Nouriel Roubini made a typically depressing assessment of the future for the dollar if the US does not rapidly move to rein in spending and borrowing and pursue growth that is not based on asset and credit bubbles. Writing in the NY Times the NY University Stern School of Business professor explained that the US’ position as reserve currency should not be taken as a foregone conclusion and that only countries that are net foreign creditors and net lenders survive in the long term as a reserve currency. Taking the example of the British Empire in the 1800 and early 1900’s he explains it was the massive debts incurred by the UK as a result of the second world war that undermined the pound’s position as the worlds’ reserve currency at that time.
The US enjoys many benefits from being the world’s reserve currency, among which are:
- Allows Americans to borrow at better rates
- The US has been able to finance larger deficits for longer and at lower interest rates
- The US has been able to issue debt in its own currency pushing exchange rate risk onto the lender
- Having commodities priced in dollars has also meant a fall in the dollars value doesn’t automatically lead to a rise in import costs (although we would add some commodities like oil and copper have become currency plays in recent years)
Building on this he paints a picture of what would happen if the US lost its reserve currency position:
- The US would have to pay more for imported goods
- Interest rates on both private and public debt would be higher
- The higher private cost of borrowing could lead to weaker consumption, lower investment and slower growth
There are undoubtedly benefits to being the holder of the global reserve currency. It is also true that such status is not a god given right that will last indefinitely regardless of global change but at the same time we have a hard time seeing what is going to take the dollars’ place anytime soon. The Euro and the Japanese Yen are both reserve currencies in their own right but looking at the state of the European banks and the massive levels of public debt in many European countries does anyone seriously think the Euro qualifies any better than the dollar? Added to which any appreciation of the Euro against the dollar would further push the European economies deeper into recession than they already are. It is almost as inconceivable that the dollar would sustain a prolonged collapse against the Japanese Yen; any strengthening of the Yen would only add further recessionary pressures to an economy struggling under even higher levels of debt. The Japanese aging population demographic also brings into question its ability to remain a major reserve currency in the long term.
The Chinese have called for a move to a new IMF sponsored reserve currency based on Special Drawing Rights related to a basket of currencies (of which they say the Renminbi should be a part). But we see this as more of a call in the dark than a serious suggestion that the dollar should be replaced. In an interesting article Victor Zhikai Gao, director of the China National Association of International Studies voiced similar concerns to Nouriel Roubini but even he said the Chinese call for SDR’s is more of a warning to the US to keep a focus on currency stability in what they see as a growing risk of inflation and indebtedness. For the Chinese Renminbi to come remotely close to becoming a reserve currency it would have to be freely convertible and import/export controls would have to be swept away. The whole domestic banking regulatory framework would have to be re-written and markets freed up. Mr Roubini suggests Chinese efforts to set up currency swaps with Argentina, Belarus and Indonesia are examples of efforts to make the currency more widely adopted. No criticism is intended of those countries, Argentina produces some fine polo players and racing drivers, but the combined economies of all three come to only 10% of the US and about 2% of the world GDP according to the IMF, that is a country mile from having a freely exchanged currency. China does qualify in certain areas however. The country is a net creditor, indeed the world’s largest, with large current account surpluses, a small budget deficit and low public debt as a share of GDP. It also has, even in the face of a severe global downturn, shown robust growth. But if the Renminbi were to become a reserve currency it would inevitably rise in value considerably as dollars were sold and Renminbi were purchased which would cripple China’s export focused economy and result in massive losses for China’s dollar holdings, undermining one of the supposed cornerstones of it’s qualification.
The reality is there is no pretender waiting in the wings to take over from the dollar. 25-30 years from now the world may be a different place, indeed it will be a different place and we will live in a world with a different balance of economic powers. But by then China’s aging population will be facing some of the problems seen in Japan and will have been overtaken by India as the most populous country ” the Rupee as a reserve currency, now there’s a thought!