Stephen Foley: It’s not game over for the dollar yet

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The Independent Online

US Outlook: Richard Fisher, head of the Federal Reserve's Dallas branch, calls the foreign exchange market a "manic depressive mechanism," and we just closed a particularly manic week. To listen to the hubbub from the trading desks, you would think we have passed into a new world economic order, with the dollar consigned to history as the dominant reserve currency. To all this, I just want to say: not so fast.

The inexorable rise of the Chinese economy, and the near-collapse of the US financial system last year, have absolutely altered the balance of power in economic affairs. There is no doubt that we are feeling our way in new territory, but what has struck me most this week has been the mountain of practical problems that switching from a dollar reserve system entails. The intellectual framework is not in place, the institutional framework is woefully compromised, there are too many economic interests ranged in favour of the status quo, and the Chinese renminbi is – quite frankly – an implausible alternative to the dollar.

For a start, the dollar is not collapsing. The dollar index, which measures the greenback against a basket of currencies, is down 11.9 per cent since that old tax-and-spender Barack Obama came to power (as one anti-Obama paper pointed out yesterday), but the index is just back to the level of the end of 2007.

All we are doing currently is reversing the spike in the dollar that occurred in the post-Lehman Brothers panic, when investors the world over reached for the safest assets they could find. That they were dollar assets struck some as perverse when the US was at the heart of the meltdown, but it showed that, when push comes to shove, there is a core confidence in the US government and financial system that is not replicated elsewhere.

Will we be able to say that about a different currency? Will the combined brains of China, Russia, France, Japan and the Gulf Arab states really be able to weave a stable synthetic trading unit out of a basket of currencies, as they are considering for the trading of oil by the end of next decade? Will the International Monetary Fund's "special drawing rights," an artificial currency presently calculated as an amalgam of dollars, euros and sterling, really replace the dollar as a reserve currency, as China and others have suggested?

I am sceptical for a number of reasons. For all the weaknesses that have been exposed in the US economy, the dollar still strikes me as an attractive asset compared to a synthetic hybrid currency maintained by a shifting alliance of trading partners with conflicting economic needs, or by the IMF, which does not even appear able to have a civilised debate about how many seats round the table each nation gets, let alone what the weightings of their various currencies should be. Such a scheme ought to be killed at birth for being fundamentally unstable.

Gold bugs, sending their precious metal to record levels this week, see a new gold standard, ignoring that system's inflexibility and careless of the deleterious effect it would have on world trade. You have only to watch the television for a few hours during the day here to become nervous about a bubble forming in the gold market. The trading of gold has gone mainstream, with adverts variously suggesting that people mail in their unwanted jewellery for cash or tempting them to buy box loads of glittering gold coins. I am told that the comedy actor, Vince Vaughn, approached Congress's best-known gold standard campaigner, Ron Paul, at a recent premiere to ask for advice about whether he should put his money into the precious metal. The echoes of the dot.com bubble are all around.

Finally, it is almost laughably early to start talking about the renminbi as an alternative for filling up the reserve vaults of central banks across Asia and beyond. The benign dictatorship of the Chinese Communist party has brought the benefits of a long overdue industrial revolution in the world's most populous nation, but I for one would prefer a reserve currency – designed to instil confidence – to be one grounded in an entrenched capital democracy, rather than one manipulated by a cabal of technocrats whose hold on power over a huge and fractious country is based on coercion. The Chinese Communists have not yet built a self-sustaining economic model based on domestic demand, and growth forecasts that show the country's GDP surpassing the US within a couple of decades ignore every risk of political instability.

Most important to me are the entrenched economic interests of nations – China included – whose reserves are overwhelmingly in dollars, and who have nothing to gain from precipitating its demise. More likely, they will gang up on the US to take the necessary actions to pull up the dollar, rather than walk away.

After a period of highfalutin talk about a new economic world order, kicked off by the formal shift of power from the Group of Seven to the G20 last month, we ought to pull our time horizons back to the foreseeable future. Do that and the conclusion is this: better the dollar you know than the devil you don't.

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