The Dollar in Doubt?

I’ve found it puzzling that there’s all this talk about the prospects for the dollar, in the wake of the G-20 meetings, and more recently World Bank President Zoellick’s comments about the primacy of the dollar as a reserve currency. My puzzlement arises from the fact that many of the concerns now being voiced have been voiced before.

The Dollar as the Key Reserve Currency

First, to Zoellick’s comments. From Bloomberg:

“There is every reason to believe that the euro’s acceptability could grow,” Zoellick said in a speech today in Washington. “Of course, the U.S. dollar is and will remain a major currency. But the greenback’s fortunes will depend heavily on U.S. choices” on inflation, the budget deficit and financial oversight, he said.

The World Bank chief outlined ways he sees the balance of power in the global economy shifting after the financial crisis. China and probably India will rise in influence and the U.S.’s economic might may be diminished as the international system is “overhauled before our eyes,” he said.

In excerpts of his speech released yesterday, Zoellick said, “there will increasingly be other options to the dollar,” and the U.S. shouldn’t “take for granted” its standing. While didn’t specifically mention the yen in the full text of the speech, he said Japan’s “old export model” of growth may not be sustainable in a world that’s less reliant on U.S. consumers.

As I’ve noted on previous occasions [0] [1], Jeff Frankel and I [pdf] have outlined the conditions under which the dollar could lose primary reserve currency status to the Euro. In short, calamitously bad policies that induce rapid currency depreciation, or high inflation, would do the trick. Our results, last updated in early 2008 [pdf], might seem somewhat out of date given all the turmoil that has occurred in the meantime. But it’s important to realize that it’s the relative performance (US versus euro area) that matters, and I see no greater reason to believe that the conditions are in place for a drastic “reversal of fortune” than before. (A slightly different perspective by Jeff Frankel here and here.) I’d note that part of our results for the euro displacing the dollar depended on a London greatly overtaking New York as a financial center; well, that remains to be seen.)

So, if one looks at the breathless commentary about the euro’s share rising to new highs, well, that’s true, insofar as one looks at known euro reserves and known allocations.


Figure 1: US dollar share of allocated reserves (blue), euro share of allocated reserves (red), and share of allocated reserves accounted by sum of Deutsche mark, French franc, Dutch guilder, ecu (pink squares). NBER defined recession dates shaded gray; assumes latest recession ends 2009Q2. Source: IMF, COFER, September 30, 2009, NBER and author’s calculations.

The picture looks a lot less clear when one tries to think about total reserves, a large share of which is of unknown (well, unreported) composition. As always, a little perspective is helpful. Figure 2 shows a longer sample (using different data), and the US dollar share normalized by total reserves, rather than allocated reserves.


Figure 2: Log nominal value of US dollar against major currencies (blue, left scale), US dollar share out of total reserves (red, right scale), US dollar plus 60% of unallocated reserves (green, right scale). US dollar index for September through 9/22. Source: IMF, COFER, September 30, 2009, Federal Reserve via FREDII, and author’s calculations.

Notice that the estimated dollar share was relatively low, during the mid-1980s, despite the extremely high trade weighted value of the dollar. Further observe that while the reported US dollar share is now at a record low level (a few percentage points below what it was at the end of 1995), this is the known share. The unallocated share is quite large, and making an educated guess that 60% of unallocated reserves are in dollars yields a somewhat different perspective (the 60% figure makes the end-2003 old series match the guesstimated series). Then the dollar share has been lower, particularly in the early 1990’s.

In other words, in terms of analysis, the speech was much ado about nothing, although I may be missing some sort of political subtext (i.e., [2]).

The Dollar’s Value, Post-Pittsburgh

What about all the talk about the dollar decline and rebalancing? [3] It was clear before the G-20 meetings that, regardless of what was said and agreed to, dollar adjustment would occur. The extent to which adjustment would occur was, admittedly, obscure before. But it still remains so, exactly because the trajectories of consumption and potential GDP in the US, Europe, and East Asia remain uncertain.


