The world economy has been built on a major fault line: a national currency, the U.S. dollar, which is also the world monetary unit. The two different roles played by the American dollar have become increasingly incompatible. Today, low U.S. interest rates are needed to reduce recessionary pressures in the American domestic economy. But, lowering U.S. interest rates has made the U.S. dollar less attractive as an investment vehicle for foreign businesses, banks, and governments, rendering it unsuitable as world money, an international storehouse of value.
Developments in financial markets in recent months have brought the dilemma of using the U.S. dollar as the world currency back to the forefront of issues that need to be addressed. Commentators are so far taking stock of the bad news, but not addressing what needs to be done.
If central banks and finance ministries around the world know what to do next, so far they have kept it to themselves.
The bad news is that the U.S. economy is going into a recession. Since it is the world’s largest importer, its economic slowdown will hit others as well. With the U.S. dollar at record lows against the Euro, and recent lows against the Yen, U.S. purchases abroad are bound to fall precipitately.
The worse news is that the trouble in U.S. financial markets could be amplified by the recession, putting U.S. banks and financial institutions in an even weaker position than today. Loss of confidence in dollar-based assets will cause ever greater disruptions in financial markets abroad.
Those countries that have been selling more to the U.S., than they have been buying from the U.S., have, until now, accumulated surplus dollars, and placed them in U.S financial markets. But, since July, purchases of U.S. securities by foreign governments have dropped dramatically, driving the U.S. dollar down, and making financial markets more fragile.
Everybody who holds U.S. dollars or securities is losing money, and stands to lose more when, to fight recession, American interest rates go down again, and the U.S. dollar plunges even further.
The U.S. Treasury Department says it is pursuing a strong dollar policy, which no body believes. The U.S. Federal Reserve makes monetary policy to suit the domestic economy, not the overseas holders of U.S. dollars.
The U.S. policy response to the falling dollar has been to blame those countries, principally China, and other emerging economies, which have continued to peg their currencies to the U.S. dollar, rather than allow their currencies to rise. To avoid a domestic recession, the U.S. wants poorer economies to slow down. China remains unconvinced. Why should it adjust to U.S. needs?
For the past 60 years the U.S. has enjoyed the imperial privilege of having its money accepted all over the world, giving it the ability to buy real assets with its own money. The world held U.S. dollars as financial assets, and the U.S. dollar was used to calculate prices, and make payments throughout a world banking, and financial network.
Because there was a requirement for foreigners spending abroad to earn U.S. currency through international trade, but no requirement for U.S. spenders to earn foreign currency, the world had adopted a dollar standard.
Today, because of U.S. over-spending abroad, many businesses, banks, and governments are moving out of dollars and into Euros, British Pounds, or, even Swiss Francs or Yen. Investors are buying art, and real property outside the U.S., which have become more attractive investments than dollar denominated assets.However, by diversifying out of the dollar, investors only reduce its value further. The U.S. authorities have no back up plan to stop the U.S. dollar from shrinking in value even more.
The market is not going to fix the problems created by using a national currency as the world money. What is needed is a plan to create a genuine world currency to settle debts among central banks. At Bretton Woods, in 1944, John Maynard Keynes presented a plan for such a currency. He called it the âeoebancor.âe His ideas were rejected. American bankers did not want to give up their lucrative business of trading dollars on foreign exchanges.
The world needs a truly international monetary unit, because the dollar cannot fulfill its international role, and replacing it with the Euro will not resolve the contradiction of using a central bank currency to fulfill two roles, one internal and one on the world stage.