Dump the Dollar ?

The “dump the dollar” as a reserve currency campaign continues to grow legs in the media, but they [the media] are doing a terrible job of explaining some fundamentals about such an idea.

First, one of the biggest “facts” which makes the idea of dumping the dollar, at least as one of the “major” reserve currencies, highly unlikely, is that America is, by far, the largest exporter. America exported over 1.84 Trillion dollars (1) of goods and services which means, foreigners, NEEDED 1.84 Trillion DOLLARS to buy those goods and services from America. Therefore, as the “largest” seller of goods, requiring the “largest” amount of a particular currency- it is no doubt that, by dictat of market forces- the U.S. Currency would be the largest “reserve” and more importantly- “trading” currency in the world (also THE major settlement currency- which means the majority of international transactions are denominated in dollars no matter the currencies of the two trading partners).

Second, there is NOT a better “alternative” to the US dollar. Using another existing currency, like the Euro (currency of a trading bloc) the Yen or Sterling, offers no better guarantees of avoiding the pitfalls that the American currency finds itself in. And, those countries are suffering most of the same negative trends found in America. Currencies like China's RMB cannot be a “reserve” currency replacement because its NOT fully convertible. China's currency is 100% political fiat- the value can be changed tomorrow regardless of objective market indicators or pressures and it lacks any independence. The dollar is fully convertible, reacts to market forces and conditions- as it should, the dollar's value reflects the American economy, and the dollars administration (by the Federal Reserve) is “independent” of the American government. Let's not even consider the Russian “Ruble”, or Brazilian “Real” being considered as a replacement reserve currency.

Creating a “supra-national” currency, like a new trading currency made up of a basket of values (money deposits, gold, international currencies, etc) will simply not happen. Such an artificial currency would pose enormous practical problems like the influence and inability to agree on its administration. And, we already have, basically, such a currency, its called the SDR (Special Drawing Rights) created by the IMF (International Monetary Fund in 1969) which has been actively around since the early 1980's specifically designed to move away from domination of the US dollar and allow countries to hold or use SDR's for trading or reserves, instead of the dollar. The SDR is a unit of value based on a basket of international currencies. The SDR has fallen flat, the very alternative the BRIC's are proposing already exists and there are few takers or users. In fact from 1981 until today, only 21.4 Billion SDR's have been created (equivalent value in USD is 31.9 Billion) which is not even one days worth of international trading (goods+forex). The idea of an international reserve or trading currency is a non-starter, proven by the complete failure and non-use of the SDR, full stop.

Third, the country making the most noise about the American currency, China (the author currently lives in Beijing China), has an alternate reason why it keeps such large reserves of US dollars. It's simply that China “holds” the US dollar back from re-entering the market place to prevent buying of the RMB, lest it put upward pressures on China to re-value the RMB. The RMB is currently at 6.8 RMB to the dollar, were it to rise in value to 3.5 to the dollar, for example, it would double the cost of Chinese exports- or in other words, possibly cut in half the amount that China exports to the US. Chinese exports are a much larger percentage of their GNP and overall trade volume than are US exports to China a part of the American economy (which means the issue is a lot more important to the Chinese than it is to us). Therefore, it's far more important for China to “keep back” all the dollars it earns from exporting to America, in order to keep the value of the dollar high- if China were NOT to keep those dollars- and instead sell them back on the market- it would put enormous downward pressure on the dollar- symmetrically putting upward pressure on the RMB. This is the PRACTICAL reason why China is certainly making “noise” about the Federal Reserve policies, but its more of a “rant” rather than any sort of a serious warning that China will “dump” dollars. China is NOT doing America any favors when buying US treasury bonds, they are simply mopping up the dollar liquidity THEY hold from all the goods they sell to America, and buying treasuries keeps the RMB undervalued- which is essential to keep low quality Chinese goods “competitive.”

In sum, when you're selling 1.84 Trillion dollars of goods and services, there is no way to avoid having a handful of U.S. Dollars, and in that case, you can dump them, which would push up the value of your currency and weaken the dollar (which is not good for all the investments you have in America or holding T-bills) – or, you hold them- whether as reserves or treasury bonds. This remains the economic reality of 2009 and for the above reasons, will not change in the short term future.

Ignoring all the political intrigue and bravado of countries which have insignificant economies, if you sell the most goods in the world, your currency is the most needed, its that simple and there is no way around it. When the British Empire was in decline, the British economy did not contract, it simply became irrelevant as it was in decline- “relative” to other economies rapidly outpacing the UK. Therefore, as Britain's exports became a smaller percentage of world trade, obviously, people didn't need Sterling, therefore, although its value remained high- it was phased out as THE major reserve currency and replaced by the dollar. But, what is important to know is that event occurred naturally- by market forces- not by decree by a bunch of second rate semi-developed countries which ranted about “their” irrelevance in the world economy. And so it may be, in the distant future, that as the US economy and exports become “less” dominant in relation to others, its value and importance as a reserve currency may decline. However, the U.S. Still represents 23% of the entire world economy, only 2% less than it held since WWII. Therefore, reality shows that there is little real decline in America's world economic market share, and therefore, the dollar will and continues to reign supreme no matter what the BRIC countries (Brazil, Russia, India, China) rant and rave about. One should also note that the rich and influential people of those BRIC countries continue to keep the majority of their personal assets in dollars and gold, not their own currency- that alone tells you what the real bottom line is.

The point of this article is to illustrate the reasons why the media hype and BRIC rants about replacing the dollar is pure fantasy, and to supplement the poor job the media is doing of pointing out why the ideas of replacing the dollar is not realistic, plausible, doable, or about to happen in the least.

Endnote:

(1) 4th Quarter Estimate 2008 of the US International Trade Administration US Govt.


James Luko

Former United Nations Official, International Criminal Tribunal for the Former Yugoslavia, Deputy Head of Office- ICTY Office of the Prosecutor, Canadian Defense Department-Ottawa Canada, National Council for Soviet-East European Research- Washington DC

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