — but so are a large and growing segment of the US population.
Moreover, US history suggests that the road forward may not be as dismal as it now seems.
Don't write off he dollar.
- The US holds Congressional elections every two years, and Presidential elections every four years. President Obama is spending his political capital almost as fast as he is spending taxpayer money. Opposition is growing faster than one would have expected. The genius of American Democracy is the ability to “turn the rascals out”. It seems likely that the Obama administration will become weaker with each passing day.
- The US financial system will probably emerge from the debacle stronger than ever. Capitalism is all about “creative destruction” and the process is already well underway. Things will be different, but not necessarily worse.
Already there are signs that Americans are saving more, credit card use is being cut, lending to the non-credit-worthy is no longer in fashion, leverage is being reduced, stock buybacks are ending … the system is healing itself.
New leaders will come forward.
We’ll see.
What do you think?
Tags: 
There is no question that the threat of US inflation is a serious concern for all those holding dollars or that alternatives to the dollar as the world reserve currency, in view of this threat, are now being considered and advanced.
If dollar inflation, of the magnitude some are predicting, actually becomes reality, the utility of the dollar as the reserve currency could quickly disappear — basically as a result of US government policies.
Beyond inflation, other threats to the dollar would include protectionist measures being suggested by the Obama administration.
However, both dollar inflation and US protectionism are still potential rather than actual. The popularity of the current administration on a variety of economic issues is waning daily. If this trend continues, it is possible that more reasonable economic policies could prevail and that the danger of extreme inflation could pass. Cancellation of spending projects, not yet initiated and aggressive anti-inflation measures, like raising bank reserve requirements, could reduce the threat of inflation.
At the same time, there are those who now fear deflation, rather than inflation.
Bilateral agreements between governments are, in my opinion, unlikely to compete with the free market preferences of exporters regarding settlement currencies, especially when the actual volume of cross-border holdings of specific currencies in the hands of potential importers are taken into consideration.
That is why I think that it is a little too soon to write off the dollar … but this is not to say that a realignment of the concept of an international reserve currencies could not come about during the next decade.
Too soon, but that seems to be the plan.
What about, bilateral agreements between China and Brasil, China and Argentina, and I think between Brasil and Argentina, to use their own currencies instead of the dollar?
What about Gas and Petroleum priced in Euros as Iran wanted? (although the Euro, has internal problems)
With success or not, it seems there are tactics movements in certain big countries riches in commodities, with the idea of trying to replace dollar monopoly in international transactions.
“One stone doesn´t make a building but helps their colleague”