As Jean Pisani-Ferry and Adam Posen, director of Brussels think tank Bruegel and fellow at the Peterson Institute for International Economics in Washington, respectively, have pointed out, "There is no sign of a move to the euro as a global currency. The share of dollars in global reserves remains almost three times that of the euro." The reasons for this failure of the euro to advance further as a global currency are not clear, but seem to be rooted in the failure of the EU to encourage economic growth, to develop better systems of economic governance, and to broaden the euro area by taking on new members. Talk about pricing oil in euros instead of dollars remains just that -- talk. And in the recent crisis it was the Federal Reserve Board that was called upon to provide currency to meet emergency needs for liquidity -- that means dollars.
Still, doubts about the dollar's future persist. Its recent decline may be consistent with its performance in previous currency cycles. And the drop might be due to a willingness by investors to take on more risk, now that the recession seems to be ending, rather than to a lack of faith in the safety of the dollar, to which they will scamper back at the first sign of international trouble. But investors do remain worried that the dollar's decline, so far acceptably gradual, will turn into a rout, perhaps not next year, but by 2011.
Federal Reserve Board chairman Ben Bernanke says that
can be avoided if two policy steps are taken. First, the US government must make "a clear commitment to substantially reduce federal deficits over time." Second, Asian countries must boost domestic demand so that they don't have to rely so heavily on exports to the US, and allow their currencies to appreciate against the dollar so that the US trade deficit continues to fall as a percent of the American GDP.
What Bernanke did not say, either because he was playing the discrete central banker or because he doesn't believe it, is that neither of these things is likely. The Obama administration has already penciled in huge deficits for a decade and more, and is in the process of adding perhaps another trillion to the US deficit by "reforming" health care -- claims of savings are somewhere between delusions and lies. It will then turn its attention to the energy sector, and the subsidies required to fund its green revolution. Only Obama knows what spending comes next as he seeks to go down in history as the president who "transformed" the American economy.
Meanwhile, the Chinese are unlikely to allow their currency to appreciate in value, and other Asian nations will continue to intervene to prevent their currencies from rising against both the dollar and renminbi. Trade imbalances therefore will persist.
Which puts the ball right back in the Fed's court. Unless Bernanke drains liquidity from the financial system, and shrinks the Fed's balance sheet by winding down $2 trillion in support programs -- and does so precisely when the recovery takes hold so as not to cause a relapse by moving too early -- the dollar's decline will accelerate, shattering confidence in its long-term value. One well-respected expert tells me that in two-to-five years the dollar will no longer be considered safe enough to be the currency in which the world does business. Its replacement: separate deals in local currencies -- the Chinese paying for Brazil's oil in renminbi, which the Brazilians use to purchase stuff made in China -- and the International Monetary Fund's drawing rights, bits of paper backed by a basket of currencies, including but not limited to the dollar. That would mark the end of an era that has seen world trade flourish and millions emerge from poverty. Sad.
Irwin M. Stelzer is a contributing editor to THE WEEKLY STANDARD, director of economic policy studies at the Hudson Institute, and a columnist for the Sunday Times (London).
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