The Inside Assyria Discussion Forum #5

=> End of dollar’s hegemony?

Posted by Tiglath (Guest) - Thursday, April 2 2009, 5:39:45 (CEST)
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Headed South.

Jacob Chandy

Many writers have predicted the death of the dollar, but its impending demise has always been exaggerated. But with the sub-prime crisis and the resulting global contagion, the dollar’s death as the world currency, may have graduated from being mere talk to desirable necessity.

Would the fruits of casino capitalism have spread so wide, if the dollar were not the world currency? Wouldn’t it be possible to isolate the damage from economic mismanagement to the offending economy, if the dollar were not the world currency? Should Third World countries bear the brunt of American profligacy facilitated by the reserve currency status of the dollar?

The Almighty Dollar

During the mid-20th century, the dollar became the world currency because of American diplomacy designed to establish its hegemony. What better way to pip the British Empire than orchestrate a coup to usurp reserve currency status from the pound sterling?

The weary pound sterling, drained of vitality after years of war, could not continue as the world currency, given the weakness of the British economy. The dollar, insulated from German blitzkriegs, was flaunted as the only currency that could meet the demand for global liquidity. Furthermore, the American commitment at Bretton Woods to peg the dollar at 1/35 ounces of gold, made the dollar even better than gold, since it could earn an interest.

Nobody objected, and the dollar became the world currency with all other currencies pegged to it. John Maynard Keynes who was one of the negotiators at Bretton Woods, argued energetically for a world central bank with a world currency called the Bancor, whose value was derived from a commodity basket. Keynes was bulldozed and an institutional framework was established consisting of the World Bank and the IMF — essentially extensions of the American treasury designed to perpetuate the dollar’s almightiness.

The Paper Tiger

This situation was not problematic since pegging ensured that currencies essentially derived value from gold. The Fed promptly redeemed dollars from doubters at 1/35 ounces of gold. The world economy chugged merrily on and everybody could happily depend on dollars being worth what they were.

On August 15, 1971, President Nixon, without warning, closed the gold window thereby refusing to honour the commitment to convert dollars to 1/35 ounces of gold. Crucially, this announcement was without prior consultation with any Bretton Woods signatory. This “Nixon Shock” meant that the US had been merrily printing dollars knowing that it had no gold to meet obligations. The dollar transformed into a paper tiger not worth its weight in gold. The world paid the price for trusting the dollar.

By February 1973, the Bretton Woods markets collapsed and a floating regime ensued. Funnily, although the most crucial clause in the Bretton Woods agreement had been breached, the world permitted the dollar to continue as the world currency although it had been debased by its controllers and was now pegged to a vacuum without the prior consent of its stakeholders.

Pax Americana

The Fed was now the de-facto world central bank, in complete control of the dollar, unrestrained by a gold peg, with the world having no say in its operations. It had unrestricted rights to print the world currency and determine world monetary policy. However, there is a fundamental flaw in this arrangement — the Fed is only mandated to preserve price stability and economic growth within America, with no mandate to protect the global economy. It has authority over the world currency with no responsibility to the world.

America can print dollars to buy a barrel of crude whereas the rest of the world first has to export to the US, earn the dollar, and then pay for the crude. Exporting to America became the prime sport in developing economies resulting in exploding American trade deficits peaking at 6 per cent of GDP. Saving dollars insured nations against a rainy day and foreign governments had accumulated a war chest of $20 trillion by 2007. Pax Americana was at its most virile and rich Americans could forever borrow what poor foreigners saved and could forever consume what they produced. However, the problem with overeating is that it causes indigestion.

About $20 trillion flooding into a $13 trillion American economy causes indigestion. Those Wall Street banks did what banks with a surfeit of deposits do — they lent and lent until they could lend no more, at least not to borrowers who could repay.

Thereafter, lending required talents in extreme financial engineering which was Wall Street’s strength. Having run out of borrowers who could repay, they invented the borrower who couldn’t repay. Enter the Ninja loan — Wall Street lingo for lending to those with No Income, No Job or Assets.

Ninja loans caused financial Armageddon, bringing about destruction of capital on an unprecedented scale. Finally, they even assassinated banks which were their original masters.

Back to the Future

One reason why America retains its pre-eminent economic position is because of the dollar’s hegemony. This gives it advantages that are impossible if market forces assume primacy. Hitherto, American markets provided investors with better returns than competing avenues. But now the Fed has responded with negative real interest rates and the spectre of inflation looms large on the horizon fuelled by fiscal stimuli in trillions — impossible sums without overworking printing presses, thus debasing the dollar.

America has fattened itself by feeding off the world, but the world is mulling its options. The French President, Mr Nicolas Sarkozy, has demanded a rethink of the world financial system, and as these calls grow louder, the dollar’s days as the world currency are numbered.

Savvy investors will diversify dollar holdings and since these total $20 trillion, the dollar is headed south. American economic mismanagement is already causing untold suffering on the world’s poor and the worth of their dollar savings is eroding — the result of the world currency being managed by a single country.

America cannot rescue itself from this humongous mess. Generally not known for multilateralism, it has sought assistance from the G-20 — acknowledging that the solution is beyond the G-7, all of whom are embroiled in the mess.

Only prudent emerging economies have the savings needed to provide succour. The moment has come to arm-twist Uncle Sam and install an equitable world financial system and a new world currency insulated from the folly of particular economies.

(The author is Professor, IBS, Bangalore. blfeedback@thehindu.co.in)

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