The Buck Stops Here

The nation’s economy is struggling. The country’s most fundamental problem is the decline in traditional export industries. It has become a nation of consumers that produces less and less, and the resultant balance of payments problem is like a noose around its neck. The nation is relying on imports to sustain the lifestyle of its citizens, who live beyond their means. At the same time, capital flows out of the country, leaving the nation’s industry lacking investment. Long-term unemployment is an escalating problem. The currency’s value is undergoing a continual decline, and economic competition is arising from other countries as they narrow the technology gap.

No, this is not the United States. This was Britain, 80 years ago, in the twilight of the pound sterling’s reign as the world’s reserve currency.

The dollar has long enjoyed the same glory that sterling had at the beginning of the 20th century. For over half a century, the dollar has reigned supreme, enabling the United States to consume endlessly in exchange for little pieces of greenbacked paper. Approximately 70 percent of currency reserves in world banks are U.S. dollars. Half of world trade is conducted using dollars. The world’s main commodities are priced in dollars.

Over recent months, however, the value of the dollar has dipped lower and lower. Economic analysts and the media have expressed the possibility of an end to dollar dominance and its status as the world’s reserve currency. Could it be that U.S. dollar-based financial hegemony is near its end? Is the dollar to suffer a similar fate as the pound sterling? If history is any guide, the answer is yes.

Sterling’s Fall

At one time, Britain found itself in a world-dominating economic position, much as the U.S. has enjoyed since World War ii. Britain’s empire extended around the world, and it boasted a dynamic yet stable, trade-based economy. Backed by gold, sterling had the confidence of the world—literally being as “good as gold.” For over a century, it was the “global economy’s lifeblood,” as the London Telegraph put it. It certainly must have seemed that the pound would never falter. Likewise today, many cannot imagine an end to dollar dominance.

Leading up to sterling’s decline, Britain ran gargantuan deficits. World War ii dealt a further blow to Britain’s already ailing economy, leaving the nation and its empire with debts amounting to $30 billion. “[T]he deficits grew so large that it became impossible to defend sterling” (Spectator, Oct. 18, 2003).

Today, the U.S.’s $600 billion trade deficit (which has virtually doubled in five years) —in addition to its gigantic budget deficit —has passed all records.

At the same time as pre-World War ii Britain was weighed down by its huge deficit, its industrial capacity was declining and its coal industry failing. America’s unprecedented deficits are also coupled with a dramatically shrinking industrial base.

Again, just as Britain faced challenges to its technological supremacy from industrializing countries, so today the U.S. is facing the prospect of technological challenges, particularly from Europe. In an article titled “Battle Over the World’s Reserve Currency,” the Independent described how long-term trends in the scientific and mathematical fields show a shift away from the U.S. toward Europe (Oct. 21, 2003).

Finally, confidence in sterling waned as the nation could not meet its financial obligations. Similarly, America’s habit of consuming the world’s goods and services in exchange for paper dollars (in reality, only enlarging the deficit) is increasingly being seen as unsustainable. Just as investors turned away from Britain, “global investors are beginning to lose faith in the greenback” (Spectator, op. cit.). This is significant because, after all, the role of a reserve currency is underpinned by confidence.

Howard Wachtel, professor of economics at American University, described the obligations of a reserve currency country as being two-fold: to “provide worldwide liquidity, [which] requires a predictable economic growth path”; and to be the “lender-of-last-resort, to sort out debt problems.” While doing so, the country must maintain “a reasonably stable set of internal and external currency values.” Wachtel says that “Absent these stable conditions, countries become reluctant to hold this currency as a reserve …” (Le Monde diplomatique, October 2003).

So, are conditions developing in the U.S. economy such that countries will become reluctant to hold its currency as a reserve? Consider some current indicators that confirm what history teaches us.

Exodus From the Dollar

Already, investment coming into the U.S. in some areas has begun to falter. The most dramatic example involves foreign direct investment (fdi), which plunged 56 percent from 2000 to 2001, and then a further 64 percent the following year (Investment Dealers Digest, Aug. 11, 2003).

