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BookmarkThe average life expectancy for a fiat currency is less than 40 years.
But what about “reserve currencies”, like the U.S. dollar?
JP Morgan noted last year that “reserve currencies” have a limited shelf-life:
As the table shows, U.S. reserve status has already lasted as long as Portugal and the Netherland’s reigns. It won’t happen tomorrow, or next week … but the end of the dollar’s rein is coming nonetheless, and China and many other countries are calling for a new reserve currency.
Remember, China is entering into more and more major deals with other countries to settle trades in Yuans, instead of dollars. This includes the European Union (the world’s largest economy).
And China is quietly becoming a gold superpower, and China has long been rumored to be converting the Yuan to a gold-backed currency.
Why China Doesn’t Want the Yuan to Become the Reserve Currency
But a switch to a totally-different system – say, a gold-backed yuan – would cause enormous disruption and chaos. China – which has been a long-term planner for thousands of years – doesn’t want such a sudden change.
Moreover, housing the world’s reserve currency is a huge burden, as well as a privilege. Venture Magazine notes:
The inherent burden of housing the world’s reserve currency is that the U.S. must continue to run a balance of payment deficit to meet the growing demand. However, it was this outstanding external debt that caused investors to lose confidence in the value of the reserve assets.
Michael Pettis – the well-known American economist teaching at Peking University in Beijing – explains:
A world without the dollar would mean faster growth and less debt for the United States, though at the expense of slower growth for parts of the rest of the world, especially Asia.
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When foreigners actively buy dollar assets they force down the value of their currency against the dollar. U.S. manufacturers are thus penalized by the overvalued dollar and so must reduce production and fire American workers. The only way to prevent unemployment from rising then is for the United States to increase domestic demand — and with it domestic employment — by running up public or private debt. But, of course, an increase in debt is the same as a reduction in savings. If a rise in foreign savings is passed on to the United States by foreign accumulation of dollar assets, in other words, U.S. savings must decline. There is no other possibility.
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By definition, any increase in net foreign purchases of U.S. dollar assets must be accompanied by an equivalent increase in the U.S. current account deficit. This is a well-known accounting identity found in every macroeconomics textbook. So if foreign central banks increase their currency intervention by buying more dollars, their trade surpluses necessarily rise along with the U.S. trade deficit. But if foreign purchases of dollar assets really result in lower U.S. interest rates, then it should hold that the higher a country’s current account deficit, the lower its interest rate should be.
Why? Because of the balancing effect: The net amount of foreign purchases of U.S. government bonds and other U.S. dollar assets is exactly equal to the current account deficit. More net foreign purchases is exactly the same as a wider trade deficit (or, more technically, a wider current account deficit).
So do bigger trade deficits really mean lower interest rates? Clearly not. The opposite is in fact far more likely to be true. Countries with balanced trade or trade surpluses tend to enjoy lower interest rates on average than countries with large current account deficits — which are handicapped by slower growth and higher debt.
The United States, it turns out, does not need foreign purchases of government bonds to keep interest rates low any more than it needs a large trade deficit to keep interest rates low. Unless the United States were starved for capital, savings and investment would balance just as easily without a trade deficit as with one.
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Only the U.S. economy and financial system are large enough, open enough, and flexible enough to accommodate large trade deficits. But that badge of honor comes at a real cost to the long-term growth of the domestic economy and its ability to manage debt levels.
For the reasons outlined by Pettis, China – which has the world’s 2nd biggest economy (or 1st … depending on the measure used) – doesn’t want the burden of housing the world’s reserve currency.
As such, China is pushing for a basket of currencies to replace the dollar as reserve currency.
Indeed, China – as well as Russia, the U.N. and many other countries and agencies – have called for the “SDR” to become the new reserve currency. SDR stands for “Special Drawing Rights”, and it is a basket of 4 currencies – the US dollar, Euro, British pound, and Japanese yen – administered by theInternational Monetary Fund.
Jim Rickards – one of the leading authorities on currency, having briefed the CIA, Pentagon and Congress on currency issues – says:
China is not buying gold to create a new gold standard; rather it is aiming to make the Yuan more attractive, with the end result of being included in a basket of currencies, referred to as the Special Drawing Rate (SDR). He added that there is a move to make the SDR the new global reserve currency.
“Everybody knows that the U.S. dollar’s days are numbered but there is no really currency to take its place except for the SDR,” he said. “What the world is trying to do is move to the SDR and China is fine with that.”
Rickards added that China’s goal of being in an SDR basket is the best of both worlds; the country can still have total control over its monetary policy and capital accounts but still influence global economics by being part of a basket of currencies.
“What the Chinese want is to have the Yuan in the SDR basket but not open up their capital account,” he said. “That is a backdoor way for the Yuan to be a de facto reserve currency without having to give up control.”
