Myth No. 1: The Dollar Will be Replaced as the Major Reserve Currency

Michael McTague |

US DollarAs discussed in the first installment in this new series, the purpose is to take on those pervasive and seemingly plausible myths about business that threaten reason. Ideas begin; they gain traction; and, if politicians latch on, new policies may emerge. In recent years, credit card legislation has tightened profits; FDIC insurance levels have risen; new consumer watchdogs and regulators appear.

A pervasive myth currently making the rounds is that the dollar will be replaced as the world’s leading reserve currency. After all, the IMF is already planning for it. The argument runs this way. The dollar has been declining against the euro and the yen as well as gold for some time. US debt has multiplied in an environment of massive trade imbalances. Russia and China are unhappy with the dollar. Given all this, a replacement is inevitable. Indeed, these gloomy developments spell trouble for the dollar. Recently, some countries and commodities traders have reduced their dollar holdings and shifted toward the euro or other currencies.

So far, the anti-dollar argument sounds credible. Consider how little the US government has done to support the dollar. The nation’s currency has not made the short list of hot political issues. So, the dollar slides with no support from Washington. But, even if the anti-dollar argument holds some merit, is it true?

Here are three arguments that expose the inaccuracy of this position. First, consider the euro. Seventeen nations participate in the euro including Europe’s economic powerhouse, Germany. But the euro zone and the euro currency show significant ambivalence about this widely used circulating medium. Some countries are discussing a withdrawal from the euro currency. Paul Krugman writes, “The Eurozone Is Now In ‘Meltdown Territory’" (June 1, 2011).

Waves of fear shake the capital markets about debt and deficits mostly in the smaller European economies. Compare that to the US where the currency is not at risk of abandonment. California is not struggling with Michigan to keep the dollar as Germany is struggling with Greece to keep the euro.
The Spanish currency predicament is especially telling. Before they entered the euro zone, Spain was able to walk away from its debts by devaluing its currency, which they did in the 1990’s. While Germany works to maintain the alliance, several countries balk about being tied down to the euro.

The ultimate meaning – or net-net as some like to say – is that the euro stands as a shakier prospect than the dollar for economic and political reasons.

The second argument concerns Russia. For several years, Russia has advocated a move away from the dollar. Then there is the economic evidence. Russia famously shored up the ruble by spending billions of dollars to the point where their remaining reserves – ironically consisting of dollars – shrank to a very low point. In the 1990’s, money loaned to banks inside Russia quickly moved into other currencies, notably including the dollar. Curious indeed that a leading euro advocate depends so strongly on the dollar! Doesn’t it seem that this is a politically tinged position?

The third argument is that the evidence shows a pattern of hedging rather than a mass exodus from the dollar. The dollar is falling. So, why not shift some reserves toward another currency or gold.

The conclusion is that while the dollar is not as strong as it might be and certainly not as strong as it once was, no feasible alternative exists including the euro. The capital markets know this since dollars outweigh euros by about 2 to 1 as the dominant reserve currency. Nor is gold a suitable replacement. Gold may take a nose dive when the economy revives and gold is not a true currency.

Remember that this myth is durable. To avoid losing an argument, someone may advocate a return to the gold standard. To paraphrase President Ford referring to Abraham Lincoln, ‘If William Jennings Bryan were alive today, he’d turn over in his grave.”

Please comment on this first myth and let us know which myths you feel need exposure.

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Michael McTague, Ph.D. is Senior Vice President at Able Global Partners, a financial consulting firm in New York City.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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