Figure 3: Log nominal value of US dollar against major currencies (blue), log nominal value of US dollar against broad currencies (red). US dollar index values for September through 9/22. Source: Federal Reserve via FREDII, NBER, and author’s calculations.

In thinking about the prospects for the dollar, I think it’s useful to break the forces affecting it into separate pieces. In particular, reserve currency status is not directly linked to the dollar’s value, although they are of course related. The dollar could lose value without losing primary reserve currency status, and could gain reserve share without gaining value. In addition, in thinking about the other forces that can affect the dollar in the absence of tectonic shifts in the dollars international currency role, one can identify a number of factors:

  • Portfolio balance effects (dollar asset supply versus demand).
  • Cyclical factors (demand for credit, relative price movements, interest rates).
  • Safe haven factors
  • Structural factors (composition of demand, trend output).

This is not an exhaustive list [4], but it highlights the variety of the relevant effects that have different influences at different horizons (I’ve skipped purchasing power parity, pure monetary models, etc.). Let me talk about each of these factors in turn.

Portfolio Balance. In this approach, one focuses on stocks of assets denominated in different currencies. In the standard (mean-variance/CAPM) approach, demand for assets depends upon the covariance of relative returns with dollar returns, and the coefficient of relative risk aversion. See this post for the technical exposition.

Increasing amounts of US government debt should, holding all else constant, result in a higher risk premium on dollar assets, or a weaker dollar, or both [5]. Of course, during the next few years, governments around the world will be issuing a lot of debt as well.

Rising default risk relative to other countries could also be put into the model; if the perceived default risk were to rise (once again relative to other countries’ government debt), then the risk premium would again rise. But there was nothing at the G-20 meetings to infer a greater incipient increase in US debt than was previously forecast.

Cyclical Factors. Where the economy is in terms of the business cycle has an also impact on the exchange rate. For instance, the US was entering into recession before the euro area; and as shown in Figure 3 the dollar was declining before collapse of Lehman spurred the flight to safety in September 2008. In part, this correlation is due to the empirical strength of Taylor rule fundamentals (see [6], [7]). Now that we’re at the zero interest bound in the US, that effect may be in abeyance. Nonetheless, if the US recovers before Europe (and Japan), then the relative price of US goods will rise, pushing up the dollar. So, I’m a bit mystified by the short term pessimism about the dollar’s value (over the longer term, other concerns will dominate).

Safe Haven Effects Inspection of Figure 3 reinforces the notion that dollar weakness, for now, is a function of the return of risk appetite. The spike in the dollar from September 2008 through the beginning of 2009 was flight to the safety of Treasurys. In this sense, the dollar decline is a good thing as it highlights the success of policymaker measures to normalize the financial markets. (See for instance the 9/11 Bloomberg Financial Conditions Index, shown below.)


Figure 6: from Michael Rosenberg, Financial Conditions Watch (Bloomberg, September 11, 2009).

Structural Factors. One of the main points emanating from the G-20 meetings (communiqué) was the need for rebalancing [8]. In my previous post I observed that given the considerable evidence in favor of US consumer retrenchment, rebalancing would be more likely than in the past. However, one of the big questions involve what happens in China and East Asia. I am somewhat skeptical about China experiencing a consumption boom, and sustainable growth in government spending and investment; but Nick Lardy has a more optimistic outlook on these counts [9]. To the extent his more optimistic view turns out to be more accurate, then the adjustment that has to be effected by exchange rate changes will be smaller.

That being said, lower trend consumption growth is also consistent with a weaker dollar, holding all else constant. Once again, I don’t see how the G-20 meetings would have induced a revision in views regarding the paths of consumption in the US and China.


33 thoughts on “The Dollar in Doubt?

