Monday, March 14, 2011

On the Dollar, Euro, and RMB

. Monday, March 14, 2011

I had been planning on blogging about Barry Eichengreen's recent book-hype talk -- about the coming decline of the dollar as pre-eminent global currency (see here and here, for examples), and the rise of the Euro and RMB as its replacements -- but I haven't had the time. Thankfully, Michael Pettis wrote a characteristically long, thorough post on why that won't be true (for the RMB at least) any time in the foreseeable future. Highly recommended. The gist:

1. In order for China's currency to become a significant international reserve currency, even at the level of the yen, its internal economy would have to go through wrenching reforms.

2. China's financial system cannot handle the international competition that would come from capital account liberalization.

3. China has no reason to want the RMB to be a reserve currency, at least as long as it thinks it can benefit from the export-led growth that comes from a low peg to the dollar.

Pettis also notes that everyone was saying the same things about the yen knocking off the dollar 20-30 years ago. And while the yen is an important international currency, it's just not in the same league as the dollar. Pettis is higher on the Euro (I'm not, at least not for another decade), but acknowledges that for that to happen the Euro will likely need to first kick some members out. Right now, dollar holdings are about 250% higher than Euro holdings despite the fact that the EU has a larger cumulative economy, and obviously the Euro has things to work out before full confidence is restored.

Pettis also explains why having the world's reserve currency isn't always good for the U.S., and can be very good for other countries, especially those that pursue growth via exports. Which then begs a question: if the U.S. is willing to provide a public good at its own expense, and other countries benefit from that, then why wouldn't the dollar persist as the pre-eminent global currency? A move away from the dollar would represent a redistribution to the U.S. from other countries relative to the status quo. It seems like those countries would be happy to take advantage of that situation as long as they are able. It's true that the U.S. is able to fund its debt cheaply because of the high demand for dollars, but that would be true even if it didn't issue the largest reserve currency. Other advanced industrialized countries pay the same rates, or in some cases less, on their bonds than the U.S. does, and they are able to borrow in their own currencies as well.

In other words, there isn't any particular reason to expect the international monetary system to change much, especially in the short run, most likely because of positive feedback loops. The dollar's status as reserve currency isn't primarily an indication of the U.S.'s current or future economic performance, it's an remnant of its past role at the center of Bretton Woods. And while the U.S. gets some privilege from issuing the reserve currency, it isn't all that exorbitant. The international monetary system benefits from having a universally convertible currency, no matter what it is. So the dollar is the reserve currency, and will remain the reserve currency, mostly because it has been the reserve currency.

If that's the case, then the dollar's role as the pre-eminent reserve currency is likely a stable equilibrium for some time to come.


On the Dollar, Euro, and RMB
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