THE DOLLAR´S FATE / THE NEW YORK TIMES OP EDITORIAL ( HIGHLY RECOMMENDED READING)

August 29, 2009

Op-Ed Contributor

The Dollar's Fate

By PAUL KENNEDY

There is a most interesting debate going on at present about the longer-term fate of the U.S. dollar as the supreme reserve currency for foreign-exchange transactions and, more importantly, for the currency holdings of national governments, global companies and the producers of oil, gas and other raw materials.

This attracted attention at the time of the G-20 meeting in London this past April, when the International Monetary Fund received a fresh allocation of $250 billion in special drawing rights (SDRs).

Two months later, the issue came up again at Yekaterinburg, Russia, where the meeting of the BRICs — Brazil, Russia, India and China — suggested to commentators that a coalition of rising states might pull Uncle Sam down to size, in part by shifting their currency holdings from the dollar into these I.M.F. units of account.

A generous interpretation of all of this talk is that it actually is rather better for the world to have its monetary exchanges based upon some international “spread” of currencies rather than upon a single one that, if it toppled due to domestic mismanagement, could bring ruin to many innocent players. Had not the great economist John Maynard Keynes proposed this with the creation of the “bancor” in 1944, to head off a dollar-denominated world that would in the end meet its fate of carrying too much on its shoulders?

This would have been good for the international community and, actually, good for America. Why should the Weary Titan have to stagger under the too-vast weight of its single-currency burden? But Washington vetoed Keynes’ scheme. It’s nice to feel you are Top Dog. Besides, if you possess the world’s leading foreign currency, you can run enormous trade and current-account deficits without being punished for it.

The nastier interpretation of this move toward ending the dollar’s preeminence is, let there be no doubt, an anti-American one. It seems to be in the nature of things that the leading power in world affairs is always resented by countries further down the totem pole, even when that hegemon is fairly successful at distributing what economists term “public goods.”

If, therefore, the rising economies of Brazil, Russia, India and China decide to have their own get-together, it is scarcely surprising that they would discuss the international trading and financial system, and how to become less dependent on America’s capacity (through sub-prime mortgages, lousy banks, currency dominance) to wreak damage upon it.

To some, a weakened dollar might also be good as a blow to U.S. arrogance, and a reminder that even top dogs can be tripped up. Removing the dollar’s “unfair” advantage as the primary reserve currency has always seemed agreeable to French intellectuals and, the record shows, to French presidents from de Gaulle to Sarkozy.

So why not, then, push for a more equitable “basket of currencies” to grease the world’s commercial exchanges or, as a variant of that, try to arrange trade through the medium of the I.M.F.’s special drawing rights?

It turns out that there all sorts of reasons why those SDRs cannot at present function as a common currency — that is, as something you would price a Toyota car in, or as a wad of bills you could withdraw from a cash machine. Their function is intergovernmental by nature and not at all like, say, Barclay’s foreign-currency departments.

This was well explained recently by the financial writer Swaminathan S. Anklesaria Aiyar of the Cato Institute, in Washington (see www.cato.org/pub_display.php?pub_id=10331). It should be noted that Aiyar is not like certain nationalist American commentators on this topic who seem to regard a reduction in the dollar’s world role as something like a threat to one’s masculinity.

In fact, Aiyar cold-bloodedly argues that the dollar’s relative fall will much more likely come as a result of the continued growth of China’s G.D.P. and the future arrival of the yuan as a fully convertible currency — and not as a recourse by the governments of the world to some artificial I.M.F. instrument like the special drawing rights. With the yuan joining the euro, the yen and the dollar as the four biggest foreign currencies by far, there will be even less pressure and logic for substitution of the traditional means of money exchange.

Just a short time before reading Aiyar, my eye was caught by a rather extraordinary article, “The World Supremacy of the Dollar at the Rendering (1917-2008),” by the superb Italian scholar Antonio Mosconi of the Einstein Centre for International Studies (CESI). The title itself is so intriguingly biblical that I immediately wanted to know what it said.

For those with less time on their hands than university professors, it said this: The U.S dollar has lived two lives, the first as the currency of a powerful creditor country from the 1920s to the 1960s, the second as the currency of an “empire of debt” from the 1970s until today, with much more international indebtedness to come, simply from the wretched fire sale of Treasury bonds every week.

It is impossible to summarize in a few sentences Mosconi’s devastating and elegant description of the U.S. government’s exploitation of its domestic paper-printing capacity upon the international fiscal scene, but his general conclusion is blunt: “This crisis is not like the others, but it is the last convulsion of the international role of the dollar.” At some time in the future, much of the world will take steps to avoid having its fate rest upon the autistic decisions of the U.S. Treasury and the Federal Reserve Bank. And then will come the rendering….

Well, we shall see. Given the nervousness of world markets at present, it is as possible that we could see an improvement in the dollar’s exchange value as watch a sudden slump.

Overall, though, these academic papers make some basic sense. We live in a world right now where one single country, possessing only about 5 percent of the earth’s population, has roughly 20 percent of its G.D.P., spends almost 50 percent of its total defense expenditures, and freely prints bills that account for 65-70 percent of global foreign-currency reserves.

If one believes in the economists’ theory of “convergence” — that is, the coming closer together of the product and income of companies, regions and countries — then the conclusion is clear: As China, India, South Korea, Brazil, Mexico and Indonesia all “catch up,” the American share of things will relatively shrink. Sooner or later — and this debate really is about “sooner” or “later,” not about “if” — we are going to witness another major shift in the global balances of power.

Even in the shorter term, I guess I would be looking a little more keenly at the current distribution of my portfolios, just to ensure that when I had to come to “render my accounts,” I would not look awfully out of date. And, as an international author, I am happy to take my fees and royalties in many currencies, just to be on the safe side.

Paul Kennedy is Dilworth Professor of History and director of International Security Studies at Yale University. His books include “The Rise and Fall of the Great Powers.”

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Copyright 2009