What’s Missing?
It is silly to exclude the Yuan from the basket of currencies.
Indeed, given that there are privileges and burdens of having the reserve currency, I would argue that – if we are going to move away from the dollar as sole reserve currency – all of the currencies of the world could be in the basket … in proportion to the size of their economies. It is simple to look up theGDP of the world’s nations.
That way, each country would all share in the benefits and costs, in proportion to its size and strength.
(Obviously, some countries have such small or unstable economies that no one would want to settle in their currency. To be realistic, they’d probably be dropped out of the basket. But the ideal of including everyone is worth maintaining.)
Keynes and Other Economists Say We Should Use a Basket of Commodities
While having a basket of different things acting as the world’s reserve currency may sound like a new idea, John Maynard Keynes – creator of our modern “liberal” economics in the 1930s – promoted a basket of 30 commodities called the “Bancor” to replace the dollar as the world’s reserve currency.
The arguments for currency fixed on a basket of commodities – as opposed to currencies – was that it would stabilize the average prices of commodities, and with them the international medium of exchange and a store of value.
As China’s head central banker said in 2009, the goal would be to create a reserve currency “that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies”. Likewise, China suggestedpegging SDRs to commodities.
Economics Professor Leanne Ussher of Queens College in New York concludes that a reserve currency made up of a basket of 30 or so commodities would:
Reduce the disorderly swings in individual commodity prices … reduce supply constraints, stabilize costs of production, promote global effective demand from the periphery and balance growth between periphery and core countries.
Monetary expert Bernard Liataer – formerly with Belgium’s Central Bank – writes:
The idea of a commodity-based currency may seem to some a step backwards to a more primitive form of exchange. But in fact, from a practical point of view, commodity-secured money (for example, gold- and silver-based money) is the only type of money that can be said to have passed the test of history in market economics. The kind of unsecured currency (bank notes and treasury notes) presently used by practically all countries has been acceptable only for about half a century, and the judgment of history regarding its soundness still remains to be written.
With a commodity-based currency, a central bank could issue a New Currency backed by a basket of from three to a dozen different commodities for which there are existing international commodity markets. For instance, 100 New Currency could be worth 0.05 ounces of gold, plus 3 ounces of silver, plus 15 pounds of copper, plus 1 barrel of oil, plus 5 pounds of wool.
This New Currency would be convertible because each of its component commodities is immediately convertible. It also offers several kinds of flexibility. The central bank would agree to deliver commodities from this basket whose value in foreign currency equals the value of that particular basket. The bank would be free to substitute certain commodities of the basket for others as long as they were also part of the basket. The bank could keep and trade its commodity inventories wherever the international market was most convenient for its own purposes–Zurich for gold, London for copper, New York for silver, and so on. Because of arbitrage between all these places, it doesn’t really matter where the trades would be executed, as the final hard currency proceeds would be practically equivalent. Finally, since the commodities also have futures markets, it would be perfectly possible for the bank to settle any forward amounts in New Currency, while offsetting the risks in the futures market if it so desired.
This flexibility results in a currency with very desirable characteristics. First of all, the reserves that the country could rely on–actual reserves plus production capacity–are much larger than its current stock of hard currencies and gold. The New Currency would be automatically convertible without the need for new international agreements. Since the necessary international commodity exchanges already exist, the system could be started unilaterally, without any negotiations. Because of the diversification offered by the basket of several commodities, the currency would be much more stable than any of its components–more stable, really, than any other convertible currency in today’s market.
3 Choices for a More Stable Money System
The 2 choices for reserve currency discussed above are using a (1) basket of currencies or (2) basket of commodities.
A third choice – which may be the best – is to use a mixture.
For example, we could have 50% currencies and 50% commodities.
That would give us some of the desirable characteristics (like stability) of a commodity basket, but not immediately move away from the fiat money systems which are now status quo for the current system.
Any of these 3 choices would give us far more stability and prosperity than we have today … without the chaos and misery – especially for Americans and perhaps Chinese – that switching to a Yuan-only reserve currency would bring.
Notes: You might assume that public banking advocates would be for a currency-only basket. But Bernard Lietaer was one of leading public banking advocate Ellen Brown’s main teachers, and he is pushing for a basket made up solely of commodities. (But public banking advocates might argue for adding currencies to the basket currencies to allow for some elasticity in the money supply.)
Gold standard advocates would obviously prefer commodities to currencies. A basket of commodities might not have the simplicity of a gold standard, but it would accomplish a lot of the same goals.
As an American who wants stability and prosperity for my country, I think a basket would be the best option for a healthy future for the U.S. And as someone who wants good things for the rest of the world, I believe that a basket would help to share political influence more widely.
