Implications of Dollar Losing Sole Reserve Status?

[jimmygu3]

Dear iTulip,

It is often said on this site and elsewhere that the US dollar plays by different rules than other currencies because of its status as a reserve currency. Exporters' dollar pegs keep goods prices low even as the US runs unprecedented current account, trade, and budget deficits. FCBs invest in Treasuries with tiny real yields just to keep the game going.

Let's assume that the dollar is replaced by a mixed reserve basket. What would be the most likely items in that basket? Dollar, Euro, Yen, PMs? Would this system even be possible or sustainable without a Euro bond market? What is your best prediction of what this reshuffling of the cards would do to the dollar's exchange rate, the US economy, consumer prices and asset prices? Would this put more pressure on the US to be fiscally responsible and give the EU and Japan more leeway to engage in the excesses the US has enjoyed since Bretton Woods? Or might all currencies in the basket get into a printing press "arms race", inflating to keep up with the others?

Sorry for all the questions but hey- the section is called Ask iTulip! Thanks!

Jimmy

[jk]

Re: Implications of Dollar Losing Sole Reserve Status?

i think this is a great question, by which i mean it is both thought provoking and [for me, at least] unanswerable. i think there will be more chaos than your question assumes. to say the dollar is replaced by a mixed basket carries an implicit notion that the basket is defined, while i think the dollar is already being replaced by an undefined and varying mixture of other reserves. every country said to be "diversifying" is picking up euros and yen and british pounds and perhaps swedish krona, swiss francs, gold and god knows what else: collectible porcelain figurines and commemorative plates? the swf's can be viewed as another form of diversification, so to your basket you've got to add stock purchases like abu dhabi's in citigroup, acquisitions [rumor has it that the chinese fund and the chinese steel makers are preparing a bid for rio tinto], private equity investments, and so on. so don't restrict your thinking to just currencies.

What is your best prediction of what this reshuffling of the cards would do to the dollar's exchange rate, the US economy, consumer prices and asset prices?

this is not a theoretical question. go to bloomberg.com and what you see is what this process is doing to the dollar's exchange rate, u.s. economy, etc. the dollar will continue to drop, the u.s. economy is affected by this but not as much as it is being affected by various other processes.

[DemonD]

Re: Implications of Dollar Losing Sole Reserve Status?

go to bloomberg.com and what you see is what this process is doing to the dollar's exchange rate, u.s. economy, etc. the dollar will continue to drop, the u.s. economy is affected by this but not as much as it is being affected by various other processes.

I just had a thought. This process, if it continues, wouldn't it lead to the following:

1. Less FIRE jobs because of less investor demand for dollar denominated assets
2. More consumer/production economy due to the fact that global wage arbitration will lead to US labor becoming more economical

And wouldn't that be a great thing overall?

By the way I believe this is indeed happening. Not that US labor will be "cheap" by global standards in the next 5 years, but when you see that prices and wages in China are accelerating, and US trade deficit is starting at least to move back in favor of the US, it is a possibility isn't it?

As anecdotal evidence, I offer tourism: For many decades it was americans going to europe, australia, etc. And of course many still do. And the typical tourist coming to the US was a Japanese family with a video camera. But if you go to any national park, ski slope, or resort/vacation destination, you will find nowadays many more non-english languages and many many more tourists from outside the US than just 10 years ago.

Of course I know the caveat to that is the FIRE economy is embedded in politics and won't like this to happen, but if it were to organically play out in a truly free market I believe that is what we would see.

[Spartacus]

Re: Implications of Dollar Losing Sole Reserve Status?

I just had a thought. This process, if it continues, wouldn't it lead to the following:

1. Less FIRE jobs because of less investor demand for dollar denominated assets

Exactly the opposite. FIRE has the political lobbying boots on the ground to get more tax incentives and bailouts passed.

If not in absolute numbers, then at least relative to manufacturing, FIRE will come out ahead, IMHO.