raises talk of alternative world
Just about every day seems to
bring more bad news for the dollar.
Recent months have witnessed a steady erosion in the
greenback's value, down 16% since March against the currencies
of the top U.S. trading partners. On Wednesday, the euro broke
through the symbolically important $1.50 barrier for the first
time in 14 months.
Depending on whom you believe, a dollar hovering near its
52-week low represents either the market's devastating verdict
on the Obama administration's profligacy or a salutary
rediscovery of risk by newly emboldened investors.
Maybe it's a bit of both. But the downbeat drumbeat bangs on.
Chinese officials openly worry about taking a bath on their
enormous U.S. Treasury holdings. Foreign bankers talk of
promoting an alternative global currency, such as the euro,
yuan or a new synthetic medium of exchange cooked up by the
International Monetary Fund.
In the U.S., some voices on the right, such as Rep. Michele
Bachmann, R-Minn., detect an anti-American conspiracy to
scuttle the dollar. But the roster of those opining on the
dollar's woes includes establishmentarians such as Robert
Zoellick, president of the World Bank and a former top official
in Republican administrations. "Looking forward, there will
increasingly be other options to the dollar," he warned last
As the U.S. tries to repair its crisis-battered economy, is the
end of dollar supremacy about to make a tough job even
Not any time soon. There are "lots of reasons to be concerned
about the dollar. … (But) a weaker dollar is a fantastic boost
for the United States, and it's a problem for the rest of the
world," says Kenneth Rogoff, former IMF chief economist.
A natural monopoly
Since supplanting the British pound more than 60 years ago, the
dollar has reigned supreme in global markets. As of the end of
June, the most recent data available, 62.8% of foreign exchange
reserves worldwide were held in the form of U.S. dollars. An
additional 27.5% were stockpiled in euros, according to the
The dollar's position has eroded in the past five years. In
mid-2004, it made up 67.9% of world reserves. "A lot of people
get excited about this. But in the 1970s and 1980s, there was
even bigger volatility in the dollar share of reserves," says
Stephen Jen, managing director of BlueGold Capital Management,
a London-based hedge fund.
In March, Chinese Central Bank chief Zhou Xiaochuan proposed
shifting global finance to a reliance on a new international
reserve currency rather than the dollar or any other national
unit. The aim would be to avoid the periodic crises that have
characterized recent decades. But Zhou acknowledged that any
such change would take "a long time."
The instability of a world economy so dependent on any single
national currency is prompting even some leading American
figures to argue for a gradual move away from the dollar. Fred
Bergsten, former assistant Treasury secretary in the Carter
administration, says a major cause of the current crisis was
the destabilizing linkage between the U.S. trade deficit,
enormous capital flows from abroad that financed it and the
global dominance of the U.S. dollar. He argues in a new Foreign
Affairs article that, to avoid a repeat episode, the U.S.
should promote a move to a "multi-currency system" involving
the euro and the yuan.
For now, the dollar's fundamental standing remains what it's
been for decades: a convenient medium of exchange for buyers
and sellers around the world. Just as Chinese merchants speak
the global language of English when trading with Saudi oil
barons, they use the global currency to buy the oil. "The
reserve currency is a natural monopoly. It's so convenient to
list prices in a single currency," says Harvard University's
Rogoff, co-author of This Time Is Different, a study of
The U.S. benefits from the dollar's unique role, enjoying what
French President Valery Giscard d'Estaing memorably labeled the
"exorbitant privilege" of being able to borrow abroad in its
own currency. That insulates Americans from the danger of
seeing their debts skyrocket in response to a sharp decline in
the dollar's value.
The dollar doesn't owe its global role to international
affection for Americans. Investors relying on the cold logic of
the marketplace are drawn to the greenback by specific
advantages that make the rise of a dollar rival inherently
difficult. "There's no equally attractive alternative," says
economist Barry Eichengreen of the University of
In the short run, the only currency that could challenge the
dollar is the euro. It, too, has a continental-size economy
behind it, and a decade after its introduction, the European
currency has established itself as a fully convertible, stable
store of value.