  1. Cedric Regula

    Could it be as simple as now that Safe Haven wore off, people are starting to talk about what they were talking about pre-Lehamn?
    Also, we aren’t at pre-Lehman lows yet, but getting there.
    Still reading thru the attached links, but I’ve been keeping an eye on FX for most of this decade. Most of the FX analysts I’ve followed seem to agree the primary driver was interest rate differentials this decade(pre-Lehman of course). One of them made charts using the difference in two year forward interest rate futures for each currency pair and that showed a striking correlation vs the pair value.
    They watch macro data, but their reason for doing it was to forecast CB interest rate moves. In hindsight I think this was maybe a case of tunnel vision that worked in spite of itself, because the recent risk aversion, and now lack of it, showed how big a role US private financial flows play in it. And long ago Milton Friedman said it is the net amount of trade and financial flows that matter.
    Then in the US, so far the trade deficit comes back dollar for dollar into US financial assets. That’s usually the currency killer for most countries, but for now we can eliminate it as the culprit. Making it smaller doesn’t even make the dollar go up!

  2. Cedric Regula

    Come to think of it, Lehman wasn’t the beginning of the dollar safe haven move. It was more around Bear Sterns time, or marked by Bernanke doing currency swaps with foreign CBs because of a dollar credit crunch in foreign lands. I also heard that when London brokers bail on equity markets anywhere, they go to t-bills to wait things out.

  3. ppcm

    Few figures may drive to modesty when trying to read a short term event in the forex world.
    USD daily exchange (wikepedia)
    $1.005 trillion in spot transactions
    $362 billion in outright forwards
    $1.714 trillion in foreign exchange swaps
    $129 billion estimated gaps in reporting
    75% of the usd in circulation is hold abroad, 75% of the US assets are hold by foreign investors.
    The world GDP is hovering around 45/50 trillion usd.
    Does current account ,interest rate differential matter, inflation differential matter?
    During Mr Greespan era one may have seen a strong dollar in a weak USA economic cycle (with aggravating CA deficit)a weak dollar in a stronger economic cycle.
    Remembering G Jonhson The dollar the long run problem

  4. kharris

    Having a currency used as a reserve currency requires generating enough assets to meet private and reserve needs. There is a sort of a feedback involved. When the demand for assets denominated in a currency grows, more such assets are likely to be created. Since the US generates more assets than the Eurozone, the euro would have a tough time equaling the dollar in reserve holdings.
    While the ‘exorbitant priviledge’ may be attractive, it comes with a cost. You gotta go into debt to other countries in order to be a reserve currency country. Now, one possibility is that greater balance in global trade will reduce reserve holdings, and that dollar holdings will be pared more than those for the euro. That would mean greater balance without a big rise in Eurozone indebtedness to the rest of the world.

  5. Buzzcut

    Totally off the wall comment: what would happen to the dollar’s status and value relative to other currencies if the Treasury stopped printing any bill over $20? No more $100 bills.

  6. DickF

    Why do you hold currency?
    Is it because of your trade balance with your positive trade balance with your employer or the negative trade balance with you grocery store?
    After answering those questions, ask yourself what your attitude would be toward your currency and what actions you would take if you believed the currency would be worth only half of its value in 12 months?
    None of these considerations would cause you to change your holdings based, not the health of your employer (except you might save more). And you would not change your holdings based on the status of your grocery because you could simply go to another grocery with the same currency if necessary.
    But your decision based on the purchasing power of the currency would directly and quickly alter your behavior concerning the currency you held.
    The FED has placed the Sword of Damocles over our heads in the form of a massive increase in the FED holding of various bank paper, a huge increase in the money supply, and the potential need for a huge increase in the money supply to support the outrageous bailout commitments in the future.
    A reserve currency is only as good as its exchange value. The dollar is losing value every day both against other currencies and even more so against real goods. The one condition that will threaten the world reserve currency status of the dollar is if another currency steps in to better fulfill the role of a reliable unit of exchange.
    Right now those who are crying the loudest about the reserve status of the dollar do not understand what it is that gives a currency world reserve currency status, so there is little chance of the dollar being replaced, especially by the euro. But the day the monetary authority of a major currency realizes the power and benifit that would come from anchoring to a commodity base, that will be the day the dollar falls from grace.

