Goodbye to the Dollar?

World currency standards have enormous inertia. But, as the world’s financial leaders, meeting in Washington this month at the World Bank-International Monetary Fund annual meeting, ponder how to intervene to prop up the dollar, they should also start thinking about what to do when the time comes to pull the plug.

CAMBRIDGE – As the world’s financial leaders meet in Washington this month at the World Bank-International Monetary Fund annual meeting, perhaps they should be glad there is no clear alternative to the dollar as the global currency standard. If the euro were fully ready for prime time, we might well be seeing it’s dollar exchange rate jump to over 2.00, and not just to 1.65 or 1.70, as it seems poised to do anyway. You can’t treat your customers as badly as the United States has done lately if they can go elsewhere.

Over the past six years, the value of the trade-weighted dollar has fallen by more than a quarter, as the US has continued to rack up historically unprecedented trade deficits. With a soft economy, a badly compromised financial system, and serious concerns about rising inflation, the long-term dollar trend is downward, however the current crisis ends. And it is not over.

The Federal Reserve’s bailout of the financial system is unlikely to stand up unless banks find fresh capital, and lots of it. Ultra-rich sovereign wealth funds have the cash to rescue US banks. But they are unlikely to want to do so at this point, even if the US political system allowed it. Instead, as the credit crunch and housing price decline continue, an epic mortgage bailout appears increasingly likely, possibly costing US taxpayers a trillion dollars or more. The problem is that after so many years of miserable returns on dollar assets, will global investors really be willing to absorb another trillion dollars in US debt at anything near current interest rates and exchange rates?

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