The value of dollar reserves overseas is declining (Le Monde diplomatique, op. cit.). The euro is increasingly being used as a reserve currency, with global foreign exchange reserves having “risen substantially over the last years,” according to Ulrich Preuss, vice-president of the Berlin and Brandenburg Division of Germany’s federal reserve bank, the Bundesbank.

In a speech before the Economic Club of New York in November last year, European Commission President Romano Prodi related how “[i]n just a couple of years, the euro has established itself as the second-most-important currency after the U.S. dollar on the world’s financial markets.” He then gave some rather startling figures. By mid-2003, the share of bonds and notes issued in euros had increased to 41 percent of world issues, with the dollar’s share only slightly ahead, at 43 percent. Moreover, by the same time, money-market instruments denominated in euros, at almost 46 percent of world issues, had overtaken those issued in dollars, which had fallen to 30 percent. Less than five years earlier, the euro’s predecessor currencies accounted for only about 17 percent, compared to 58 percent for the dollar.

In trade, according to the Pakistani newspaper Dawn, the dollar is being replaced by the euro in business between European companies and non-U.S. businesses (March 17, 2003). There is talk of the euro replacing the dollar in oil sales, with Russia already declaring its desire to denominate its oil sales in euros. In an ominous message for the U.S., the Daily Telegraph noted that, historically, “When Saudi Arabia’s oil company announced that it would settle accounts only in dollars, rather than dollars and sterling, the effect on the pound was immediate and close to catastrophic. It marked the end of sterling as a reserve currency” (Oct. 11, 2003). The dollar is threatened with the same fate.

A leading South African financial services group warned last year, “Although a change in a monetary system may seem hard to imagine, it has happened historically and it could happen again” (www.StenhamGestinor.com, August 2003). Stenham Gestinor went on to explain its concern for the U.S.’s financial position and advised investors of alternatives. “It would seem unsustainable that the currency of the world’s largest debtor nation should also constitute the monetary standard of the day. At some point the buyers of dollars may stop to question the blind faith they have displayed to date.” Just as shareholders in any company want out if their shares continually decline in value, so ultimately will holders of a declining currency.

History is witness to the inability of a country to sustain a reserve currency and a large deficit indefinitely. One day, America will find that the dollar’s friends will flee. As Dawn predicted, a day of reckoning will arrive: “That day could come in around five years” (op. cit.).

Day of Reckoning

Today, the position of the dollar is well known as it falls to record lows against the euro, creating regular headlines around the world. “The dollar is on its knees,” said Merrill Lynch economist Andrew Roberts (Daily Mail, London, Dec. 9, 2003). The Mail went on to say, “If the dollar’s decline continues it will put pressure on its status as the world’s sole reserve currency.” Indeed, as the Spectator reports, “the U.S. currency is already under siege as never before” (op. cit.).

History warns of the end to dollar supremacy —but only when there is another currency in a position to replace it. There is much talk of the euro pushing out the dollar in the future. At this stage, various realities belie this possibility, namely the relative strength of the American and European economies. But Europe’s economic influence is growing and in the future will become dominant (see “Trading Places,” in the November 2003 Trumpet).

Euro dominance in world markets has been an EU goal from the euro’s inception. Virendra Singh, a former World Bank and U.S. Treasury economist, points out that the eurozone’s “political leadership is quite straightforward in saying they want a strong euro, and they want the euro to be a reserve currency …” (Investment Dealers Digest, op. cit.).

At the same time, we see Nobel Prize-winning economist Robert Mundell, who laid the groundwork for the euro, calling for a new international currency to replace the dollar (www.EUobserver.com, Jan. 5).

Indeed, we do not know if it will be the euro that in the future will supplant the dollar, but we do know, as the Trumpet has often prophesied, that the U.S. financial system will collapse and be replaced by a European-dominated system.

When a viable substitute emerges, the dollar’s supremacy will be history.