  7. spencer

    If we are entering an era of weak or very low consumption growth doesn’t this imply that the US
    trade and/or current account deficit should not return to the extremely high levels of the last cycle (6% of GDP).
    I can see a gradual shift in dollar holding as a share of reserves, but it is difficult for me to see a crises type scenario where the world suddenly decides to try to shift a significant share of reserves out of dollars.
    From 2002 to 2008 the trade weighted dollar fell something like 40% and it did not seem to have a big negative impact on the US economy or inflation. The Casandras carrying on about the dollar weakness being an end of the world crises
    seem to be making a mountain out of a mole hill.
    Moreover, we are seeing the dollar weaken versus the Euro and the Yen, but the Chinese Yuan, Korean Won, Indian Rupee and other currencies against the dollar have remained rock solid.
    This suggest to me that the dollar weakness we are seeing is due to private trading(speculation) that has little or nothing to do with countries desire to hold reserves in other currencies.
    This implies what we are seeing is an improvement in the world terms of trade against Japan and Europe that will lead to worsening trade deficits for those two areas but not the US.

  8. David Pearson

    I think its instructive to talk about what DIDN’T happen at the G20.
    Despite signs of recovery in the global economy, the G20 did not firm up exit plans from emergency fiscal (and monetary) measures — just the opposite. The consensus was clear: the employment of longer-term stimulus is necessary for a permanent recovery in the job markets.
    Absent a self-sustaining recovery, the path of fiscal deficits and debt growth could put the dollar in peril. Markets are discounting mechanisms, and they are concerned not only with the median forecast but also with the tails. The tail risk of a self-sustaining debt spiral in the U.S. is rising. It is this tail risk, primarily, which drives the preference for holding dollars as a reserve currency. Not the median forecast. In effect, reserve currency status implies a promise by the reserve country not to allow that tail risk to exist.
    Economists think in terms of median forecasts and not in terms of fat tails. They have proven this again and again.

  9. Cedric Regula

    This is the major weakness that the Euro has, tho I wouldn’t characterize it that the USG has better debt generation technology than Europe.
    But when you get down to it, CBs want some interest on their reserve holdings, if for no other reason than to fund their operations. This means they buy bonds, not just hold currency. The problem with the EU is finding some bonds you would like to buy. You get a short list of German and French flavors rather quickly, and so far, those come with a higher debt/GDP ratio than US Treasuries.
    So the problem with Europe is the incremental expansion in debt/GDP ratio still looks worse than the US. But we seem to be closing the gap, tho recessions are very damaging to country balance sheets everywhere, so it is a moving target.
    I’ve heard some forecasts that say the new normal for the majority of the G20 is debt/GDP of 100%. That means we will all be like Italy.
    But there is also talk of CBs moving to a more diversified basket of currencies, one that really is managed in accordance with trade partners. That would also mean the dollar share would get pared down.
    It’s just that the BRICs and some oil producers talk about things like this, but then they would need to give up their dollar pegging ways, so we will need to see how serious they really are.

  10. ppcm

    The State of Public Finances:
    Outlook and Medium-Term Policies After the 2008 Crisis
    Prepared by the Fiscal Affairs Department
    In cooperation with other departments
    Approved by Carlo Cottarelli
    March 6, 2009
    Italy is running a debt/GDP at 120% up and running and though seems to be unscathered or at least less than other EEC members when it comes to the financial debacle.
    P25 of the IMF shows the disparity of the fiscal deficits among the G20 and the projected Debt/GDP ratios not all are reaching the Ponzi status that is 100 %

  11. Cedric Regula

    Just got this from RGE(Roubini) today.
    Back to Global Reserves Accumulation?
    Data released by the IMF in September 2009 confirms that reserve accumulation restarted in Q2 2009, with global reserves rebounding to US$6.8 trillion, from US$6.48 trillion at the end of Q1 2009. However, the data suggests that the global reserve stock remains below the peak reached in early 2008 following reserve depletion during the financial crisis. The IMF data also suggests that the dollar share of reserves of countries that report currency composition has inched up to almost 63%, the share of pound and yen in reported reserves has fallen, but the euro share rose slightly.

