Deflating Greenback ….To Encourage Diversification
The Dollar, which was the “Stellar” currency worldwide until recently, is slowly losing its crown of being “global reserve currency”, which is mainly due to the recent meltdown in its value in relation to other currencies. It is notable that Dollar is used as reserve currency since 1945. With Dollar’s 45 percent decline against Euro during the past six years and 6.4 percent decline against a basket of currencies in 1st quarter of this year thereby raising concerns that the Greenback’s six-decade reign as the world’s most significant currency may be diminishing.
George Soros, a global financier, also warned in the World Economic Forum at Davos that the role of Dollar as a reserve currency and the 60-year credit expansion by US is nearing its end.
Benefits of Dollar as reserve currency to U.S. Ø Reserve currency status allows the U.S. government to borrow in its own currency
Ø Helps U.S to run trade deficits because borrowing is much easier.
Ø Helps the U.S government and American companies to fund themselves at low interest rates. It makes it easier for U.S. companies to do business and increases the international demand for U.S. assets.
Ø US benefits from the increased demand for the Dollar that the reserve currency status creates.
Ø It allows the Federal Reserve to control the global economic system by creating credit out of “thin air”. Creating credit out of thin air means when we deposit our money into bank, it goes into a pool of money available for the bank to make loans. When the bank creates a loan, it creates an asset. This asset is new money and using it in the purchase of valuable manufactured goods and resources.
Tumbling Dollar raise Gold use as Reserve currency: –
The weakening of US Dollar has led to an increase in the demand for gold. Gold, which is also known as anti-Dollar, is the ultimate reserve currency. When confidence in the Dollar is shaken, more financial institutions and people buy gold and the price tends to go up. Following are some countries percentage of forex reserve in Gold: -United States 77.4%, Germany 66.4%, France 56.7%, Italy 66.1,while India is only 3.3% of the forex reserve in terms of Gold.
Drawback of Diversification of Dollar:-There are costs involved in switching to another currency unless a critical mass of countries switches. The decline as well as reduction in Dollar use has therefore been gradual rather than sudden, and this may continue. When we use Euro it has some limitations because its charter prevents the European Commercial Bank from giving the kind of support to markets that the US Fed can.
Following are some examples of countries, which have taken steps for diversification:
Ø Chinese textile exporters have finalised contracts in Euros or British pounds to avoid foreign exchange losses.
Ø Russia, the world’s second-largest oil-exporting nation, has been preparing to switch trading in Russian Ural Blend oil, the country’s primary export, from the Dollar to the Rouble.
Ø Iran’s decision to cease pricing its oil exports in Dollar is political. But given Saudi Arabia’s staunch support for the US, OPEC is unlikely to follow.
Ø Change in Developing countries’ pattern of their foreign exchange holdings.
Decline in Dollar holdings in Forex reserves of developing countries
Developing countries are slowly inching away from Dollar. Their foreign-exchange reserves surged to $4.9 trillion in 2007 from $1.2 trillion in 2000. Emerging-market countries accounted for 76 percent of total global reserves in 2007, up from 56 percent in 1997, according to the International Monetary Fund and it is worth noticeable that during that period, their Dollar holdings shrank to 61 percent from 73 percent.
In the graph above one can easily notice that Euro has been the beneficiary, rising to 28 percent of developing countries’ reserves in the fourth quarter from 19 percent when the decade began.
What the Asian countries and Gulf countries are doing presently ?
Although emerging markets have reduced the share of US Dollars in their reserve assets (to 60% in end 2006 compared to 70% in end 2000), absolute Dollar demand remains high. Countries with large Dollar holdings are vulnerable because their reserves will lose value if Dollar depreciates.
Central banks of Asian and Gulf countries are seeking to diversify their portfolios away from Dollar. Countries like China, Russia, Kuwait, Singapore and Norway are slowly transferring their Dollars holding to sovereign wealth funds.
In the past 10 years, the exports from Asian economies to the US – except the Japanese – has increased by 50 percent from Hong Kong, Taiwan and Singapore, by 200 percent from Korea, India, Malaysia, and Thailand, and finally by a 300 percent increase from China and the Philippines. So due to the higher exports to the U.S any devaluation in the Dollar directly affects the export income of these countries.
Gulf Cooperation Council (GCC) countries should end their currency pegs to Dollar to give themselves more flexibility to combat against rising inflation. So these countries can peg their currencies to a basket of currencies, including Euro, British Pound and Japanese Yen, or shift to a managed float. Certain Oil producing countries such as Iran and probably, Venezuela have already started invoicing Oil in Euros and to some extent in Yen.
In 1971, almost all Japanese exports were priced in Dollars. About 40 percent of Japan’s total exports are invoiced in yen, up from 34 percent in 2001.
Idea of single currency like Euro
Euro land has almost caught up with US in economic size, and gains from the strength of the Euro, and relative stability of the financial system. The best long-term solution for stable money is the “Single Global Currency”. Other regions are exploring the creation and expansion of monetary unions in Latin America, West, South and East Africa, the Arabian Gulf and South and East Asia. A key value of a monetary union is that the value of its money does not depend upon any particular national government, but upon the management of a central bank, the primary goal of which is stable money.
