6351. The U.S. Dollar and Prosperity: Accidents Waiting to Happen
- Author:
- Reuver Brenner
- Publication Date:
- 07-2006
- Content Type:
- Journal Article
- Journal:
- The Cato Journal
- Institution:
- The Cato Institute
- Abstract:
- Development in the rest of the world depends on the United States because America continues to be the engine of the world economy and the U.S. dollar is the main reserve currency. In this article, I examine the prospects of America remaining an economic superpower and the dollar maintaining its status as a reserve currency. I also show that unless the United States succeeds financial markets and development around the world will suffer. During the last decade, the U.S. dollar has experienced wide fluctuations. The dollar’s real effective exchange rate relative to the seven major currencies varied from about 80 in 1995 to 120 in 2001, and back to 90 in 2005 (BIS 2005: 91). The dollar was up roughly 30 percent relative to commodity prices between 1997 and 2001. Then, between 2002 and the end of 2004, the dollar fell by about 30 percent relative to gold and commodities. During the first 10 months of 2005, all hard currencies (except the Canadian and Australian dollar) were down by another 15 percent relative to gold. Nevertheless, the bond market still expects a stable dollar over the long haul, as reflected in long-term interest rates. The relative stability of the long-term interest rates offers comfort because the world depends on a predictable value of the dollar. The havoc its demise as reserve currency would provoke is hardly imaginable. The significant upward movement in the U.S. dollar during the late 1990s brought financial, political, and social havoc in countries that either pegged their currencies to the dollar or had currency boards, Argentina’s case being the most prominent. Later, the decline in the dollar between 2002 and 2004 has brought about much antagonism in trade relations around the world and cries for protectionism. Even with the dollar’s volatility around a downward trend since 2002, the euro did not displace the U.S. dollar as the world’s main reserve currency—and will not do so unless drastic events happen, which I do not foresee.1 One such drastic event would be an utter mismanagement of the U.S. dollar. Another would be the European Central Bank (ECB) announcing that it was moving toward targeting the price of gold to manage the euro. The ECB would then become a supranational monetary institution independent of all political pressures. Anchoring the euro to the price of gold would reflect changes in global demands for euro liquidity, functioning as a reserve currency. The reason I do not expect the euro to replace the U.S. dollar as the main reserve currency, unless either of these two events happens, is that the euro is the very first paper currency not backed either by a strong government or by gold. It is a unique experiment. For the euro to become a reserve currency, the eurozone would have to run persistent trade deficits, allowing surplus countries to build up their euro reserves. To achieve that outcome, however, the eurozone countries would have to radically reform their fiscal and regulatory policies, to encourage far more domestic entrepreneurship and consumption than they presently do. This scenario does not seem to be in the cards. Indeed, as Europe’s population gets older, meaningful reform becomes less likely, and I do not see any chance for a strong European government to emerge and tackle the situation. Aging baby boomers, who dominate Europe’s voters, prefer the status quo. In sum, the chances of the euro becoming a serious alternative to the U.S. dollar as a reserve currency are slim, or nonexistent. The Federal Reserve would have to seriously mishandle monetary affairs for this to happen.
- Topic:
- Currency, Economic Development, and Dollar
- Political Geography:
- Global Focus and United States of America