  12. DickF

    David Pearson,
    You may be interested in the election win of Angela Merkel over her major opponent Frank-Walter Steinmeier. Merkel ran on a program of tax cuts and support for nuclear energy. Steinmeier opposed both.
    Merkel had been in a coalition government with Steinmeier but said that she could govern better if she could form a coalition with the Free Democratic Party rather than Steinmeier’s Social Democrats. The German people agreed and gave her what she asked for.Steinmeier’s loss gives Merkel the power to form her own government and that means that Germany is turning away from Keynesian demand side policies of redistribution and toward supply side policies of growth. The headlines read “European Stocks Rally to New Highs on German Election.”
    Germany is leading Europe out of the recession while the US flounders. Germany is quickly becoming the new leader of the western world.

  13. mthomas

    agree that we have severe long term issues to deal with concerning the huge govt deficits and currency debasement that is occurring. I just saw a really good article at that discussed this problem of continuing to try to cure a patient with the drugs that made him/her sick in the first place. It goes on to discuss the potential investment implications for fiat currencies due to all the money printing by central banks around the world. I personally feel that the power of central bankers to print money has gotten completely out of control, and that we will go back to a gold standard or another form of hard currency once there is enough social unrest to force our politicians to make the necessary changes.

  14. bryce

    writes Dick F “…the day the monetary authority of a major currency realizes the power and benifit that would come from anchoring to a commodity base, that will be the day the dollar falls from grace.”

  15. Mike Laird

    It strikes me that the talk about the role of the US$ was triggered by some aggressive talk by China several months ago. But they were faced with a new and unknown President, Treasury Secretary, and Council of Economic Advisors. They were also surprised by the stock market dive, and apparently learned a lot about it by reading Brad Setser’s blog – amazingly. With a trillion in US$, they felt the need to get some attention – I guess. Others on Wall Street have jumped on the Chinese comments because they can use it to generate trading income for themselves by stoking fear and greed with clients. But the US$ has been through much larger stresses and trading ranges and not much changed in the US economy or in international relations. This is the likely outcome this time.

  16. don

    I would express another view. The U.S. won’t be the main one to suffer if the dollar overhang leads to a dollar route. An important contributor to the overhang has been export-led growth strategies (currency mercantilism) in east Asia. If these persist (which the current movements in global reserves and the stubbornly maintained undervaluations of east Asian currencies suggest), and are accompanied by continued U.S. high unemployment and weak consumer demand, they will lead to serious trade tensions. When it finally comes, the rebalancing will be very painful for east Asia. It would be nice if the rebalancing could be accomplished painlessly in a time of flush aggregate demand, but such does not appear to be in the cards. (If it were, the adjustment would probably be postponed and we would continue in a state of denial.)
    One story is that the dollar reserves accumulated abroad allow the U.S. to get ‘free’ goods and services in exchange for merely providing reserves that are locked up in foreign monetary systems. Another story is that the reserves represent a reduction in aggregate demand for U.S. goods and services and operate like a negative fiscal stimulus. In ordinary times, when supply constrains the goods and services we can consume, the first story is more valid. In times of insufficient aggregate demand (like the present), the second story is more valid. That is why I find bothersome the recent climb in foreign reserves (cited by Cedric), which amount to a fiscal de-stimulus for CA debtors of $320 billion in one quarter.

  17. DonDen

    On the one hand this, on the other hand that.
    God….give me a “one handed economist”.
    Dude…you can’t straddle the fence and hope to get anywhere in life.
    Spit it out soldier. Take a stand and tell us… what’s your prediction.

