No less an authority than
Goldman Sachs CEO Lloyd Blankfein said at the
Clinton Global Initiative last week that the
United States could risk its status as the world's
reserve currency if congress fails to act and the
"fiscal cliff" program of spending cuts and tax
increases is enacted January 1.
Actually
Blankfein's statement was the reverse of the
truth; enaction of the "fiscal cliff" program,
halving the US budget deficit at a stroke, is one
of the few outcomes that could AVOID the US losing
its reserve currency status. But on the assumption
that the
politicians continue to
misbehave after November 6, that trillion-dollar
deficits continue, and the US does indeed over
time lose its reserve currency status, what will a
world without a reserve currency look like?
There is no relatively recent historical
parallel we can examine to answer that question.
The world has had the dollar as undisputed reserve
currency since 1945, or really since 1939. Between
1914 and 1939 there were two reserve currencies,
the dollar and sterling, with sterling more used
in the 1930s than the 1920s, because that decade,
once Britain went off the Gold Standard, was a
period of robust health for the British economy,
while the United States was mired in depression
and isolationism. For more than a century before
1914, the world's undisputed reserve currency was
sterling, although there were various regional
alternatives.
To see a world with multiple
reserve currencies, you thus need to go back to a
world before sterling's sway, which in practice
means before Britain's smashing victory in the
Seven Years War (1756-63) took it to both military
and economic supremacy.
In those years
numerous currencies circulated, with their use
being determined largely by their local
availability. In the American colonies, for
example, the greatest circulating medium was not
gold (British) guineas, whose supply was very
limited, but silver "pieces of eight" from the
Spanish colonies, coins of 8 reals that had been
minted to the same standards since a currency
reform in 1497 - these remained legal tender in
the new United States alongside the dollar until
as late as 1857. When Long John Silver's parrot
squawked "pieces of eight" it was expressing a
rational preference as to the reserve currency in
which its pirate horde should be denominated.
At the same time or a little later, a
German currency reform of 1751 made the Maria
Theresa thaler, also silver, the common currency
of the German speaking world, even those parts of
it that were Protestant and did not acknowledge
her supremacy as Holy Roman Empress. In this case,
the coin's reserve currency status spread far
beyond Germany; it was minted in six mints outside
the Austrian dominions, and circulated not only in
Africa but also the Middle East long after Maria
Theresa's death in 1780, coins minted after that
date being date-stamped "1780" even though they
were freshly minted.
Thus when my father
first visited Saudi Arabia in 1963, Maria Theresa
thalers were still circulating - doubtless many of
the local inhabitants, users of the Muslim
calendar, were unaware that it was no longer 1780
in the outside world! The last coiner of Maria
Theresa thalers was not Austria but Britain, which
finally abandoned the practice in 1962, after
representations from the post-war republican
Austrian government.
The dollar would lose
reserve currency status, not through a sudden
attempt at fiscal probity, but through a further
period of current policies, trillion dollar
deficits accompanied by random large-scale Fed
buying of Treasuries and agency bonds. At some
point, whether because of a resurgence in
inflation or the dawning of doubt about long-term
US solvency, international demand for both dollars
and Treasury bonds would decline sharply, and the
world would seek the benefits of diversification.
One such avenue of diversification would
be gold, but with the world's central bankers
fanatical in their determination not to consider a
gold standard, this would simply drive the price
of gold up to extraordinary heights, at which its
price risks were so great that conservative
investors would not dare hold it for more than a
small portion of their assets. Accordingly the
search would be on for an alternative store of
value and currency in which trade could be
denominated.
None of the major currently
available alternatives look very attractive.
Sterling is in the same pickle as the dollar; the
coalition government's cuts in spending have been
minimal and the Bank of England's purchases of
gilts huge. The yen suffers from an overhang of
government debt second only in size to those
experienced by Britain at the end of the 1815 and
1945 world wars (other than debts that eventually
defaulted). The renminbi, or yuan, is
over-controlled by China's communist government,
and in any case China's economy is full of hidden
mysteries like the bad debts in the banking
system.
