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<font color="#002864" size="1" face="Verdana">http://www.mises.org/fullstory.asp?control=1348</font>
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<font face="Verdana" size="2"><font color="#002864" size="5"><strong>The End of Dollar Supremacy?</strong></font>
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<p class="MsoNormal"><font face="Verdana, Helvetica" size="4">by Antony P.
Mueller</font>
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">[Posted October
20, 2003]</font>
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2"><img alt src="http://www.mises.org/images3/billephant.gif" align="right" border="0" width="242" height="168">Given the
current account deficit in the United States of more than five per cent
and a negative net foreign investment position of over twenty per cent of its
gross domestic product, it is the relative stability of the US dollar that
needs explanation and not the fact that the effective exchange rate of the
dollar has declined by twenty per cent since late 2002. It is even more
remarkable that U.S. interest rates did not have to rise as might have been
expected in order to attract foreign investment as a compensation for the
deficit in the current account.</font>
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">Balance of
payments numbers such as those the United States currently has would have
broken many other currencies and would have triggered severe financial crises
in other countries much earlier. But the United States is different. It holds
a privileged position within the international monetary system and its path to
ruin may be longer and smoother than that for other nations. Nevertheless,
even for the U.S. there is a limit and the country seems to be getting closer
to it every day.</font>
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">The relative
strength of the US dollar despite the deteriorating external position results
from the role of the dollar as the world's global reserve currency and because
the pillars on which the dollar's supremacy rests do still seem intact.
Furthermore, there is not yet a ready substitute for the dollar in sight which
could replace it as a functioning global currency.</font>
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">Compared to its
potential rivals such as the euro or the yen, the US dollar has a historical
and a quantitative advantage. For more than half a century, the world-wide use
of the US dollar has been common practice. The dollar is the unrivalled global
currency, a currency whose position as an international means of exchange
rests on a prolonged experience. The dollar's origin as to its source of
production is the visible power of the United States in terms of its national
unity and its global military presence. Additionally, the dollar's
predominance rests on the strength of the U.S. economy as there is no other
economy of size which could match it in terms of productivity and innovation. </font>
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">All these
pillars have strengthened since the early 1990s. The use of the dollar has
become more widespread on a global scale with the integration of the former
Communist countries into the world economy; the position of the United States
as the principal global political and military player has strengthened with
the fall of the Soviet Union; and, particularly since the mid 1990s, the
American economy has experienced a period of outstanding dynamism and
resiliency.</font>
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">So why the
jitters about the imminent decline and fall of the US dollar that have emerged?
Isn't there reason to believe that the dollar's supremacy will remain
undisputed in the future as well?</font>
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">Unfortunately,
the outlook is more dramatic than the question may suggest at first glance.
The dramatic statement says that—at least for a while—the dollar will not
be replaced by another global means of exchange but that the dollar may lose
its supreme role nevertheless. A fall in the dollar from its pedestal
with no substitute to replace it would be the very disturbing outlook
suggested by an interpretation of the current trends. The disastrous
consequences of the demise of the dollar as the global currency with no other
means of exchange to replace it refers to the outlook that we may enter a
period of currency chaos and a global economic contraction.</font>
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">Losing trust
does not mean that there must be a ready substitute. On the contrary: when
distrust will emerge towards the US dollar this would affect the attitude
towards all paper currencies. In the final stages of the currency crisis, the
dollar will most likely devalue not so much against the euro and the yen, but
all of these currencies and most of the rest will devalue drastically against
gold.</font>
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">There is neither
a theoretical nor an empirical reason to believe that the dollar should be
different from the other fiat currencies that have emerged and disappeared in
the past. Even more so, given the unique position of the dollar in the current
monetary system, the temptation to abuse this privilege has been greater for
the United States than that which inflicted other nations and led to their
decline. </font>
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">From early on,
the United States has taken advantage from the privileged position of the
dollar in the modern monetary system, but it has been essentially only since
the early 1980s when the enjoyment of a privilege began to turn into an abuse;
and it is only in the past couple of years or so when the abuse has turned
into an almost complete lack of consideration. In due course, confidence of
private investors has begun to erode.</font>
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">In the past
couple of years there has been a massive fall of foreign direct investment
flowing into the United States and in 2002 the flow became negative (see table
1). In 2001 the basic balance turned negative and reached 218 billion US
dollar in 2002. This signifies that there is less capital inflow to compensate
for the expanding current account deficit.</font>
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">Table 1</font>
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">United States.
