Dollar’s Last Lap

Dollar’s Last Lap As The Only Anchor Currency
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By Wolfgang Munchau, FT | 25 November 2007

It has been one of the most influential theories about exchange rates in the age of globalisation and it may be about to go up in smoke. In 2003, the economists Michael Dooley, David Folkerts-Landau and Peter Garber* proposed what has since become known as the Bretton Woods II theory. The idea is based on the observation that newly industrialised countries peg their currencies to the dollar at an undervalued exchange rate in pursuit of export-led growth. In return, they reinvest their loot back into the US, which acts as an anchor and consumer of last resort. I can think of two scenarios. The first is that the dollar’s global monopoly will give way to a duopoly of the dollar and the euro. It is impossible to predict the timing of any such shift. Over time, as countries replace a dollar peg with a mixed basket peg, they are likely to readjust reserve portfolios as well. Another, at least theoretical possibility is the emergence of regional exchange rate regimes, along the lines of what happened in Europe after Bretton Woods I. There has been a lot of talk for a long time about Asian monetary union, with little progress so far. Either way, we are probably in the last long lap of the dollar as the world’s only anchor currency. We do not yet fully comprehend the new era, but it is fair to say that it is probably not going to be Bretton Woods III.

AntiSpin by Eric Janszen, iTulip:

Each person I have interviewed over the past year and a half has contributed at least one major insight to my understanding of how the aging international currency regime will go through a long overdue transition. Neither scenario Munchau forecasts will happen, and I'll tell you why.

Jamie Galbraith noted that a multilateral dollar/euro/yen global monetary system is limited by lack of a euro bond market, that is, while there is a market for German bonds in euros and French bonds in euros, etc., there is no institution that acts as a "euro Treasury" as a U.S. Treasury or Japanese Treasury functions, that is, no centralized euro bond institution. How can any currency act as a true global reserve currency without such an institution?

Louis-Vincent Gave of GaveKal contributed the insight that in an economic crisis the lack of a euro bond Treasury authority raises deflationary threats because inflation via bond monetization cannot be coordinated across the euro zone. This helps explain the recent investor rush during the credit crisis to short term treasury bonds while euro denominated bonds have not participated.

I have long warned that the euro is not stress tested. My seemingly odd obsession with gold over the euro as a dollar hedge since 2001 is predicated on worries about how the euro will fair in a crisis as national needs overwhelm euro loyalties. These appear, unfortunately, to be coming to pass.

Eurozone Split As Bond Spreads Hit 6-Year High Nov. 23, 2007 Ambrose Evans-Pritchard— Telegraph UK) Investors in Europe have suddenly become wary of Italian, Greek, Spanish, and Belgian sovereign bonds, driving spreads over German government bonds to the highest level in six years. Belgian Treasury Promises No Default Yields on Italian 10-year bonds rocketed to 40 basis points over comparable German Bunds today as the flight to safety gathered pace. The spread had been stable at around the mid 20s for several years until this month. The scramble to dump riskier bonds hit all the southern European countries, as well as Ireland and Slovenia. While the markets have not begun to discount a possible break-up of the eurozone, they are clearly pricing in an ominous rift between the Latin and Germanic halves of the monetary system.

Ambrose Evans-Pritchard is getting carried away looking for European nations to split with the euro near term. I don't see that as a possibility unless and until a severe global recession spans European national elections.

Getting back to Munchau's report, regional currency regimes may be an outcome of the global currency regime crisis but cannot forestall the crisis.

I'm sticking to my 2001 forecast of a global currency crisis, emanating from a U.S. economic recession, as the most likely forcing function for a new global currency regime. A new regime can only be created out of crisis because the transition costs to a new global monetary system are too high for each member of the system, or even for members collectively, to initiate or achieve avoidance of crisis through negotiation.

