When you travel for 32 hours from Singapore to Chile—a country that is referred to as the “World’s end” —to speak on Asia, it is important to be prepared for the inevitable question on the rise of the Chinese yuan as an alternative to the US dollar. What better preparation could there be than reading Exorbitant Privilege by Barry Eichengreen?
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If Lords of Finance—the FT Book of the Year in 2009—took the readers on a tour of the monetary policy history of the world leading up to World War II, Eichengreen begins from where Liaquat Ahamed left off. With his assessment of the future of the US dollar, he takes us through the post-WW II exchange rate regimes and arrangements and how the dollar came to dominate them.
Contrary to popular impression, Eichengreen does not treat the collapse of the dollar or the ascent of the yuan as inevitable. For him, the most likely scenario is that of three dominant reserve currencies in the world— the US dollar, the euro and the yuan. He reckons that the latter two would be more widely used in their respective regions for transactions and trade settlement, whereas the dollar would remain the globally dominant currency, partly due to the advantage of incumbency.
If anything, Eichengreen is more pessimistic about the euro than about the other two. Recent developments in Europe justify this. At the same time, he does not foresee a collapse of the euro, and rightly so.
He makes two key observations. One, Germany went along with an extended and large monetary union because it did not want smaller European nations with a history of weak and depreciating currencies to remain outside the Union and thus steal a competitive advantage over Germany chiefly through the exchange rate. Second, given Europe’s experience with Germany, other European nations wanted to bind Germany’s destiny with the rest of the continent, especially after unification made the country larger and more powerful. Both these considerations remain relevant today. Hence, the importance of maintaining the monetary union as it stands remains undiminished.
As for the yuan, Eichengreen thinks China is following the path taken by the US Federal Reserve, in the early years of its existence, to popularize the use of the dollar internationally. That is, to create a market for trade acceptances in the currency. Beijing is trying to settle bilateral trade with many countries in renminbi. The dollar became internationally accepted because the US economy became more powerful and larger than others. China, too, has grown at an impressive rate to become the world’s largest economy. Perhaps the similarities end there.
The dollar’s strength lies, first, in the fact that it is used to settle international trade in commodities. Second, trade between third countries are denominated in US dollars. Third, the US was substantially helped by the destruction of industrial capacity in Europe due to the two World Wars. Britain, too, suffered extensive damage because of its imperial overreach, and the state of its finances was parlous. It was easy to create a market for trade acceptances in dollars since the US dominated manufacturing and exports for a considerable period in the 20th century.
The final and perhaps most important of all is that, after the World War II, the US helped rebuild Europe and Japan with its Marshall and Dodge plans. That yielded enormous moral, political and economic advantages to the US. On the other hand, China’s assistance to and trade with many nations meet at best with mixed reception, and at worst with outright hostility. In sum, Eichengreen is right that the “changes to the Chinese economy required to make the renminbi convertible would be even more far-reaching”. He might as well have added that Chinese politics and culture need changes too.
If these considerations leave the US smug, that would be understandable. But it would also be terribly complacent. Eichengreen points to the risk that the US’ present and future government spending obligations pose to its economic growth potential, indicating that it was the post-WW II dismal economic performance that marooned the British pound.
Arguably, there are worse dangers. One is that the complacency over the TINA factor working in the dollar’s favour could make the US pursue blatantly inflationary policies as it is currently doing. Second, the return of the dominance of finance in the American economy barely a few years after it caused the worst economic crisis in the country does little to enhance either the country’s economic stability or its political and economic governance. The finance sector’s profits are rising the most again in the US.
In other words, Eichengreen is right to send across the message that the dominance of the dollar is for the US to lose. But, in this columnist’s view, it is a loss that the country appears determined to bring about.
V. Anantha Nageswaran is chief investment officer for an international wealth manager. These are his personal views.
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