Current account and composition of capital account 2000-2002 (a)</font>
<div>
<table class="MsoNormalTable" cellSpacing="0" cellPadding="0" border="1">
<tbody>
<tr>
<td vAlign="top" width="150">
<p class="MsoNormal">
</td>
<td vAlign="top" width="150">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">2000</font>
</td>
<td vAlign="top" width="150">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">2001</font>
</td>
<td vAlign="top" width="150">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">2002</font>
</td>
</tr>
<tr>
<td vAlign="top" width="150">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">Current
Account</font>
</td>
<td vAlign="top" width="150">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">-410</font>
</td>
<td vAlign="top" width="150">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">-393</font>
</td>
<td vAlign="top" width="150">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">-503</font>
</td>
</tr>
<tr>
<td vAlign="top" width="150"><font face="Verdana" size="2">Net
long-term capital</font>
<font face="Verdana" size="2">hereof:</font></td>
<td vAlign="top" width="150"><font face="Verdana" size="2">422</font></td>
<td vAlign="top" width="150"><font face="Verdana" size="2">335</font></td>
<td vAlign="top" width="150"><font face="Verdana" size="2">285</font></td>
</tr>
<tr>
<td vAlign="top" width="150"><font face="Verdana" size="2">Direct
Investment</font></td>
<td vAlign="top" width="150"><font face="Verdana" size="2">129</font></td>
<td vAlign="top" width="150"><font face="Verdana" size="2">3</font></td>
<td vAlign="top" width="150"><font face="Verdana" size="2">-93</font></td>
</tr>
<tr>
<td vAlign="top" width="150"><font face="Verdana" size="2">Equities</font></td>
<td vAlign="top" width="150"><font face="Verdana" size="2">90</font></td>
<td vAlign="top" width="150"><font face="Verdana" size="2">15</font></td>
<td vAlign="top" width="150"><font face="Verdana" size="2">35</font></td>
</tr>
<tr>
<td vAlign="top" width="150">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">Bonds</font>
</td>
<td vAlign="top" width="150">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">203</font>
</td>
<td vAlign="top" width="150">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">317</font>
</td>
<td vAlign="top" width="150">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">343</font>
</td>
</tr>
<tr>
<td vAlign="top" width="150">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">Basic
Balance (b)</font>
</td>
<td vAlign="top" width="150">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">12</font>
</td>
<td vAlign="top" width="150">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">-58</font>
</td>
<td vAlign="top" width="150">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">-218</font>
</td>
</tr>
</tbody>
</table>
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<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">(a) in billions
of US dollars
(b) Current account plus net long-term capital
Source: Bank for International Settlements, 73rd Annual Report, Basel 2003,
table II.4</font>
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">It has been
mainly due to the buying of bonds by foreign central banks that a dollar crash
has been averted so far. The massive buying of U.S. bonds by central banks in
2001 and 2002 has led to an increase in global US dollar reserves which surged
by 219.8 billion in 2002 reaching a total of 1,751.4 by the end of that year (see
table 2).</font>
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">Table 2</font>
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">Annual
changes in official foreign exchange reserves 2000-2002 (a)</font>
<div>
<table class="MsoNormalTable" cellSpacing="0" cellPadding="0" border="1">
<tbody>
<tr>
<td vAlign="top" width="120">
<p class="MsoNormal">
</td>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">2000</font>
</td>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">2001</font>
</td>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">2002</font>
</td>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">Total
end-2002</font>
</td>
</tr>
<tr>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">Dollar
reserves</font>
</td>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">115.5</font>
</td>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">82.9</font>
</td>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">219.8</font>
</td>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">1,751.4</font>
</td>
</tr>
<tr>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">Other
currencies</font>
</td>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">75.2</font>
</td>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">58.1</font>
</td>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">48.6</font>
</td>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">643.8</font>
</td>
</tr>
<tr>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">Total
reserves</font>
</td>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">190.7</font>
</td>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">141.0</font>
</td>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">268.4</font>
</td>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">2,395.2</font>
</td>
</tr>
</tbody>
</table>
</div>
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">(a) in billions
US dollars at constant exchange rates
Source: Bank for International Settlements, 73rd Annual Report, Basel 2003,
table V.1</font>
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">The major buyers
of U.S. debt among the central banks are now located in Asia, and here
particularly in China, Hong Kong and Taiwan (see table 3). This trend—that
central banks substitute private investors and thus stabilize the dollar—will
hardly be sustainable.</font>
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">Table 3</font>
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">Annual
changes in official exchange reserves. Selected areas (a)</font>
<div>
<table class="MsoNormalTable" cellSpacing="0" cellPadding="0" border="1">
<tbody>
<tr>
<td vAlign="top" width="120">
<p class="MsoNormal">
</td>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">2000</font>
</td>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">2001</font>
</td>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">2002</font>
</td>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">Total
end-2002</font>
</td>
</tr>
<tr>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">Euro
Area</font>
</td>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">-9.4</font>
</td>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">-10.8</font>
</td>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">8.0</font>
</td>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">215.8</font>
</td>
</tr>
<tr>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">Japan</font>
</td>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">69.5</font>
</td>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">40.5</font>
</td>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">63.7</font>
</td>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">451.5</font>
</td>
</tr>
<tr>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">Asia
(b)</font>
</td>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">52.5</font>
</td>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">76.0</font>
</td>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">173.3</font>
</td>
<td vAlign="top" width="120">
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">943.8</font>
</td>
</tr>
</tbody>
</table>
</div>
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">(a) in billions
US dollars at current exchange rates
(b) mainly China, Hong Kong SAR, and Taiwan
Source: Bank for International Settlements, 73rd Annual Report, Basel 2003,
table V.1</font>
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">A situation like
this which has emerged over the past few years implies an increasing
financial vulnerability of the United States. If the buying spree by
foreign central banks should stop or even reverse, the impact would affect the
dollar exchange rate, the treasury market and the domestic price level with
the consequences of a sinking dollar, a sharp rise of domestic interest rates
and an increased inflation rate. It is highly unlikely that the American
economy would prove resilient enough to withstand such a triple blow.</font>
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">The coming of a
dollar crisis would expose the internal fragilities of the U.S. economy which
currently are largely hidden. Along with the end of the favors for consumers
to indulge in spending and for private and public debtors to have their
investment and budget deficits financed by foreigners, a decline of the dollar
would expose the lack of a balanced industrial structure in the United States.