Dr. Hudson's contribution to my thinking in our interview this summer is that this ongoing currency and credit crisis can be viewed as a geopolitical "jump ball." Global players over the past few years have been pre-positioning for the grab. This gives context to otherwise inexplicable developments, such as the U.S. invasion of Iraq on a weak pretext, Putin's apparently urgent grab for power, and the development of new political and military alliances among oil producers and consumers.

Testing readers' patience by switching metaphors to poker, the U.S. held all of the cards after the long monetary crisis that started in the early 1930s and ended after WWII at Bretton Woods with a gold-based dollar standard in 1944. Almost 30 years later the U.S. still held enough cards in 1971 to force the world onto a U.S. Treasury dollar standard. Going into this new crisis, we need to ask, who holds which cards and how will they be played? If we understand that, then we understand how the crisis is likely to turn out.

Bretton Woods II is a fiction. The shipping of oil exporters' and Asian nations' economic surplus to the U.S. is not a "system" but a crude adaptation of global economic players to an outdated global monetary system, a symptom of enormous mismatches in production, wealth, and money flows that have developed within the confines of U.S.-centric Bretton Woods system.

My conviction is that as there is no single dominant economic, political and military power going into this crisis as in 1944 and 1971, the outcome remains highly unpredictable. It should be remembered that the last major global currency crisis started in the early 1930s. Resolution only arrived with the geopolitical finality of WWII. Assuming the current crisis is not compounded by a global economic recession on a scale which sets nations on unilateral economic defense paths and so does not escalate out of control, only a politically neutral global currency regime is likely to be acceptable to all parties, not one unilaterally dictated by a single dominant power as happened in 1946–because there is no single dominant power today.

Not dollars. Not dollars/euros/yen, either, for reasons discussed, but something else. A fourth currency.

One final point. The financial relationship between the U.S. and its creditors in a global economic crisis is not unlike the tie of a debtor colony to a colonial power. The political relationship is between sovereign nations, but this comes under strain; an severe economic crisis is foremost a political crisis.

The Newfoundland Lesson The relationship between between bondholder and debtor represented by Newfoundland and Great Britain in the 1933 is instructive. The self-governing dominion government of Newfoundland found itself unable to repay the principal on its bonds, and proposed onerous taxes to do so, over the objections of the dominion's parliament. The British Parliament also objected and appointed the 'Amulree commission' to establish/decide on the merits of the matter. The British parliament accepted the proposals of the Amulree commission and passed legislation suspending Newfoundland's status as a self-governing dominion. The Labour Party strongly opposed the Newfoundland proposals on grounds that they were undemocratic and that it was morally indefensible to rescue 'bondholders who had made a bad investment.' The Welsh Labour M.P., David Grenfall, said: "If you invest in coal mines in this country you may lose money, as many investors have lost their money. If you invest in steel or railways you stand a chance of losing. Why should this (moneylending) class be subjected to special government protection, and why should we and the poor people of Newfoundland be pledged bodily, physically, socially, to guarantee the claims of the bondholders?" The Labour leader, Clement Attlee, suggested that default was preferable to giving up democracy. Referring to Britain's own default on its wartime loans from the United States, he said "All the best countries default nowadays." But in the early 1930s it was impossible to imagine a British dominion defaulting. In 1932, the provincial premier of New South Wales, Jack Lang, had proposed to default on the state's debts. He was promptly dismissed by the royal Governor and went on to lose an election for the provincial parliament. As with Gough Whitlam in 1975, the voters upheld the prerogative of the crown to dismiss prime ministers threatening the law or unable to obtain the wherewithal to honor sovereign debts. In the world of the early 1930s, it was commonly accepted that democracy should be subordinate to debt. Of course, I'm not suggesting that Asian creditors are in a position to force the U.S. into giving up its sovereignty. The point is that debts form the nexus of deep political conflicts; as the next global recession unfolds, the political debt to Asia represented by U.S. financial debt to Asia should not be understimated.

  M O R E. . .

Normxxx    
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