But for all its attractions, the euro lacks some essential
attributes. Although the European Union has a central bank,
comparable to the Federal Reserve, there is no European
treasury. Instead, there are 27 European treasuries. Investors
can't easily track or influence fiscal policy on the
The dollar is also buoyed by the existence of a massive
government bond market. There's roughly $4 trillion worth of
U.S. Treasuries floating around, and almost $100 billion
changes hands each day, according to investment management firm
Pimco. Trading that's carried on almost 24 hours a day, rolling
east to west from Tokyo to London to New York, makes it easy to
move into and out of dollar positions in a hurry.
Europe, by contrast, has no analogue to the U.S. Treasury
market. Instead there is a fragmented scene with individual
sovereign debt from Germany, Italy, France and other EU
members. No individual market enjoys anything like Treasuries'
liquidity and size.
There's another potential dollar rival on the horizon, though
its day likely lies a decade or more in the future. Just as the
United States overtook the British empire, China's economy one
day is likely to pass the U.S.'s. When it does, the yuan would
be in position to fill the dollar's global role.
But before it does, China will have to thoroughly overhaul its
existing financial system. Today, the yuan isn't freely
convertible into other currencies, and there are strict limits
on the cross-border movement of the Chinese currency. Chinese
officials publicly have committed themselves to freeing the
yuan to float alongside the dollar, euro, yen and other major
currencies. That change, however, won't happen overnight.
Even if foreign investors have concerns about having so much of
their national wealth tied up in dollars, there is a limit to
what they can do about it in the short run. The Chinese, for
example, have little choice but to keep recycling into Treasury
purchases their dollar surpluses from trading with the United
States. Beijing wants to prevent the yuan from appreciating
against the dollar, to protect employment in its export sector.
Even as it worries about the long-term prospects for its
dollar-denominated investments, it has to keep buying dollars
to do so.
"There's a gap between what's feasible and what central banks
would like to do," said Steven Englander, chief foreign
exchange strategist for Barclays Capital in New York.
Further to fall
The dollar's long-run prognosis is negative. In the wake of the
crisis, a retrenchment in cross-border financial flows will
mean less demand for dollar-denominated assets. And with Uncle
Sam's printing press running overtime to cover the government's
trillion-dollar budget deficits, the currency is expected to be
further cheapened, says Eichengreen.
The decline in the dollar's value in the past seven months
largely reflects an unwinding of the "flight to quality" that
occurred during the most panicked crisis phase. Amid
unprecedented levels of uncertainty late last year, investors
flocked to assets denominated in the largest, most liquid
currency. That drove the dollar's value against the euro, for
example, up about 13% over the three months ended in March.
Since then, the euro has regained the lost ground and then
some. A euro, which settled at $1.50 Wednesday, was at $1.43 in
In the political realm, the dollar's weakness is interpreted as
a referendum on American decline. But its steady slippage this
year is in line with economic fundamentals — that is, near-zero
U.S. interest rates.
That said, neither the euro nor Japanese yen have had anything
to celebrate. The biggest beneficiaries of the move out of
dollars since March have been currencies of countries that
heavily export raw materials, such as the Australian dollar (up
33% against the greenback) and the Canadian loonie (up
U.S. officials historically repeat mantra-like that they favor
a "strong dollar." That really should be interpreted as a fancy
way of saying "no comment."
So far, the dollar has only retreated back to the level it was
at before the Lehman Bros. bankruptcy filing in September 2008
turned an economic downturn into a global financial panic. A
weak dollar would be a problem if it contributed to inflation
by increasing the cost of imports, or if it got so low so fast
that the Fed felt compelled to raise interest rates to attract
foreign investors. Neither is the case today.
The shrinking dollar also carries important economic benefits
for the U.S. economy as it tries to climb out of recession. By
making U.S. goods less expensive overseas, a weaker dollar
provides a welcome boost for exports. The Obama administration
has said it wants to rebuild the U.S. economy to rely more on
making goods here to sell to people in other countries instead
of depending on buying more and more stuff made elsewhere.
"The U.S., in the new normal, is going to have to export more
because U.S. households will be saving," said Eichengreen.
For that to happen, the dollar likely has further to