THE ALMIGHTY DOLLAR US CURRENCY STAYING ON TOP RELIES ON OTHER COUNTRIES KEEPING IT THERE

How long will the US dollar remain the world’s reserve currency?

That’s a good question. Let’s start answering it with a Woody Allen joke that goes as follows. Woody Allen is meeting with his psychiatrist. The psychiatrist asks Woody about his problems, and he replies, “my brother is driving the family up a wall. He thinks he’s a chicken. He runs around the house clucking like a maniac. ‘Cluck, cluck-cluck, cluck,’ flapping his arms like they’re wings, and it’s making us all crazy!”

“Have you told him he’s not a chicken?” the psychiatrist asks.

“No,” says Allen.

“Why not?”

“Because we really need the eggs.”

Believe it or not, by the time you’ve finished this column, this joke will tie directly into the question I introduced in the first sentence. But first it would be good to understand what is meant by a “reserve currency” and why it’s currently the US dollar. The story starts in 1944 with the Bretton Woods Agreement. Those of you familiar with history will recognize that the Second World War was raging, but it seemed certain that the days of Germany and Japan were limited, and the Allied Powers would ultimately triumph.

All told, 44 countries met at Bretton Woods and agreed that the best system to manage currency exchange in order not to disadvantage anyone would be to maintain fixed exchange rates with the US dollar. There were several reasons why the USD was chosen. First and foremost, America was clearly going to be the single global super- power after the devastation that had been wrought on the European continent. And second, the dollar itself was linked to gold, which meant that there was something inherently anti-inflationary about this currency compared to others.

As Good As Gold

And that’s how the US dollar became the world’s reserve currency. The 44 nations unanimously agreed that they would accept US dollars as payment for international transactions. Central Banks around the world began to accumulate dollars (or greenbacks) because they were almost literally as good as gold. That is, until 1971 when President Richard Nixon closed the gold window. Which meant from that point forward, foreign governments would not be able to exchange their dollars for gold. Post 1971, all the world’s currencies were fiat, that is, there was nothing tangible behind any of them.

Then why has the US dollar remained the world’s reserve currency? In 1971, the US economy accounted for 35 per cent of global GDP. The most recent numbers suggest that this percentage has declined to 24 per cent, but that’s still pretty impressive for a country that has four per cent of the global population. However, more significantly, the US currently spends more on its military than the next 10 countries combined. And that, to me, is the decisive reason why the US dollar will remain the world’s reserve currency for the foreseeable future.

By the way, I don’t think that being the world’s reserve currency has been good for America. Due to the fact that many countries have been buying up greenbacks for years, the dollar is more expensive than it should be, and interest rates in the US have been artificially low for decades. This has allowed the country to be slothful with its fiscal policy, running deficits year after year which is precisely what was anathema to the thinking of John Maynard Keynes. He believed that deficits were necessary when the economy was weak, but during the upswing of the business cycle, debts incurred should be retired.

YUAN RISING?

A few months ago, the story emerged that Saudi Arabia was seriously considering accepting payments for oil in the Chinese Yuan, rather than the US dollar. Currently, the world prices a barrel of oil in USD. If Saudi Arabia ever made this move, it seems to me that this could be the first domino to fall. Doesn’t it stand to reason that other OPEC members, like Kuwait and Venezuela, would follow? For that matter, I wouldn’t be surprised if Russia isn’t already accepting yuan for its raw material exports to China.

Now let’s get back to the joke that started this column. Why is it so funny? Yes, it’s ludicrous that a human can lay eggs. But if the joke stopped there – ‘my brother thinks he’s a chicken and he’s laying eggs’ – we wouldn’t find it nearly as amusing. It’s the fact that while Woody Allen on one hand resists the notion, he thinks that if he stops going along with it, then the eggs will stop as well. It points to the power of self-fulfilling prophecy. Which is a longwinded way of saying that the US dollar will remain the world’s reserve currency just as long as the rest of the world believes it is in their interest to make it so. And it’s pretty much as simple as that. SP