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The World's Reserve CurrencyCraig Harris Welcome to a continuing series of Q & A from Craig Harris. The questions can be found here. In this segment, we are discussing question 11. "The USD is currently the worlds reserve currency. Under what conditions would that change and what would the impact of that status shift be?" In order to answer this question, I think that first it's very important to understand this role as the worlds reserve currency. It's fairly easy to argue that the US Dollar is currently the lynch pin of the modern global financial system. It has evolved to be that way for good reason. Throughout the 1900's the US was the most stable capitalist economy in the world, and after the win in WWII, enjoyed the benefits of rapid growth due to technological innovation, a solid manufacturing base, plentiful natural resources, a stable political system and an asset backed currency. When looking at the US in the 1900's you would come to the conclusion that the US dollar absolutely deserved to be the worlds' reserve currency... and the market participants wholeheartedly agreed. In terms of a vehicle for the storage of wealth, it has been and continues to be the pre eminent asset. There seems to be no limit to the foreign appetite for US dollars. This in itself is a sort of contradiction now and here's the reason. If you forget about the history I outlined above, and look at the US today, the answer of why the US dollar is the worlds reserve currency is not obvious. As a foreign or domestic investor, what do you get when you store your wealth in US dollars or US dollar denominated assets today? When you look at the United states in the big picture view, you have a country with:- 1.) a large and expanding budget
deficit So, given these facts, I have a couple of points to make. Financial markets don't like to look backwards. They like to look forwards. Looking forwards, you can raise a lot of questions about a global reserve currency with the problems I outlined above... it would seem that there must be better choices. In fact, I think it's reasonable to believe that if this is the current fiscal and financial basis for the worlds reserve currency, things are not well. That said, it raises a couple of points. The first point is that a global fiat reserve currency isn't likely to change overnight absent some catastrophe... the market will make a more gradual move... slowly decreasing reliance on one and increasing reliance on another until there would be a new de facto standard. The second point is that Greenspan and his crew know this... so in the same way that the government is trying to fix the manufacturing problem by reclassifying fast food assembly as manufacturing, the US financial engineers are trying to limit the viable alternatives to the US dollar. They do this in several important ways... the biggest enemy of the modern financial engineer is a tangible alternative to fiat... and gold is at the top of their list. SO ONE OF THE MOST FUNDAMENTAL TENETS OF MODERN CENTRAL BANKING AND FINANCIAL ENGINEERING IS THAT THE PRICE OF GOLD HAS TO BE MANAGED. That is why gold is currently lagging the general rise in commodity prices. I'd like to make the point that the price of gold is important not just to the US but to all fiat currency issuers, so heavy g8 cooperation is required on this issue. The second source of competition comes from other fiat currencies, and the interesting thing there is that all fiat currencies are engaged in a sort of competitive devaluation against each other. One thing that we have to do is to incorporate politics into this discussion, because the reality is that the foreign leaders perceive an aggressive and belligerent, go it alone, unilateral tone coming from Washington which is not particularly conducive to political or economic cooperation, or to the US dollar's status as the worlds reserve currency. In fact, many in the rest of the world are very concerned about the new neoconservative tenants of pre emptive wars to preserve the peace, unchallengeable military superiority and even the development of a new generation of Nuclear Weapons... the same kind of weapons that the US defies anyone else in the world to develop or possess, unless they want pre emptive bombs dropped on their heads. This discussion doesn't make it much into the US mainstream press, but if you read a variety of global sources on the Internet, this comes through loud and clear. Pre emptive wars to preserve the peace or "The Bush doctrine" as it is called, has been described as "madness".. and worse by foreign leaders and dignitaries, Nobel Prize winners, etc and even in a speech to the UN members by Kofi Annan. As a matter of fact, there is a lot of global concern that since the first pre emptive war has turned to be based on "incorrect assumptions" ..and there is no guarantee that other countries won't now emulate the US and wage pre emptive wars of their own (for whatever reasons they dream up), or that the next pre emptive war the US wages will not also be based on "incorrect intelligence". The fact is that the world has become inherently less stable as a result of this policy. These are serious concerns among global leaders and these concerns can and have spilled over into economic issues. In other words, the US dollar as the worlds reserve currency is being called into question because the US is acting like a dictator to the world and an empire rather than a cooperative global economic citizen. The thing that most Americans do not understand is that the US is extraordinarily vulnerable economically to this kind of political belligerence and arrogance just for the reason I outlined above. With those 11 issues, if you lived in any other country that didn't enjoy the status as the worlds reserve currency issuer... the currency would already be collapsing and you would be dumpster diving like the former upper middle class in Argentina were