FacebookTwitterGoogle+RedditEmail

Will the Dollar Remain the World’s Reserve Currency in Five Years?

by MIKE WHITNEY

Menzie Chinn, co-author of The Economic Integration of Greater China, teaches economics at the Robert M. LaFollette School of Public Affairs at the University of Wisconsin.

Whitney: What is the present composition of reserve holdings in central banks, and has there been a substantial falloff in US dollar reserves in recent years? Are central banks ditching the dollar?

Menzie Chinn: I’ve found it puzzling that there’s all this talk about the prospects for the dollar, in the wake of the G-20 meetings, and more recently World Bank President Zoellick’s comments about the primacy of the dollar as a reserve currency. My puzzlement arises from the fact that many of the concerns now being voiced have been voiced before. As I’ve noted on previous occasions, Jeff Frankel and I have outlined the conditions under which the dollar could lose primary reserve currency status to the Euro. In short, calamitously bad policies that induce rapid currency depreciation, or high inflation, would do the trick. Our results, last updated in early 2008 might seem somewhat out of date given all the turmoil that has occurred in the meantime. But it’s important to realize that it’s the relative performance (US versus euro area) that matters, and I see no greater reason to believe that the conditions are in place for a drastic “reversal of fortune” than before. I’d note that part of our results for the euro displacing the dollar depended on a London greatly overtaking New York as a financial center; well, that remains to be seen

In thinking about the prospects for the dollar, I think it’s useful to break the forces affecting it into separate pieces. In particular, reserve currency status is not directly linked to the dollar’s value, although they are of course related. The dollar could lose value without losing primary reserve currency status, and could gain reserve share without gaining value….Safe Haven Effects reinforces the notion that dollar weakness, for now, is a function of the return of risk appetite. The spike in the dollar from September 2008 through the beginning of 2009 was flight to the safety of Treasuries. In this sense, the dollar decline is a good thing as it highlights the success of policymaker measures to normalize the financial markets. Reported reserves have declined substantially, but since many central banks — including China’s — do not report reserves, some educated guesses are necessary. Then, the dropoff in the dollar share seems less marked.

(MW Note: Present composition of reserve holdings: Dollar roughly 62 per cent total holdings, Euro roughly 28 per cent total holdings)

Is there any plausible scenario in which the US dollar could lose its position as the world’s reserve currency in the next 5 years?

Menzie Chinn: If the US administration were to pursue highly irresponsible policies, such as massive deficit spending for many years so as to push output above full employment levels, or if the Fed were to delay too long an ending to quantitative easing, then the dollar could lose its position. But I believe these scenarios are unlikely — although the policies of 2001-08 did make the dollar more vulnerable than otherwise.

What is the role of “deep, well-developed financial markets” in determining which currency will be the reserve currency?

Menzie Chinn: Deep financial markets mean that it is less costly to transact in that particular currency. The US dollar has benefited enormously from the existence of a large market in liquid government debt. Such a thing does not exist for the euro, for instance.

Is the euro gaining on the dollar, and do you think Fed policymaking has increased those gains?

Menzie Chinn: The euro is probably gaining on the dollar, but mostly as a consequence of debt accumulation during the Bush years.

Do you think that the Fed’s quantitative easing program has weakened the dollar? (or the perception of the dollar?)

Menzie Chinn: The Fed’s measures have probably weakened the dollar over the short term; but in staving off a worse recession in the US (and a collapse in the financial system), it has probably meant a stronger currency over the medium term.

How will it effect the US economy if the dollar loses its position as the world’s reserve currency?

Menzie Chinn: If the dollar does indeed lose its role as leading international currency, the cost to the United States would probably extend beyond the simple loss of seigniorage narrowly defined. We would lose the privilege of playing banker to the world, accepting short-term deposits at low interest rates in return for long-term investments at high average rates of return. When combined with other political developments, it might even spell the end of economic and political hegemony. These are century-long advantages that are not to be cast away lightly.

It’s widely believed that China will not abandon the dollar because of the nearly $1 trillion it has in USD reserves. Do you agree with this idea?

Menzie Chinn: It is true that each Asian central bank stands to lose considerably, in the value of its current holdings, if dollar sales precipitate a dollar crash. But we agree with Barry Eichengreen (2005) that each individual participant will realize that it stands to lose more if it holds pat than if it joins the run, when it comes to that. Thus if the United States is relying on the economic interests of other countries, it cannot count on being bailed out indefinitely.”

What are the effects of the current account deficits on the dollar?