  18. Namke von Federlein

    “In excerpts of his speech released yesterday, Zoellick said, “there will increasingly be other options to the dollar,”…
    You don’t need any government currency to do business. You can create your own. For instance, set up a fund with commodities and use the shares for trade.
    This is the big “invisible trend” in my opinion. It isn’t barter. It is the creation of billions of dollars of specialized (and 100% collateralized) privately held “currency units” for trading purposes between large trading partners (like between a couple of governments or between a couple of huge businesses).
    You sell a lot of oil to a steel company ? Set up a fund that holds steel, oil and gold as the assets and use the shares to do your deals. Most of these large deals happen outside the 200 mile territorial limit anyway.
    China is simply doing something internal and national right now? They are buying up commodities and encouraging their nationals to buy gold and silver (mostly to flush all the USD out from under mattresses while the USD is still worth something?). The end result is a fully collaterilized currency with both centralized commoditization and de-centralized commoditization. But the current process is simply to ensure a stable currency environment within China? When that is done, they can then move to the next level – which will probably be a “currency” created much the same way (proper collateralization) with a different name for the currency and it will only be used for doing international business. One currency for internal business, one for international business – both properly collateralized.
    Perhaps the “Great Myth” of currencies is that you can use the same currency for internal business and international trade. I don’t think that this was ever a good idea.
    So, while the G20 is goofing around – I would suggest that you start building your own currencies. Currencies are definitely not a case of “one size fits all”.
    Just my opinion.

  19. Cedric Regula

    Yes, well, don’t forget we will need to rename the US Dollar to the US Corn Cob.
    Next, Iowa will want to secede from the Union. Along with Texas, who naturally would claim the Gulf waters as their own. South Africa and Australia would become super powers. Peru would replace India in the G20 and we would need a new, pronounceable, acronym for BRPC.
    One thing people seem to have forgotten is it used to be a well known fact that interest rates are what give a fiat currency value. So there is a way to do it. Then in international trade, floating currencies are supposed to balance trade, provided export subsidiaries or import tariffs aren’t used. Multinationals can and do hedge contracts in FX markets or commodities markets. But the real problem is world isn’t doing things this way.
    And I would hate to see Monsanto come out with bio-engineered corn seed that grew smaller ears of corn so that the USG can inflate out of the national debt.

  20. don

    DonDen – In case your post was referring to mine (and even if it wasn’t), here is my prediction: One result of the economic downturn will be that Americans will hear much more about “uighurs.”

  21. GNP

    Yeah, I am also a tad mystified over the concern for the value of the US dollar. Given that this timely piece supports my priors I suppose I should go out and bet against myself, maybe increase the household exposure to gold from 0.49% to 0.87%?

    Surely there are ways that per capita US wealth can continue to decline without the dollar tanking. God will punish wicked Americans–rest assured–but her wrath may not materialize in the form of a significantly weaker US dollar anytime soon.

  22. Anonymous

    Yes, this is puzzling, because if you have concerns about something and those concerns don’t materialize at that point in time, then you never need to worry about those concerns ever again.

  23. GNP


    If we were to conduct a poll that asked Americans what they worried about more–a declining US dollar, or declining per capita wealth–what would they answer, and frankly would most people even know what per capita wealth is?

  24. jg

    Why hoi polloi do not believe economists or government statisticians:
    Sane folks looked increduously each month at the the birth/death adjustments and its various sector components and said, ‘No way is construction or finance or professional services or…adding jobs this month.’
    We little people were right, again.
    It’s a depression, Ben and Timmy, and the downward movement is now accelerating.

  25. simone

    Menzi- You cannot rely on models when policy makers are wallowing in bad policy. In addition, we have a president who confuses talking with policy actions. I wuld advise you to quit playing with your models in these days of uncertainty.