doing when their currency collapsed. The US does currently enjoy unchallengeable military superiority... and the rest of the world knows that. So if any country in the world felt pressured enough to challenge the US, it would be on an economic, not military footing, and as foreign ownership of US assets increases, the US is very vulnerable in that way too. As a thought experiment, go through the scenario of China saying to the world that they're going to quit investing in US dollars for example. So, the point is that if other countries develop problems or concerns with US policy, retaliation would likely be on an economic cooperative basis with other countries. It's no coincidence that the US dollar has fallen over 30% during a time when Germany and France were antagonistically referred to as "old Europe" by the US secretary of Defense and have banded together with Russia and other countries with new trade agreements. It's also no coincidence that the rest of the world via the EU and the new G21 and other new trade organizations are positioning themselves to become less reliant on trade with the US and more reliant on trade with each other, and that they have issued a lot of caustic trade rhetoric towards the US. I mean; the president of Venezuela, the provider of over 13 percent of the crude and products imported by the United States every day... recently ranked fourth behind Saudi Arabia, Canada and Mexico as top U.S. crude suppliers to the US, just called the President of the United States an a-hole in a public speech. Putin in Russia had issued similar proclamations shortly after the invasion of Iraq which I thought was odd for someone who Bush referred to as "a close personal friend" just months before. The reality is that Bush has burned all of his diplomatic bridges and squandered any post 911 sympathy... and not well liked (I'm being nice) among global leaders. I think all of this illustrates the degree of frustration with current US policy pretty well. My point is this. The rhetoric coming out of the current administration is inconsistent with the US dollar's role as the worlds reserve currency. When global leaders of other countries develop questions and concerns, they seek alternatives, and they seek to decrease their reliance. They seek these alternatives based on both economic and political considerations. Using an example, let's suppose that Russia doesn't like the rhetoric coming from the United States. Lets say that they begin to transact their oil business in Euro's instead of Dollars. Let's say that the UAE then follows suit. What would the effect of that change be? It would be decreased relevance for the USD and increased relevance for the Euro. In my opinion, if foreign countries were to ask to transact oil in a currency other than US dollars, it would not be long before the US dollar lost it's status as the worlds reserve currency. Unfortunately for Americans, I think that's exactly where we are headed under the current leadership. There have already been rumblings out of both Russia and OPEC regarding the pricing of oil in Euros. So what you say? Well... here's the thing. If and when this happens, it will send shock waves throughout the global financial system.The US enjoys certain advantages by being the owner and creator of the worlds reserve currency. One of those advantages is the unquestioning nature of the holders of these dollars and dollar denominated assets. For example, with the financial situation in the US I outlined above... if it was a small country that had those same issues, what would happen to that currency? It would be on a one way slide ala Argentina. Why doesn't the US have similar financial issues with only a modest decline in the value of the dollar and no real contagion? Because it's the worlds reserve currency. The world has to rely on it for their own sake and they know that. They have no choice but to continue to support the USD. If the US dollar loses that status, all bets are off... and guess what? In my estimation, the US dollar is in the process of losing that status. It is my belief that if the neocon agenda of "securing the Realm" continues to be pursued for 4 more years, we will see the death of the US dollar as the worlds reserve currency during that time, and that would be a catastrophe for the consuming public in the US. I'll sum up this answer by saying that I believe the US is currently in danger of losing it's enviable status as the owner of the worlds reserve currency. I'm not saying it's going to happen but I believe the risk is there. If the Budget deficit, the CA deficit and the geopolitics are not brought under control, ultimately the US is going to lose that status. It's currently on that path. If you hear that crude oil is being priced in Euros in any of the industrialized countries... that means it has started to happen. *** Please note this article is part of a series with a list of questions, and periodically I'll be tackling the answers one by one. To catch up on questions already answered please refer to my archives. *** Craig Harris Mr Harris offers a free 30 day trial subscription to his daily market letter. For a free trial please contact bcharris@gate.net. The risk of trading commodity futures contracts can be substantial. You should therefore, carefully consider whether such trading is suitable for you in light of your circumstances and financial resources. If you choose to open an account with Harris Capital Management, a Risk Disclosure will be sent to you. Please read it carefully before you invest. ### Harris Capital Management, Inc. CTA is a futures broker and registered Commodity Trading Advisor, meeting the needs of futures traders worldwide. They provide a high level of personal service to discriminating clients around the world, while offering commission rates comparable to discount brokers. All clients are handled directly by Mr. Harris. Copyright ©1995-2004
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