Menzie Chinn: Most recent assessments of the sustainability and adjustment of the US current account feature substantial depreciation of the dollar in the future, whether adjustment then operates via expenditure switching or a valuation effect. Our results suggest that such dollar depreciation would be no free lunch, and could have profound consequences for the international monetary system. These consequences include the loss of the exorbitant privilege of easy financing of large US deficits, both government and national. The political influence that American policy makers have internationally, including in international institutions, could also be diminished.”

All quotes used by permission from Prof. Menzie D. Chinn, Robert M. La Follette School of Public Affairs, Department of Economics, University of Wisconsin, Madison, WI 53706-1393 E-mail: mchinn@lafollette.wisc.edu

MIKE WHITNEY lives in Washington state and can be reached at fergiewhitney@msn.com

MIKE WHITNEY lives in Washington state. He is a contributor to Hopeless: Barack Obama and the Politics of Illusion (AK Press). Hopeless is also available in a Kindle edition. He can be reached at fergiewhitney@msn.com.

More articles by:
May 25, 2016
Eric Draitser
Obama in Hiroshima: A Case Study in Hypocrisy
Ryan Mallett-Outtrim
Does Venezuela’s Crisis Prove Socialism Doesn’t Work?
Dan Arel
The Socialist Revolution Beyond Sanders and the Democratic Party
Marc Estrin
Cocky-Doody Politics and World Affairs
Sam Husseini
Layers of Islamophobia: Do Liberals Care That Hillary Returned “Muslim Money”?
Susan Babbitt
Invisible in Life, Invisible in Death: How Information Becomes Useless
Mel Gurtov
Hillary’s Cowgirl Diplomacy?
Kathy Kelly
Hammering for Peace
Dick Reavis
The Impeachment of Donald Trump
Wahid Azal
Behind the Politics of a Current Brouhaha in Iran: an Ex-President Ayatollah’s Daughter and the Baha’is
Jesse Jackson
Obama Must Recommit to Eliminating Nuclear Arms
Colin Todhunter
From the Green Revolution to GMOs: Living in the Shadow of Global Agribusiness
Binoy Kampmark
Turkey as Terror: the Role of Ankara in the Brexit Referendum
Dave Lindorff
72-Year-Old Fringe Left Candidate Wins Presidency in Austrian Run-Off Election
May 24, 2016
Sharmini Peries - Michael Hudson
The Financial Invasion of Greece
Jonathan Cook
Religious Zealots Ready for Takeover of Israeli Army
Ted Rall
Why I Am #NeverHillary
Mari Jo Buhle – Paul Buhle
Television Meets History
Robert Hunziker
Troika Heat-Seeking Missile Destroys Greece
Judy Gumbo
May Day Road Trip: 1968 – 2016
Colin Todhunter
Cheerleader for US Aggression, Pushing the World to the Nuclear Brink
Jeremy Brecher
This is What Insurgency Looks Like
Jonathan Latham
Unsafe at Any Dose: Chemical Safety Failures from DDT to Glyphosate to BPA
Binoy Kampmark
Suing Russia: Litigating over MH17
Dave Lindorff
Europe, the US and the Politics of Pissing and Being Pissed
Matt Peppe
Cashing In at the Race Track While Facing Charges of “Abusive” Lending Practices
Gilbert Mercier
If Bernie Sanders Is Real, He Will Run as an Independent
Peter Bohmer
A Year Later! The Struggle for Justice Continues!
Dave Welsh
Police Chief Fired in Victory for the Frisco 500
May 23, 2016
Conn Hallinan
European Union: a House Divided
Paul Buhle
Labor’s Sell-Out and the Sanders Campaign
Uri Avnery
Israeli Weimar: It Can Happen Here
John Stauber
Why Bernie was Busted From the Beginning
James Bovard
Obama’s Biggest Corruption Charade
Joseph Mangano – Janette D. Sherman
Indian Point Nuclear Plant: It Doesn’t Take a Meltdown to Harm Local Residents
Desiree Hellegers
“Energy Without Injury”: From Redwood Summer to Break Free via Occupy Wall Street
Lawrence Davidson
The Unraveling of Zionism?
Patrick Cockburn
Why Visa Waivers are Dangerous for Turks
Robert Koehler
Rethinking Criminal Justice
Lawrence Wittner
The Return of Democratic Socialism
Ha-Joon Chang
What Britain Forgot: Making Things Matters
John V. Walsh
Only Donald Trump Raises Five “Fundamental and Urgent” Foreign Policy Questions: Stephen F. Cohen Bemoans MSM’s Dismissal of Trump’s Queries
Andrew Stewart
The Occupation of the American Mind: a Film That Palestinians Deserve
Nyla Ali Khan
The Vulnerable Repositories of Honor in Kashmir
Weekend Edition
May 20, 2016
Friday - Sunday
Rob Urie
Hillary Clinton and Political Violence
FacebookTwitterGoogle+RedditEmail