Methods of diversification away from U.S Dollar:-
Ø Dialogue of G-7, Asian central banks and Governments can help coordinate to such an outcome rather than to one of panic Dollar selling.
Ø A new exchange-traded fund holding Europe’s single currency gives investors a convenient way to hedge fluctuations in the U.S. Dollar.
Ø Gradual strengthening of other currencies and more diversification in trade baskets.
Ø De pegging away from Dollar or pegging of the currencies to a basket of currencies, including the Euro, the British pound and the Japanese yen, or shift to a managed float.
Ø Invest in Gold, which is mainly anti Dollar
Ø Transfer Dollars holding to sovereign wealth funds.
Aftermath of Diversification to Dollar:
With the introduction of Euro as global reserve currency the limitless ability to borrow of U.S will end. Then it will become more difficult for the US to obtain loans in Dollars, as more countries convert their reserves to euros. And while no one can say exactly what the limits are, a run will occur if the United States’ creditors decide that it is not such a good risk anymore.
Conclusion: -In the end it can be concluded that slowly Dollar dominance in the current global scenario will diminish in near future and developing countries are likely to stress more on making regional blocs thereby sharing both economic and political power on the global stage. And in order to protect itself from the downside risk of Greenback they must take necessary measures by evaluating each option.
You are correct that “the best long term solution for stable money is a Single Global Currency.”
The Single Global Currency Association promotes the implementation of a Single Global Currency, to be managed by a Global Central bank, by the year 2024. With the successful use of the euro and other common currencies, more and more people and organizations and nations are seeing the advantages of monetary unions. Our website is at http://www.singleglobalcurrency.org.
The Association recently published the 2008 Edition of my book, The Single Global Currency – Common Cents for the World. A copy of the 2007 edition is available at the Munchen personal archive at http://mpra.ub.uni-muenchen.de/5879/. and on the Association’s website.
The goal of 2024 is only 16 years away. If one looks at the world before the 2002 distribution of the euro to the people of the EMU, you would have seen in 1986 a Europe with a Soviet Union, an East Germany and a Berlin Wall. At that time, most Europeans would have scoffed at the idea of a new monetary union.
The benefits of a Single Global Currency include:
- Zero transaction costs to exchange currencies. Presently, $3.2 trillion is traded every trading day and all this trading and its associated costs, approximately $400 billion annually, can be eliminated.
- The end of currency fluctuations and currency speculation.
- The end of “Balance of Payments”, “Current Account” and “global imbalances” problems for currency areas. There will, of course, still be trade and wealth inequalities, and more visibly; but they will not be compounded by the problem of foreign exchange transactions and reserve requirements. There would be no need for countries to maintain international reserves of other currencies.
- Zero manipulation by countries of their currencies, and thus no more need to cajole and jawbone any particular country or currency area about the value of its currency.
- Zero risk of national and regional currency crises such as occurred in the 1990’s in Mexico, Argentina, Malaysia, South Korea and Russia.
- Minimal inflation, assuming that the future global central bank sets and achieves a low inflation rate, just as the European Central Bank has done. It’s not clear that a zero inflation rate can be secured, as that would bring an economy perilously close to deflation and a deflation spiral, but certainly a low rate of inflation would be better for the world than the current rates.
- Worldwide asset values will increase by about $36 trillion due to the elimination of currency risk. Such an increase in asset values will cause annual worldwide GDP to increase by about $9 trillion.
- With no currrency risk, worldwide interest rates would be lower.
- With zero risk of currency failure and zero manipulation and minimal inflation, the Single Global Currency would satisfy the moral obligation that a stable currency should be considered as a fundamental human right, as is the right to own property. A Single Global Currency would be far more stable than the currencies presently used by billions of human beings
While all these benefits are expected upon the implementation of a Single Global Currency, considerable benefits will also come during the implementation processes which will see the reduction of national currencies as predicted and welcomed recently by Benn Steil in Foreign Affairs.
Of course, not all economists agree with the goal of a single global currency. For those who would label the single global currency utopian, we call their attention to the euro, which began as a plan only about 30 years ago. Who would have thought in the 1970’s that Europe would not only adopt a common currency, but also that its member countries would discard their old currencies?
The single global currency might be an enlarged transformation of one of the current major currencies (dollar, euro, yen), perhaps with a new name such as “dey”, “eartha”, “geo”,”globo” or “worldo” or it might be a new currency with such a name. How we get to that point is, of course, a major challenge, but there are several possible routes. One is to continue the trend of creating and expanding regional monetary unions, and then combine those monetary unions into one. Another is for smaller countries to continue to “ize” their nations’ legal tender, as in “dollarize” and “euroize”, as has been done in El Salvador and Monaco. Compatible with all these and other routes is the need to convene an international monetary conference of nations, monetary unions and related organizations, and begin planning for the implementation of a single global currency.
Organizations such as the IMF and the Bank for International Settlements, and individual economists should begin to carefully research and write about the benefits claimed above for the Single Global Currency, and about the costs, too. When the vast benefits become better known, the people of the world will demand a Single Global Currency and ask why we have been burdened so long with the existing multicurrency system, which Robert Mundell describes as “absurd.”