The euro, generally fairly well
managed because of the large influence of the
German Bundesbank on the European Central Bank,
suffers from the feckless nature of several of its
Mediterranean members. In this context I have
referred several times in these columns to Spain
being well run, and thus not a major problem. I
hereby withdraw that judgment. It never occurred
to me that Spain's economically most important
region, itself fiscally mismanaged and responsible
for a large part of Spain's problems, would choose
the middle of a financial crisis to attempt to
hold a referendum on independence.
Whatever the merits of independence for
Catalonia (and it is only one of the independence
movements throughout Europe likely to appear now
that the European Union has made the nation state
appear largely redundant) there can be no question
that opening the matter at this juncture is an
action of gross irresponsibility and malice.
The world's reserve currencies will thus
primarily be smaller units, whose importance will
swell as their sponsors see the opportunity to
obtain massive seignorage revenues from having
their currency circulate worldwide. There are
likely to be several varieties of reserve
currency, each tailored to the needs of particular
users.
Asset-only investors will be in
despair at the difficulty of finding a unit that
does not cause their assets to shrivel like
icebergs under a Mediterranean sun; consequently
they will demand reserve currencies that pursue
Volckerite monetary policies and behave as far as
possible like Gold Standard vehicles.
Entities heavily engaged in international
trade will want a unit that favors neither buyers
nor sellers, but pursues a middle course between
the world's major trading blocs.
Borrowers
will want to continue benefiting from negative
real interest rates and will look for currencies
with sloppy monetary policy and balance of
payments problems, which are unlikely to
strengthen greatly. Asset-only investors will seek
to avoid these currencies, but financial
institutions, with liabilities denominated in weak
currencies, will be persuaded to invest in them by
the salesmanship and financial engineering of Wall
Street. Mismanaged currencies, with excessive
budget and payments deficits, will eventually
become unacceptable to international investors,
but the financial machine will denominate a lot of
long-term bonds in them first.
It's likely
that artificial currency units, such as the
International Monetary Fund's Special Drawing
Right, will also be substantially used, while in
some regions where trade is largely intra-regional
the region's currencies may come to be used for
cross-border trade even though they are not
acceptable on a global basis.
It all
sounds very jolly and free-market, reminiscent of
the buccaneering days of the early eighteenth
century, except for one factor. "Pieces of eight"
and Maria Theresa thalers had a real value; they
were silver coins and in the last analysis had the
value of the silver contained in them. This will
not be true of the multiple reserve currencies of
2015-16, which will be paper money, with only the
value that confidence in their issuing countries
gives them.
By definition, however a world
of multiple reserve currencies is one where there
is no unit of value in which complete confidence
is held. While a major unit such as the dollar can
survive a moderate lack of confidence, that may
not be true of reserve currencies that derive from
relatively small economies.
If for example
the Canadian dollar becomes used as a worldwide
reserve currency, the Bank of Canada will need to
supply the world with Canadian dollars worth many
times the value of the Canadian domestic money
supply and its economy itself. No doubt Wall
Street will oblige through the swap mechanism,
supplying the world with unlimited supplies of
Canadian dollars for which a global demand has
suddenly arisen. However, the currency's position
would then be highly unstable; any crisis or
change of government in Canada could cause global
demand for Canadian dollars to collapse, in turn
collapsing the value of the world's Canadian
dollars.
The 18th century was well aware
of the problems a collapsing paper currency could
cause; it had a healthy suspicion of US
"continentals" and French "assignats". However,
since the Weimar crisis of 1923 we have not
experienced any such crisis in relation to a major
trading currency. In a world of multiple reserve
currencies, we will undoubtedly at some stage
experience a collapse in which a major part of the
world's trade paper and international investments
becomes worthless.
At that point, with the
world economy severely damaged and confidence in
paper money destroyed, even the world's current
central bankers may be forced, kicking and
screaming, back onto a Gold Standard.
Martin Hutchinson is the author
of Great Conservatives (Academica Press,
2005) - details can be found on the website
www.greatconservatives.com - and co-author with
Professor Kevin Dowd of Alchemists of Loss
(Wiley, 2010). Both are now available on
Amazon.com, Great Conservatives only in a
Kindle edition, Alchemists of Loss in both
Kindle and print editions.
(Republished
with permission from PrudentBear.com.
Copyright 2005-12 David W Tice &
Associates.)
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