The international currency debate was addressed yesterday in a paper published by the National Bureau of Economic Research called “The Euro May Over the Next 15 Years Surpass The Dollar as Leading International Currency,” (and no, we didn’t’ make that title up.)
“In the aftermath of the Second World War,” write Menzie Chinn and Jeffrey Frankel, “the dollar emerged as the uncontested leader among international currencies, a development of historic significance. In 1899 the share of the pound in known foreign exchange holdings of official institutions had been more than twice the total of the next nearest competitors, the franc and the mark, and much greater than the dollar.”
“Even as late as 1940, the level of foreign-owned liquid sterling assets was still double the level of foreign-owned liquid dollar assets. By 1945, however, the position of the dollar and the pound, as measured by this statistic, had precisely reversed. The war itself-including US lending, UK borrowing, and other consequences-had completed the dollar’s rise to ascendancy.”
Let’s see if we have this right, then. In the mere space of five years, a strategic and historic shift was achieved in the composition of global currency reserves. People went from preferring Britain, Empire, Tea and the Pound to preferring America, Empire, Coca Cola, and the Dollar.
The means by which the shift was achieved-or the circumstances which accelerated it, if you prefer-were an expensive war which forced Britain to become a debtor to America, which itself was a creditor owing to its reserves of gold.
America’s creditors today are Japan and China. Through their purchases of T-note, bills and bonds, they fund America’s wars in Afghanistan and Iraq. Do they do this because Japanese and Chinese investors agree with America’s strategic policy objectives. Or are dollar-denominated assets the only ones in the world big enough to absorb the accumulated savings and surpluses of Asia?
While you think on that one, think on this too… once it was clear that Britain’s global position was fatally compromised by its poor finances, it took all of five years for the dollar to become the preferred international currency. It can happen fast when people have a real alternative.
What makes today so interesting is that there are no easy alternatives to the dollar. The euro is the likeliest candidate, and is being used fore more and more financial transactions and in debt markets. The Yen and the Yuan are candidates too, but both have their own set of problems.
We reckon that investors-central banks, institutions, and individuals-are just now starting to realize that paper money itself is a cheat. It is a lousy way to store capital and wealth. They are realising and even more important truth-money printed by government fiat isn’t wealth. It’s just paper, and only really useful as a medium of exchange as long as its exchange value remains stable.
But we live in a world where the primary medium of exchange-the U.S. dollar-is losing its value relative to tangible goods day by day, as the supply of dollars (and the total number of dollar-based liabilities) grows. So what does it all mean?
Look for people to tie their wealth up more in tangible goods and projects which create real physical capital. Business and government investment in infrastructure and public works is one area. A world where capital is tied up in physical things and not paper is probably a less “liquid” world.
It does mean folks will have to be a lot more careful about what they invest in. Projects will have to create real value-not the fictitious value that currently dominates the balance sheets of so many banks. A new international currency regime deserves a new kind of capitalism…one that doesn’t actually waste capital.
Markets and Money