American led new trade protectionism - Part I:

World currency: A recipe to end dollar dominance

Hema SENANAYAKE

Continued from yesterday

The unexpected result of this prosperity was the accumulation of dollar reserves in European Central Banks. Had they demanded to exchange those dollars into gold under the Bretton Woods Agreement, the US did not have sufficient gold to honour its obligations. Realizing their dollar reserves and assets would be worth nothing if the U.S. abandons the Bretton Woods Agreement, General de Gaulle of France demanded to go back to gold standards.

America shrugged away such demands and unilaterally jettisoned the agreement on August 15, 1971. The immediate result was the devaluation of the dollar. For example by the end of 1974 Europe had to tender 183 dollars to purchase 01oz. of gold.

Devaluation of dollar

The European response was to come up with a plan for a new currency for them. As a result by the end of the 20th Century, the dollar got a competitor; the Euro.

The current economic fundamentals are such that the dollar should devalue. The devaluation of the dollar or inflating the system is essential to cancel part of un-repayable debt accumulated by the US.

The Government and by its people as individual consumers, especially to get over with the current recession meaningfully to go for another growth cycle.

U.S economic scholars and policy makers know about it. For example Prof. Nouriel Roubini, senior adviser to US Treasury Secretary at the beginning of the recession said, “Rescues can occur via over Government assumption of bad debt, inflation, or both.”

So they know that inflation or ‘inflationary solution’ should play a role in solving the crisis.

However, on the other hand China has been against any devaluation of the dollar. This sentiment was openly articulated by Chinese Premier Wen Jiaba. On March 13, 2009 he said at a press conference. “Of course we are concerned about the safety of our assets. To be honest, I’m a little bit worried, I would like to call on the United States to honour its words, stay a credible nation and ensure the safety of Chinese assets.”

The US would have shrugged away the Chinese demand as they did for the demand of General de Gaulle in the 1960s.

Reserve currency

However, the US does not want to do it this time around, not because the dollar has a competitor; the Euro but because China put forward a proposal to set up a non-country based world currency for international trade and to be used as the world reserve currency. It is a recipe to end dollar dominance. Governor of Chinese Central Bank Zhou Xiaochuan posted a studious article in March 2009 articulating this proposal in the bank’s official website.

Current system

He wrote “The desirable goal of reforming the international monetary system, therefore, is to create an international 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.”

He further wrote “The acceptance of credit based national currencies as major international reserve currencies, as is the case in the current system, is a rare special case in history.

This is not to create a competitor to the dollar. The US doesn’t care for having another competitor or dozens of competitors for its dollar. But the Chinese proposal is to end the dollar dominance completely. This again is not like de Gaulle’s demand. It is a proposal to find the paper version of gold so that such a currency has the stability and flexibility to facilitate the ever-expanding world trade. Therefore it had a much greater impact than de Gaulle’s.

So, the U.S. responded quickly. On April 4, 2009, China Daily reported “US President Barack Obama, Treasury Secretary Timothy Geithner and Federal Reserve Chairman Ben Bernanke reacted quickly to Zhou’s article, saying there was no need for a new global currency as an alternative to the dollar.”

The Chinese factor

Due to the Chinese factor now the US is left with only one option to resolve the recession that is to absorb bad debt by the government as much as necessary to revive the economy. The US cannot use the “inflationary solution” however much it needed, in view of the Chinese proposal for a world currency. If the US failed to stabilize the dollar and save Chinese reserves and dollar based assets it will sure go ahead with their proposal to establish a non-country based world currency which already gained the support of Russia, Brazil and several other countries.

However, the continued US trade deficit is detrimental to stabilize the dollar. According to many economists two percent of trade deficit, which is the case now for the US is a conservative figure. But a continuing trade deficit has a very negative impact on the domestic economy other than accumulation of dollars in foreign Central Banks.

The trade deficit is one important factor that leads U.S. consumers to borrow more to pay for their consumption. That will increase the consumers’ debt to income ratio faster which in turns leads to debt crises in short time intervals; transform such crises into banking and economic crises.

In view of above now the US needs to contain its trade deficit at least to lengthen the time of periodic crises. One way of reducing deficit is to revert back to protectionism. Is this the reason behind Obama’s imposition of a new tariff on Chinese tires?

Concluded