Is the dollar really doomed?
Maybe the convulsing world financial system isn't doomed after all.
Headlines are rife with reports of currency wars and respectable people are talking about the gold standard. Yet the existing dollar-centric arrangement may well survive the current tumult in spite of its obvious defects, a top economist said Wednesday.
"The present nonsystem has done a pretty good job for 30 or 40 years in creating the conditions for economic development," said Alan Taylor, an adviser to Morgan Stanley who runs the Center for the Evolution of the Global Economy at the University of California, Davis. "We need to be cautious about how we go about fixing things."
Taylor made the comments at a panel discussion at the Council on Foreign Relations in New York. The session, covering currency wars, capital controls and the outlook for the international monetary system, focused on how to make global monetary arrangements less prone to the imbalances that are behind the current tension.
Sebastian Mallaby, a senior fellow at the Council, noted that worldwide foreign currency reserves have surged to 14% of global economic output from around 5% in the mid-1990s.
China is the biggest reserve hoarder, with a sum approaching $3 trillion held mostly in dollars, and many commentators have drawn a link between this massive savings account and China's decision to hold the value of its currency down against the dollar.
The tension between the U.S. and China over the currency imbalance and the resulting trade flows is a sign that we're living "in a world of exchange rate mercantilism," said Ajay Shah, a professor at the National Institute for Public Finance and Policy in New Delhi.
But he rejected the notion that a substantial rise in the Chinese renminbi against the dollar will do much to improve the dismal U.S. trade picture, which features persistent bilateral deficits with dozens of countries.
"There is a gap between evidence and politics when it comes to the effect of exchange rates on trade flows," Shah said. He said the most hopeful outcome from the pressure on China to let its currency appreciate could come from the effect changes in China might have on other exporting nations that peg their currencies to the dollar.
Benn Steil, a Council on Foreign Relations fellow who is writing a book about the Bretton Woods system that arose after the second World War, said it's worth recalling that China has been fixing the value of the renminbi to the dollar since 1994 – and that the United States applauded the Chinese during the Asian crisis of the late 1990s for maintaining that peg when a devaluation could have solved some local problems.
"They have had the same policy for 15 years, but the motivations have changed," Steil said.
China and other Asian nations started building up reserves in the late 1990s in response to the Asian crisis that ended with the International Monetary Fund extending aid to countries including Indonesia on tough terms.
The memorable image of the period (above) showed then IMF chief Michel Camdessus looming over Indonesian dictator Suharto, who was essentially signing away his country's sovereignty. China and others in the region decided to build up massive dollar reserves "because they decided you must self-insure," said Taylor. "It's kind of hard to argue with that."
Though Shah said he believes the case for reserve accumulation for safety has weakened since 2002, Taylor said he thinks there is hope that another shift in how emerging markets economies view the reserve question could yet save the world from a feared collapse brought on by building imbalances.
In recent years more emerging economies have issued local currency bonds, for instance, in a development that could not have happened a decade or two ago. This capacity, and a desire to rebalance away from export-led growth, could yet smooth the way forward even as the dollar paradigm seems on the verge of cracking.
This isn't to ignore the obvious bumps in the road, Taylor said – "there will still be some amusing moments where people will panic and everyone says currency war" – but to emphasize that reports of the dollar's doom may have been greatly exaggerated.