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The Replacement of the Dollar as World’s Reserve Currency

Presidio Economics | Friday July 1st, 2011 | 1 Comment

This post is part of a blogging series by economics students at the Presidio Graduate School’s MBA program. You can follow along here.

By Dustin Haggett

Dr. Barry Eichengreen, professor of economics and political science at UC Berkeley, is no different from a slew of economists who believe the greenback’s long run is nearing an end. An article published in the Wall Street Journal in March explains his reasoning. It also cites how the end of the dollar’s status as a reserve currency has serious implications for the US economy.

The US has gone to extraordinary lengths to maintain the dollar’s status as the world’s reserve currency. One example of this is the US agreement to provide the Organization of Petroleum Exporting Countries (OPEC) military support and weapons deals in exchange for only accepting dollars for its oil. Because foreign countries can only purchase oil with dollars, they are forced to keep a large amount on hand (Eichengreen, (2011). According to the article more than 60% of foreign reserves are held in dollars or dollar denominated assets.

Eichengreen goes on to list three reasons for the dollar’s demise:

1. Changes in technology are allowing foreign countries to compare real time prices in different currencies more easily. This allows for transactions to be made quickly and easily without having to default to one single currency for all transactions.

2. For the first time in decades viable alternatives to the dollar now exist: the yuan and the euro. Eichengreen notes that Europe has shown more resolve than the US to pay down debt and will soon issue e-bonds as a step in solving their crises, two moves that will increase confidence in their currency. At the same time China is working to make the yuan an international currency. It is now possible to purchase and hold yuans in a US bank account that is FDIC insured. Recently China and Russia made an agreement to make cross-border transactions excluding the dollar.

3. The ballooning US budget deficit means that in the long run, the US will be forced to stifle its economy with taxes, inflate its debt away, or go forward with a mix of the two. Foreign investors will require much higher rates to assume the risk of taking on dollar denominated assets.

The implications of the dollar losing its reserve status could be devastating. Eichengreen predicts that if demand for the dollar drops worldwide, the US will have a harder time financing its budget deficit. He calculates the dollar will have to fall by close to 20% to maintain the current demand. Although exports will increase with a weak dollar, the higher cost of imports will reduce US living standards (2011).  A weaker dollar combined with increasing oil prices paint a different future for the US economy.  While it is difficult to predict exactly how these trends will pan out, it is probable that Americans will realize a gradual lower standard of living as current trends continue into the future.


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