Is the Dollar Doomed?

World War II wreaked havoc on European powers; the exchange of bombs and artillery fire, the ravaging of invading troops, the crush of total warfare left battered cities and tattered souls. The United States, aside from relatively minimal damage in places like Pearl Harbor, escaped unscathed as the new economic global powerhouse. At a meeting in 1944 (Bretton Woods), the Allies agreed to peg global finances to the U.S. dollar, a currency which was then backed with solid gold ingots… the obvious choice given the devastation of the war.

In 1971, under President Richard Nixon, reversed the policy of backing U.S. currency with gold, and allowed the dollar to float freely in the global marketplace. Despite the erosion of the Vietnam War, the American economy was by far the strongest in the world and had no really serious challengers – not even the Soviet Union, which ultimately collapsed. But the Vietnam War was another net deficit drain on our federal budget, and we had borrowed heavily to meet the costs of that conflict. Borrowing was relatively easy, since the dollar was the currency that the world required for global transactions, so selling dollars was not particularly difficult.

That was then. You may have noted (especially if you read my blog regularly) that before recent London meeting of the G-20 nations (with President Obama in attendance), economic superpower China (and a few other nations) seemed to demand that the U.S. dollar no longer be used as the world’s “super sovereign reserve currency.” Indeed, China chaffed at the notion that the International Monetary Fund (a global fund used to distribute money to nations in need) – which is headquartered in Washington, D.C. and heavily influenced by America policy-makers – continue to hold its reserves in U.S. dollars. China saw the specter of hyper-inflation of the U.S. dollar, a, “inevitable” devaluation based on what they perceived were excessive borrowings by the U.S. government resulting from our huge new deficits.

China didn’t win this round, but the writing was on the wall. Would the Chinese Yuan or the European Euro become the next global reserve currency? Would the dollar remain unchallenged? Or was some other “currency substitute” rising as a likely substitute? Enter an old concept, actually currently in existence and in actual use, called a “special drawing right” (SDR) currency. Invented in 1969, the SDR is really a currency aggregator, and the format in the market right now is a blend of dollars, Euros, yen and pounds sterling.

Until the recent G-20 meeting, the last SDRs were created in 1981 with a current total value of about $32 billion (21.4 billion “SDRs”). But one of the most over-looked results of the G-20 meeting was an agreement to create $250 billion worth of new SDRs (which will have a more expanded currency base) as the initial stage of replacing the dollar (well, not entirely, because it will be a major SDR component, at least in the early phase) as the new global reserve currency.

At first blush, it looks like our leaders have sold us down the river by even agreeing to such a dilution in the dollar’s power; after all, it will make it that much more difficult for us to place our debt into the international markets to finance our deficits. But if the writing is already very clearly on the wall, our government’s resistance to this SDR format might have resulted in regional decisions to replace the dollar entirely with another currency – say the Middle Eastern oil powers begin to price oil in Euros only – which could slowly roll into a de facto global reality in the years that followed. In a strange way, our government’s agreement to support an SDR currency that is still heavily dollar-based may have actually extended the dollar’s value as much as possible in the current global market.

I’m Peter Dekom, and I thought this might interest you.