Money, Money Everywhere. . . .
Mini Teaser: The dollar's international dominance, which underwrites our global economic leadership, can no longer be taken for granted.
IT IS TIME the United States wakes up to a serious problem. The dollar is increasingly losing the position it has enjoyed for nearly half a century as the world's currency of last resort. And as that happens, the advantages we have gleaned from that status-the ability to finance our twin fiscal and trade deficits while keeping our interest rates low-will also be lost. And yet no one, particularly in Washington, seems overly concerned.
The world is awash in dollars right now, and the situation cannot last. My concern is that many in this country continue to have unrealistic views about the sustainability of the status quo. Yes, our domestic economy is doing reasonably well-we have modest but real growth, inflation is quiet, the stock market is booming. But we also have not done anything to address an out-of-control federal government budget deficit and the ongoing huge trade deficits we run up with other nations. How long will other countries continue to provide us with our credit card? Other countries may no longer be willing to provide Washington with a blank check-literally.
China's enormous trade surpluses with the United States have generated more than one trillion dollars worth of reserves. In the past, Beijing has purchased a large quantity of U.S. Treasury bonds, enabling us to finance our government's deficit spending. But the Chinese have now indicated that they will begin to pursue alternative investments with their surpluses, from purchasing companies and assets to diversifying their holdings into a basket of currencies-devoting at least $300 billion of their reserves to this purpose. One thing high on Beijing's agenda: trading their excess dollars for ownership of natural-resource assets.
Japan and Russia are the second and third largest holders of dollars (some $900 billion and $300 billion, respectively). Right now, Tokyo is interested in keeping the yen weak vis-à-vis the dollar in order to make its exports competitive. Russia continues to accumulate dollars because oil exports remain denominated in that currency. But there is a limit as to how many dollars can be absorbed by other countries-and no one wants to hold on to their dollars endlessly. Pressure is building to diversify. We are seeing a move away from the dollar to gold and other currencies-most notably the euro. At the end of August 2003 a U.S. dollar was worth €0.90; by May 2007 that single greenback would only get you €0.74. Other currencies are gaining favorable attention as well, such as the Brazilian real, the Indian rupee and the Indonesian rupiah.
One test of the willingness of other states to maintain the dollar standard is the extent to which they continue to use the dollar as the world's currency of last resort. We have already seen some disturbing signs. Companies increasingly go to non-American exchanges to list their shares, with London now the world's favorite destination for initial public offerings, followed by Hong Kong. And the euro has become more attractive as a currency, not simply as an alternative to the dollar, but because of increasing optimism about the economic performance of the core European states-Germany and Britain, most notably-and the expectation of reforms in France away from socialism toward a more balanced approach with the election of Nicolas Sarkozy.
There have been major shifts in the global economy over the last decade. Perhaps we grew a little too complacent. For years, India's economy was going nowhere, trapped in its socialist straightjacket; China was only in the first stages of its move to market reforms; Russia was trying to extricate itself from the collapse of the Soviet Union; Brazil was burdened by high inflation and low commodity prices. Today, in contrast to even five years ago, each of these countries is now far more competitive in world markets. They produce or manufacture things others desperately need. Brazil has seen sugar prices skyrocket as demand for ethanol has increased. Russia is the world's leading exporter of energy. And China's rapid ascent up the technology ladder has its factories producing and exporting products that even a few years ago would have been beyond its reach. These developments mean that other currencies are increasingly acquiring greater value, beginning with the euro and the British pound.
The bottom line is that the U.S. dollar is no longer the only game in town. Our currency has serious competitors, because the economies of other countries have major advantages (whether a low-cost manufacturing base or natural-resource endowments) that make their currencies more attractive as ways to hold wealth. We will also see a continuing trend of diversification into precious metals.
And we could see a major shift if the world's energy producers decide to switch both the pricing and selling of oil from the dollar to the euro-as this would cause central banks around the globe to dump more of their dollar reserves in favor of the euro-and in turn cause a further major loss in the purchasing power of the dollar. So far, only Iran has attempted to set up a new international oil exchange that would denominate oil sales in euros, and this project, first announced in 2003, has been repeatedly delayed, although Iran has reportedly asked buyers of its oil to pay in currencies other than the dollar. It is too early to say that the dollar standard has ended; but we should not assume that the ongoing exodus away from the dollar into other currencies is automatically going to be reversed and that it is just a "matter of time." And a number of countries are now worried about the potential for losses from a U.S. dollar that continues to lose value.
Other countries will not continue to accumulate and hold dollars for the dollar's sake, or continue to treat the dollar as the only possible global currency.
The position of the dollar, of course, could be immensely strengthened if we were to seriously tackle our deficit spending. The federal government needs to learn to live within its means. And most economists argue that the U.S. current account deficit, which for the last several years has run above 6 percent of our gross domestic product (GDP), would need to be reduced to under 3 percent for the dollar to become more robust. This is, of course, far easier said than done. But we do need to improve our balance of trade for American businesses and manufacturers to make our exports more competitive. And this can only come about by creating innovative products that people around the world want to purchase. This, in turn, can only come about if we do not have a regulatory regime in this country, which discourages risk-taking and limits the ability of entrepreneurs to raise capital from our domestic exchanges.
We also have to avoid the blame game. China's success in becoming the world's factory-producing high-quality, low-cost consumer goods-has been a boon to millions of American consumers. Steadily declining prices have also been an important factor in keeping inflation in check, even as energy prices have skyrocketed. It is easy for politicians here to blame China for the trade deficit but conveniently ignore how U.S. manufacturers could be exporting a number of high-value, high-technology products to China-leading to a far more balanced trading relationship. But manufacturers are hemmed in by a continuing web of export restrictions that remain inflexible in their application. Meanwhile, China simply purchases these types of products from other suppliers.
None of these recommendations are particularly new or earth-shattering. Indeed, a number of the world's recent economic success stories followed this advice. Other countries are doing the things we preached. It is time for us to preach to ourselves for a change.
Maurice R. Greenberg is chairman and CEO of C.V. Starr & Co.Essay Types: Essay