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The Dollar Unbound

VIENNA: Whenever world currencies go haywire, pundits try to make sense out of chaos by focusing on factors specific to each crisis: the 1970s oil price shocks, the 1982 Latin American debt crisis, today’s Asian crisis. But the roots of these crises stem not from discrete, particular causes like war or the fall of the Shah of Iran, but rather from an oft-ignored quirk in the international financial system: the system lacks a true global currency.

Since World War II the role of global currency has been played by one national currency: the US dollar. Most international loans and almost all global commodity exports are priced in dollars. Before 1971, a system of fixed dollar exchange rates (the Bretton Woods regime) existed. Ever since its collapse, currencies have "floated." But the power of US monetary authorities to engineer swings in nominal interest rates is incompatible with a stable world currency supporting a sustainable expansion of world trade and income.

Why? Swings in US nominal interest rates cause swings in dollar exchange rates. Declining US nominal interest rates lead to dollar depreciation as the attractiveness of investing in dollar assets decreases. Shifts in dollar interest rates and dollar exchange rates also induce large income shifts between developing and industrialized countries.