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Nathan Gardels

Nathan Gardels

Posted April 21, 2009 | 07:38 PM (EST)

The Coming Demise of the Dollar Reflects the Rise of the Rest


One of the more momentous power shifts in the last 500 years is taking place as we sift through the debris of America's busted credit bubble. The dominance of the West built up across those centuries is now yielding to the East. The latest sign of this shift is that those nations with surplus savings earned through our over-consumption of imports -- in particular China -- are proposing a new global reserve currency to replace the waning dollar. In order to protect their accumulated assets and diversify their risk they want to store their wealth in a basket of currencies instead.

I spoke with former World Bank chief economist and Nobel Laureate Joseph Stiglitz to ferret out the key issues:

Gardels: Among Obama's many challenges, isn't the overarching one correcting the imbalance in savings and consumption between the U.S. and China?

Stiglitz: In a globally integrated economy, the biggest challenge is to make sure there is adequate global aggregate demand, achieved through spending, when countries like China feel they must save high levels of dollar reserves to protect against international currency volatility.

After all, China's accumulation of reserves is a result of the IMF's mismanagement of the Asian financial crisis a decade or so ago. If countries know they can't rely on the IMF to help them, their best defense is their own reserve cushion. In a time of spreading global recession, too much emphasis on savings in surplus countries like China can impede prospects for global growth.

Gardels: Getting worried over the value of their billion-plus holdings in dollars as U.S. deficits mount and inflation threatens down the road, the Chinese have proposed a new global reserve currency based on a basket of currencies instead of just the dollar.

Is such a new currency a good mechanism for undoing the imbalance with a soft landing instead of the crash of the dollar, which would hurt the Chinese as well as the U.S.?

Stiglitz: The proposal for a new global reserve currency -- or Special Drawing Rights (SDR) -- is a good idea for many reasons. Yes, for the Chinese it would cushion any fall in the value of the dollar per se because it would only be part of a basket of other currencies, including the yen and the euro. But, above all, a new basket reserve currency would stimulate global aggregate demand by vastly reducing the fear of currency volatility, which, as I said, is what has led countries like China to put away so much money in reserves instead of spend it.

There are other benefits. As a matter of sound economics, the well being of the world should not depend on the management of a single currency. Currency risk would be diversified through a basket reserve unit, creating stability and confidence all around. Finally, there is an equity issue. Because the dollar is the reserve currency of the world, especially in a downturn where investors flee to safety, the U.S. can suck up the savings of the rest of the world even though the interest rates it pays are near zero. That would not happen if there were a global basket reserve currency.

Gardels: What would it mean for the U.S. if the dollar were replaced by a new global currency?

Stiglitz: Actually, it would be very much in the long-term interest of the U.S. because it would help de-financialize the American economy. Of course, the U.S. gets a bit of a break by being able to borrow at low costs from the rest of the world. But that comes at a macroeconomic cost at home. One way of looking at it is that the U.S. has turned to exporting T-bills instead of automobiles or other commodities. Global demand for dollars has supplanted demand for manufactured goods and services, resulting in multilateral trade deficits and loss of jobs at home.

Gardels: At their summit in London recently, the G-20 leaders decided to create $250 billion in new SDR. Is that an important step on the way to creating a new global reserve currency?

Stiglitz: I think it is. The question is how quickly it happens. In my view, though, the IMF is not the best place from which to launch this currency unless it becomes a more fair and balanced institution that represents the real world economy instead of the post-World War II powers, dominated by the United States. The East Asian countries, Brazil and others need a much greater say.

For example, of the $250 billion in SDR committed, only $19 billion was allocated for developing countries. So, the idea of greater SDR is a good one. The institution is flawed.

Gardels: Even so, the fact that the Chinese have proposed a new global SDR currency and the G-20 has taken a step toward its creation surely marks a powershift in the world?

Stiglitz: Without question, it is a recognition of the reality of a genuinely multipolar world that requires moving to a genuinely multilateral system of governance. The powershift began already several years ago, under the Bush administration, when the dollar became very volatile and started declining. That is when China shifted from having almost 100 percent of its reserves in dollars to 75 percent. Some countries went completely out of the dollar. The dollar, for all intents and purposes, lost its special reserve status and people starting talking about a portfolio, or basket, approach as a store of wealth instead of the dollar.

The momentum today behind the idea of a new global reserve currency reflects, in effect, the rise of the rest in world politics and economics, led by China.