WHAT if the dollar crashes? The mere suggestion is sufficient to send half the globe into a tizzy. For, such is the power and hold of the American currency in world’s finance.
Author Barry Eichengreen raises this query and answers it in sufficient gory detail in his book Exorbitant Privilege: The Rise and Fall of the Dollar. Dollar replaced the sterling as the international currency over five decades ago, flush with funds from World War II. It has held on to that position, despite several threats, during the cold war, the several oil crises and economic depression.
Sample this statistics: countries like South Korea, Thailand and Australia set the price of more than 80 per cent of their trade in dollars despite the fact that only a fraction of their exports go to American buyers. The principal commodity exchanges quote prices in dollars. Oil is priced in dollars. The dollar is used in 85 per cent of all foreign exchange transactions worldwide. It accounts for nearly half of the global stock of international securities.
While America was the dominant economy 50 years ago, today, China and Germany export more than the US. The share of US global export is only 13 per cent. “The United States is the source of less than 20 per cent of foreign direct investment, down from nearly 85 per cent between 1945 and 1980. And yet dollar maintains its privilege position. Trillions of dollars of non-American countries are tied up in the US treasury and quasi-government agencies. The adverse fallout of this situation for the world has been huge.” As Eichengreen explains “Other countries question whether the United States should have been permitted to run current account deficits approaching six per cent of GDP in the run-up to the crisis. Emerging markets complain that as their economies expanded and their central banks felt compelled to augment their dollar reserves, they were obliged to provide cheap finance for the US external deficit, like it or not. With cheap foreign finance keeping US interest rates low and enabling American households to live beyond their means, poor households in the developing world ended up subsidising rich ones in the United States.” What an irony!
The book traces the ‘birth’ of dollar and its symbol. The Congress passed a resolution in 1785 determining the currency of the new nation to be dollar. It was defined in terms of grains of silver and gold at a ratio of 15.253 to 1. The dollar was accepted very fast within the country as the Spanish dollar was already in circulation. The dollar sign is the Spanish legacy. “The sign “$” derives from the peso, the two parallel lines being the vertical portions of “P,” and the “S” indicating the plural.”
Dollar has been subjected to much fluctuations and the several countries, notably the oil bloc, have criticised the US fiscal policies that led to the decline of the dollar time and again. They even tried to move away from the dollar. The closest challenge came from the euro. The vulnerability of the dollar and its disastrous implications for countries world over became clear during the latest depression. This depression is directly blamed on the wayward economic and fiscal policies of the United States, where there are no controls and monitoring. Eichengreen gives a short but crisp tour de force of the financial crisis.
Americans directly benefitted from the savings of the Asians, especially the huge money available in China. The capital outflow from China ballooned from one tenth of one per cent of the global GDP in 2002 to one per cent in 2007. “The household savings rates in the United States fell from seven per cent in early 1990s to near zero in 2005-07.”
Eichengreen discusses the possible scenarios in which the dollar will crash and lose the position of pre-eminence. One, if China unleashes the financial weapon. It holds 13 per cent of all US. government securities. But in this, China will also take a huge loss. And hence it is a distant probability. The second could be a sudden shift in the market sentiments. “Investors might wake up one morning and decide that holding dollars was a losing proposition.” Thus, triggering a dollar crash. This also appears improbable because the US Fed would intervene.
The third most plausible turn of events Eichengreen discusses is “not one in which confidence collapses on the whim of investor or as the result of geopolitical dispute but rather because of problem with America’s own economic policies. The danger here is budget deficits out of control… the fate of the dollar ultimately hinges, in this case, on US budgetary policy.” The factors for concern are the deterioration in the fiscal position prior to the financial crisis, the “eye-popping” deficits resulting from the financial crisis and thirdly the prospect of even larger deficits once the baby boomers start retiring in large numbers around 2015, raising health and pension costs.
Eichengreen has gone over the whole ground on dollar with needle searching thoroughness. The book is a heavy financial read but insightful. If dollar falls question is answered with a discussion on the possibility of more than one global currency, with regional currencies ruling in their respective regions, like renminbi or euro. It is not always that the world had one currency. It is only in these modern hegemonic times that there is only one place at the top. Will dollar lose its win-win position in a world of geo-political churning? Will emerging economies continue to allow their earnings from blood and sweat to be frittered away? The book definitely sets one thinking on these lines. Barry Eichengreen is Professor of Economics and Political Science at the University of California, Berkeley and has authored several books on economics.
(Orford University Press, Great Claredon Street, Oxford ox2 6DP UK, www.oxford.oup.uk)