The Hindu Business Line : Dollar decline and solutions

Fred Bergsten, the American economist, has put forward a novel proposal to help solve the problem of the dollar. He suggests that the IMF create special drawing rights (SDRs) into which the dollars held by various countries could be deposited.

Dipping dollar has economic and diplomatic dimensions across the globe.

S. Venkitaramanan

The decline of the dollar has created a dilemma for both the US and the group of countries that hold their reserves in dollars. America faces the inevitable consequence that its declining currency brings in the shape of inflation and loss of confidence of foreigners. Countries that hold dollars or dollar-denominated securities are bound to dread the resulting erosion in value in their holdings.

The fall in dollar value has resulted in the international news media having a field day discussing the various aspects of this problem. In this connection, it is pertinent to refer to the news item that Mr Hugo Chavez, Venezuela’s President, has been pressing his colleagues in OPEC to de-link oil pricing from the dollar. He belongs to a minority that holds the view that by de-linking the price of crude from dollar, the revenues of OPEC might increase.

Economists, including those influential in Saudi Arabia, differ. They believe that such a step will only increase the possibility of further decline of the dollar and thus impact the value of the reserves OPEC countries hold. In any event, the crisis of the dollar is such that a simplistic remedy, such as Mr Chavez’s suggestion, may not solve the problem, without creating other problems.

Besides the economic consequences of the falling dollar, there are important diplomatic dimensions that are increasingly being noted by observers of the global scene. The US has been using the positive circumstances of the dollar being the reserve currency to obtain low-cost resources from various other countries, including, in particular, Asia’s central banks. Note that the US has been only too willing so far to utilise the strength of the dollar so long. It has denied access to dollars to countries such as Iran and North Korea, deferring their plea for dollar funds for various investments. By so doing, the US has been able to influence these countries to go slow on their nuclear ambitions — a geopolitical use of the dollar as a reserve currency — a success that has been particularly marked in the case of North Korea. These potential uses of economic power are threatened by the decline of the dollar.

Observers note that whenever a country has been in economic distress, it needs dollars and the US has had the right to print it. It has been in the fortunate position that it had used this strength, the right to print the world’s reserve currency, to finance military adventures in various parts of the world, such as Iraq and Afghanistan. History is replete with instances of the US willing to use its dollar or rather its dominance in the dollar markets to change the course of action of even countries, such as the UK. It drove the UK to desperation by withdrawing the dollar support in the 1960s when the latter tried to go on its Suez adventure against US advice.

The very fact that the US has used the dollar as a diplomatic weapon also shows its increasing vulnerability — with the decline of the dollar. No longer can the US afford to believe that its dollars will allow it to dictate foreign policy in many countries. This vulnerability is implicit in any reserve currency country. More so in the US, with its low saving habits and reluctance to raise taxes to finance its hegemonistic ambitions and military adventures.

Euro in spotlight

Speculations are rife as to whether in the event of the dollar falling off its pedestal as a reserve currency of the world, the euro will take its place. That is a distinct possibility as the euro has recently started rising against the dollar. But the European Union countries seem to be unwilling to face up to the responsibility that a strong reserve currency will devolve on them. Already, the President of France, Mr Sarkozy, has expressed strong protest against the rising strength of the euro, which affects the competitiveness of euro nations’ exporters. Given this situation, it will not be an easy path for the euro to substitute the dollar.

Some economists recently suggested that the coming century may well see the renminbi, the Chinese currency, take the place of the dollar as a currency of account in all trading transactions between various countries. Whether the Chinese will welcome this doubtful privilege is also a question for Chinese policy-makers. Already, let us note that they are trying to resist the revaluation of renminbi. They may not welcome its coronation as the “dollar” of the twenty-first century.

Bergsten proposal

In this regard, Fred Bergsten, the well-known American economist, has put forward a novel proposal to help solve the problem of the dollar. He is suggesting that the IMF should create special drawing rights (SDRs) into which the dollars held by various countries could be deposited.

Special drawing rights, it may be recalled, were suggested by the IMF in 1969 to combat the situation created by a free fall of the dollar in the sixties, which closely resembles the current circumstances. Bergsten argues that if the excess dollars of the various countries are converted under the SDRs, it will obviate the need for the particular countries to appreciate their currencies against the dollar.

The details of the proposal have to be worked out. But there seems to be some justification for considering Bergsten’s proposal in the light of the dilemma faced by the fall of the dollar and the fear of appreciation of the respective currencies, which the various countries seem to have.

According to Bergsten, the US will be spared from higher inflation and potentially much higher interest rates that would be needed to stem an even sharper decline of the dollar. These potential developments require to be taken into account in deciding on Bergsten’s proposal.

Throwback to Keynes

In a way, this is a throw-back to John Maynard Keynes’ proposal of an international currency, Bancor, which he had suggested at the time of the setting up of the IMF itself. Unfortunately, the American collaborators of the British visionary economist torpedoed the proposal for fear that it would lead to creation of extra liquidity in the international monetary sphere and might promote giveaway schemes by international do-gooders.

The wheel has come full circle and Keynes’ proposal is being reincarnated in Bergsten’s version. The decline of the dollar has diplomatic and economic consequences for both the US and the rest of the world. It is no use merely emphasising flexible exchange rates or measures, such as the revaluation of the renminbi, to solve the problem. We need to think radically so that a catastrophic collapse of the global economy can be avoided.

Fred Bergsten’s proposal is one that deserves consideration by all those interested in reorganising the financial architecture of the global economy without too much dislocation of developing and developed countries. It requires statesmanship of the highest order to consider such a proposal.

We need a visionary, such as Keynes, to do what Bergsten has put forward. Will the world be able to produce and back such a visionary?

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