After the dollar, what? DNA 9th October 2009

There has always been the requirement for an anchor or reserve currency in the world, which started off with gold and then the pound, moved over to the SDR (special drawing rights) and then settled with the dollar.
The reserve currency is one which is accepted as being strong, safe and stable. While individuals can default, the country that owns the currency cannot and has to be seen as one which is well governed and has to be responsible because it does not have any limit on the quantity of currency that can be printed. In a way it has to be seen as one which writes cheques that will not be cashed.
It is not surprising that the dollar is the reserve currency and between 60 to 100 per cent of foreign exchange reserves of countries are indollars with an average of 64 per cent reserves being in dollars, while euros, yen, pound and SDR take up the rest. Further, 88 per cent of world trade is in dollars and USA has anchored the global economy -- its deficits and monetary policy pronouncements are tracked assiduously.
The question raised today is whether or not we can continue to depend on the dollar for support. Let us look at the reasons for dissatisfaction with the dollar. The US deficits, both current account and fiscal, are very high at 2.9 per cent and 13.5 per cent of GDP respectively.
The Americans are clearly spending more than they should be doing and the dollar has been depreciating sharply and is close to $1.48 per Euro. This gives the USA an unfair advantage in world trade, as its exports become more competitive.
Last year, this has been exacerbated by the bailout of the financial system which has already been valued at close to $5 trillion which is one-third of the GDP of the USA. The fiscal stimulus programme has been another factor driving down the dollar and the earnest talk by president Obama on Medicare means that the deficits will persist.
Under these circumstances, the issue raised is whether such a state is sustainable in the medium run. Would any other country have survived under such economic conditions?
Anecdotal evidence shows that around 80 per cent of currency failures follow a pattern: a large country borrows cheap (other countries invest in the US bonds) and loads up debt by importing much more than it produces.
The other (emerging) markets benefit to begin with until the borrowing country gets overburdened and trade retreats causing deflation which erases the wealth of creditors as less dollars are available externally. The amount of dollars available is dependent on the trade deficit and creates a problem for those countries trying to trade in dollar denominated assets. In fact, 2008 would have been catastrophic had the US Federal
Reserve not agreed bail out the system by inducting dollars in currency. Is the world satisfied with these developments? The answer is no, as can be seen by relentless noises being made by the oil producers, Russia and China. China is the largest subscriber to Fed treasuries (with forex reserves of over $ 2 trillion).
China has already flexed its muscle by setting up currency swaps with several countries like Argentina, Belarus and Indonesia and by letting institutions in Hong Kong issue bonds denominated in the Chinese currency, renminbi. Brazil and China are now working towards using their own currencies rather than the US dollar.
The oil-producing countries had even earlier justified the increase in oil prices in 2007 and 2008 to the shaky dollar as they are denominated in dollars. Further, there has been a tendency for foreign trade between nations to also be reckoned in alternative currencies like the Euro as it is seen as being more stable.
What then should be an alternative anchor currency? In the 1960s, an economist by the name of Triffin came up with the paradox that as the marginal supplier of the world's reserve currency, the US had no choice but to run persistent current account deficits.
Today, China could be a choice but its economy is opaque.The euro will be a good idea, but again it is based on the coordination between several members' nations -- some weak and others strong and cannot sustain the world economy.
As the emerging markets do have a fair say in the world economy, they would necessarily have a bigger role to play and we need to think of reinventing the SDR (a basket of four key currencies created by the International Monetary Fund in 1969) with the renminbi, euro, peso and so on, and maybe also the rupee, playing a role. The Stiglitz Committee under the auspices of the UN has suggested this route.
Will the dollar collapse? Not really as doomsayers predict but it will gradually lose its sheen as a currency that will be globally acceptable. The fact that nations are moving away to alternatives means that one is not overly dependent on the dollar. This by itself should induce more discipline in the way in which the US operates.