  26. rjs

    this is a pretty euro-centric approach; there is a lot of talk about regional reserve currencies which could slowly undermine the dollars status

  27. GNP

    Menzie: Stop what you are doing and “it” will all go away (before the weekend). Hot damn, just like popping the right pill.

    Actually, if the USA were to slow down the DFA policy (Death from Above), “it” might indeed all go away. Being the premier terrorist nation state in the early part of the 21st century strikes me as an economically burdensome way to maintain “freedom”, and in this context a sure way to erode hegemony and all the privileges that come with being the undisputed top dog.

    Translation? Economy got you down? Don’t worry, just think about all those civilians the US armed forces are killing and continue to kill. Americans are number one! Maybe that will get you back to the ‘happy place’.

  28. Menzie Chinn

    jg: You must be commenting on other people’s views than mine — I have previously stressed the likelihood of downward revisions, in both GDP and other variables, particularly around maxima.

  29. jg

    Doc, I am glad that you had your eyes wide open.
    Too bad the folks at the controls did not, and do not. Or, too bad that they are lying and not revealing what they really see.
    Folks who do not study the economy for a living require honest, candid, correct assessments to help them in their daily resource allocation decisions.
    This is a depression, and the downward movement has only just begun.

  30. steve from virginia

    Good to see a few mentions of energy here in the comments. The real trade that matter is dollar/crude. Priced in crude, the dollar has been stable for the period even as the establishment (and speculators) have been whining about the dollar’s lack of stability. This has been manifest even as the dollar’s speculative value declines/advances relative to other currencies.
    The Forex dudes need to eat, too.
    As to those who yearn for a hard currency; we have one already, and the iron fist of the oil/dollar relationship is squeezing the life out of companies that cannot make adjustments, like exiling their labor forces to Mexico or China. You wanna see an imbalance, there it is! The ‘niewe labor force’ cannot afford the products they themselves make. Business death is put off but not cancelled.
    If the ‘plan’ is to devalue the dollar – by having US proxy Israel attack Iran, for instance – the effect of the resulting oil price spike would be another deflationary crash and demand destruction six months later. The dollar price would increase as a haven.
    Otherwise, the currency trade probably isn’t dynamic enough to destabilize dollar/currency relationships enough to matter. Cedric R gets it; the ‘diving dollar’ theory requires US inflation and the end to the Great Recession. Ain’t happenin’!
    It’s deflation all the way, until the Fed starts monetizing Social Security and starts cutting checks to individuals in lieu of Medicare payments.

  31. Cedric Regula

    Well, whenever I think of the dollar devaluing, I wonder against what? If we assume all major currencies have pretty much the same problem as the dollar, and there is a de-facto rush to commodity backed currencies as the proposed solution to stable currency(like supply-demand is stable with commodities…haha), then that would lead to the majors conducting trade and finance in the US Corn Cob, the Euro Grape, Japan would need to choose between industrial waste or rice, or a basket of the two, and Britain would be stuck with the Pound Electron, which would unfortunately still be weightless with a negative charge.
    On the other hand I have similar doubts that a collapsing economy leads to a plentiful supply of cheap goods. I did pass Econ 101, after all.

  32. Tom

    Wow, popular topic. Naturally the dollar will decline in global importance over time as the Euro zone expands and other countries catch up in wealth. This is happening. But it is a very slow process. I guess it will take about 20 years for the Euro to catch up with the dollar in trade and reserve use. Besides relative economic performance, size matters, and the Eurozone is already bigger than the US. As for “calamities”, I doubt any will have long-term effects. Judging from this recession, they seem to produce temporary retrenchment back to the dollar.
    I think a lot of the worry about the dollar’s status as a reserve currency is really about the possible problems that could arise from China’s massive stockpiling of dollars and Treasuries. Stockpiling of anything on such a scale is bound to distort and terrorize its market.

  33. Tom

    ps On a technical note, the fact that the EU lacks a unified debt issuer is a very important factor limiting the Euro’s use as reserves. So the Euro will gain faster as a trade currency than as a reserve currency.

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