'Dollar poses danger to global economy'
by Phil THORNTON
The World Economic Forum has often served as a launch pad for attacks
on the dollar.
At Davos two years ago, the billionaire financier George Soros
predicted the dollar's status as the world's reserve currency of choice
was under threat.
Last year, Russian Prime Minister Vladimir Putin claimed the world's
over-reliance on the dollar posed a danger to the global economy.
There is little sign of that reliance diminishing just yet. In the
year following the collapse of Lehman Brothers, foreign holdings of U.S.
Treasuries rose 15.6% to $2.38 trillion.
But currencies trade heavily on confidence and there are worries that
such attacks are having a cumulative effect.
Although the dollar has risen recently against the euro, the U.S.
currency has lost over a quarter of its value since reaching its peak
trade-weighted exchange rate eight years ago this month.
Prof. Joseph Stiglitz of Columbia University and a former World Bank
chief economist, wants to see an "orderly transition" from a
dollar-based global economy.
"It is peculiar that we still have the dollar system when we are so
globalized," he says.
"[There is a] need for a new global reserve system to replace the
dollar-based system." With the U.S. government committed to spending
trillions of dollars underpinning the financial system and supporting
the economy, inflation remains a real possibility.
This would further debase the value of the greenback. This is a worry
for many countries, especially emerging-market nations that hold vast
quantities of dollar-denominated debt, often in the form of Treasury
securities.
Not only has the value of the dollar fallen, but with official
interest rates close to zero and yields on bonds at record lows, the
dollar has started looking like an unappealing asset to hold.
Some central banks have acted on their worries. In December, South
Korea signalled its intention to restructure its $245 billion of
reserves and diversify out of the dollar while both China, which holds
$2.2 trillion, and India have mulled plans to swap dollars for gold.
Figures from the International Monetary Fund show that the share of
foreign-exchange reserves held in dollars by central banks resumed a
downward trend in the third quarter of last year.
The dollar's share has declined to 61.6% from 71.6% in the first
quarter of 2002, when the currency hit its peak.
Prof. Benjamin Cohen at the University of California, Santa Barbara,
believes the dollar's prospects are being driven by the relative
economic outperformance of developing nations. "Some movement away from
the greenback can be expected as the center of gravity in the world
economy shifts towards China, India and the other emerging markets," he
says.
Ann Pettifor, executive director of Advocacy International, who
campaigns for debt-relief for poor countries and wrote the 2006 book
"The First World Debt Crisis," argues that this re-distribution of
economic power requires a radical reform of the global financial
architecture. "We have to end the role of the U.S. dollar as the global
reserve currency," she says.
"It is a large injustice that poor countries are obliged to hold
Treasury bills." But what could replace the dollar as the global reserve
currency of choice? One option would be for existing currencies' the
euro, Japanese yen or Chinese yuan to take a more prominent role.
Each has problems.
Although the euro represents 25% of Central Bank reserves, it is not
backed up by the political, military and diplomatic clout that investors
look for in a reserve currency. The same goes for the yen. China may
have those three attributes in spades but won't achieve reserve status
until the yuan is allowed to float and is traded beyond the country's
borders.
Another option is the Special Drawing Right, the international
reserve asset created by the IMF. This is an idea that has the backing
of both China and Russia. However, the SDR is not a currency in its own
right. Instead, it is a potential claim on the currencies of IMF
members. Prof. Cohen describes it as the "dark horse" in the race
against the dollar, pointing out that it would have difficulty attaining
"even a minimal level of credibility."
Ms. Pettifor opposes using the SDR because she believes that the IMF
is too tightly controlled by the Group of Eight, the forum of large
developed nations, to the detriment of emerging economies.
She favours an idea set out by the U.K. economist John Maynard Keynes
for a truly independent global central bank with its own currency.
IMF Managing Director Dominique Strauss-Kahn warns that the idea of
an independent global currency has been around for 65 years but nothing
has been done about it.
The dollar's rise to dominance took time slowly taking over from
sterling between the end of World War I until the U.K. Government
devalued the pound by 30% in September 1949, when its exchange rate
against the U.S. dollar was slashed to $2.80 from $4.03. Prof. Cohen
believes the decline of the dollar's reserve status is also likely to
take decades rather than years. He worries that this will create a
monetary vacuum that would present the constant risk of instability for
global finance and world trade. "The economic and political impacts of a
more fragmented currency system could be considerable," he says.
Strauss-Kahn is also convinced that we are moving from a
single-currency world into a multicurrency environment.
"But I don't see the role of the dollar changing rapidly in the
direction of a smaller role," he says. "[That] does not mean that over
the coming decades the role of other currencies including the euro
cannot be bigger." Strauss-Kahn adds that an alternative to the dollar
has been debated since the IMF was founded 65 years ago. "Maybe it will
happen before the end of the next 65 years," he says.
"But certainly not during the next 65 weeks."
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