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SPEAKING FREELY
The next reserve
currency
By Toni Straka
Speaking Freely is an Asia Times
Online feature that allows guest writers to have
their say. Please click here
if you are interested in
contributing.
Oil prices seem to
have reversed their recent correction, capital
inflows into the United States are falling, and
there has been no significant moderation of
producer and consumer prices. Under these
circumstances, questions are being raised about
America's preeminent economic status. Taking into
account the slowing in US industrial production,
worsening demographics in all Western
industrialized nations and the general expectation
that the global economy will slow in the second
half of 2005, here's some historical perspective
about reserve currencies - a status that many say
the dollar is perilously close to losing.
Time-traveling from the Greek to the Roman
empire, the British empire, and the young history
of the US, one notes that the most widely accepted
(reserve) currency always had its home in the
political powerhouse of its times. Political power
rests on three determining factors: the productive
capacity of that nation; its international trade
relations; and its capability to defend itself.
While there were several denominations of
silver coins in circulation in the Greek empire
that had their origins in the provinces of
Byzantine, Macedonia and Peloponnesia, to name
just a few, the Roman empire first introduced the
silver drachmae in order to facilitate trade with
the Greeks. The drachmae was followed by the
golden aureus, the silver denarius and the bronze
sestertius. One aureus was equivalent to 25
denarii or 250 sestertii.
Inflation,
the beginning of the end
The aureus had a
respectable lifespan of more than 400 years before
inflation diminished its reputation. Nothing has
changed since: whenever a currency loses its
value, so does its popularity. First the Roman
emperors started chipping away at the edges - the
need to prevent this resulted in the edge grooves
still seen on many coins now in circulation - and
then the purity of the coins was tampered with
until they became pieces of lead covered with a
thin coat of gold.
As the Roman empire
declined, so did the Roman money as a means of
tangible form of payment for goods and services.
In medieval times, all forms of money, and their
respective strength, were mainly tied to the
content of precious metals - a system that
continued till World War I. One Swiss gold franc
had the same value as one Austrian gold crown or a
Dutch gold coin of the same weight. There was no
need for a Bretton Woods agreement in these times.
The reserve currency of the 18th and 19th
century was undoubtedly the British pound
sterling. As the name says, a one pound note could
at any time be redeemed against one pound of
sterling (pure) silver at the Bank of England or
before that at the treasury of the king. The
sixpence stemmed from the custom of cutting a
silver penny in six equal pieces for small
purchases.
With the demise of the British
empire, which went hand in hand with the
outsourcing of its productive capacity to the
colonies, where labor was cheap, the pound was
replaced by the US dollar in the early 20th
century, when the US ascended to the throne of the
biggest economy in the world, a place it has held
ever since.
Menzie Chinn of the University
of Wisconsin and Jeffrey Frankel of Harvard look
at the next 20-30 years and conclude, in their
study entitled "Will the Euro Eventually Surpass
the Dollar as Leading International Reserve
Currency?" that "under any plausible scenario, the
dollar will remain far ahead of the euro and other
potential challengers for many years".
I
wonder whether this Western approach will still be
valid in 30 years. Under the assumption that the
European Union with its strong productive base and
its highly developed financial markets -
especially once Britain joins the Euro - will come
back to the path of stronger growth again, the
euro could climb to the number one spot in the
line-up of international currencies. But this
might be for a transitory period only. Most
forecasts see China becoming the biggest economy
on the globe by 2020, give or take some setbacks
along the way that are inherent with the growth
rates that the country has been enjoying recently.
China is still some distance away from
liberalizing its currency controls, not least for
the reason that its financial sector is still in
its infancy. But China will develop this sector
and gain knowledge along the way. With a consumer
base of probably more than 1.5 billion people by
then, it will have a huge backyard on which it can
rely for further growth to fuel its growing
international importance. As the country has been
on the path to a more liberalized economy for the
last 15 years, taking one step at a time, its
careful planning for the future will lead to a
more prominent role in the capital sector. Those
who produce can save, too, and therefore become a
supplier of capital needed elsewhere.
Of
course it is premature to speculate about the yuan
becoming the reserve currency of the world. But it
is not premature to speculate when the
resource-rich countries will begin to favor the
euro as the preferred means of payment for the
riches in their soil. Until now, commodities have
been predominantly priced in dollars on the world
markets, stemming from the fact that the US is the
single-biggest buyer and consumer of energy and
has been the biggest buyer of most other
commodities. In an age of global redistribution,
this might change as the US gives up its number
one purchaser position.
Staying with
dollar-based prices - which could mean using the
currency of a third country that is primarily
known for its huge amount of debt and no plausible
recipe for a turnaround - could become too costly
a way for others to conduct their bilateral trade.
After outsourcing American production, an
outsourcing of control of international trade
could well be on the way. The race for financial
dominance is on. And it will be decided in favor
of the country or region that manages to maintain
a lead in production, which will inevitably be
located in proximity to the world's largest base
of consumers.
Toni Straka is a
Vienna, Austria-based independent financial
analyst and portfolio manager, who worked as a
financial journalist for over 15 years and now
evaluates global market trends. He runs a young
blog, The Prudent Investor, where this piece first
appeared.
Speaking Freely is an
Asia Times Online feature that allows guest
writers to have their say. Please click here
if you are interested in
contributing.
(Copyright 2005 Toni
Straka) |
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