More than twenty years of persistently high trade deficits have led to an
industrial structure which has made the United States highly dependent on
foreign imports with a lack of domestic suppliers that could readily
substitute dearer imports.</font>
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">What would
happen if the dollar should surpass the threshold and a crisis of confidence
emerges? The consequences would not be confined to the United States itself.
The dollar crisis would affect the rest of the world and it would put the
current international monetary system at stake with the potential of bringing
it down. While the pillars on which the dollar stands may still seem to be
intact today—the statue itself may come down. But when the dollar should
fall, the pillars on which it has stood, will crumble too.</font>
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">Given the trend
that the U.S. foreign debt position will continue to deteriorate, a severe
dollar crisis seems almost inevitable. But this is only half of the story. The
dramatic part of the enfolding scenario is that there is no ready substitute
for the dollar as a global currency and that the dollar crisis will put the
overall economic and political position of the United States at risk. With the
loss of the privileged position of the dollar the economy would weaken and
this in turn would undermine the political role that the United States plays
presently as the world's hegemon.</font>
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">International
finance is closely intertwined with international politics. While a
predominant role in international finance does not come without the basis
provided by politics, it is sound finance on which the continuation of the
dominant global role will depend later on. Both of these, however, have a more
profound basis: it is basically the ethical attitude to the matters of money
and finance, the deeply rooted sense for prudence and rectitude, which is
required to be maintained in order to keep the privileged position.</font>
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">Near the end of
the Hapsburg Empire, before the outbreak of World War I, Eugen von Böhm-Bawerk
wrote in his essay"Our passive trade balance"</font><a id="_ednref1" title href="http://www.mises.org/fullstory.asp?control=1348#_edn1" name="_ednref1"><span class="MsoEndnoteReference"><font face="Verdana, Helvetica" size="2">[i]</font></span></a>
<font face="Verdana, Helvetica" size="2">that all those theories brought forth
to explain the persistently negative trade balance of the Austro-Hungarian
Empire—such as a surge in industrial strength and its attractiveness for
foreign investment—do not stand a more profound analysis. These argument
would imply that the"passivity" would be transitory. The
persistency of the trade deficits requires that the situation be analyzed
beginning with the capital balance, and this way, Böhm-Bawerk pointed out,
the negative trade balance had its roots in a lack of domestic savings, the
unproductive use of resources and"wasteful consumption" (pp. 509).</font>
<p class="MsoNormal"><font face="Verdana, Helvetica" size="2">A"change
of mind" had occurred, said Böhm-Bawerk, and the accumulation of massive
deficits reflected a"lack of morality" (p. 511):"We slithered
from surpluses into a phase of easy-hearted and willing expenditures, and we
continued to slither even after the surpluses were long gone."</font><a id="_ednref2" title href="http://www.mises.org/fullstory.asp?control=1348#_edn2" name="_ednref2"><span class="MsoEndnoteReference"><font face="Verdana, Helvetica" size="2">[ii]</font></span></a>
<div>
<hr align="left" width="33%" SIZE="1">
</div>
<div>
<div id="edn1">
<p class="MsoEndnoteText"><a id="_edn1" title href="http://www.mises.org/fullstory.asp?control=1348#_ednref1" name="_edn1"><span lang="PT-BR" class="MsoEndnoteReference"><font face="Verdana, Helvetica" size="2">[i]</font></span></a><span lang="DE"><font face="Verdana, Helvetica" size="2">Eugen
von Böhm-Bawerk: Unsere passive Handelsbilanz (1914), in: F. X. Weiss
(ed.): Gesammelte Werke von Böhm-Bawerk, Vienna and Leipzig, 1926,
pp. 449-515.</font></span>
</div>
<div id="edn2">
<p class="MsoEndnoteText"><a id="_edn2" title href="http://www.mises.org/fullstory.asp?control=1348#_ednref2" name="_edn2"><span lang="PT-BR" class="MsoEndnoteReference"><font face="Verdana, Helvetica" size="2">[ii]</font></span></a><font face="Verdana, Helvetica" size="2">Translated
by the author of this article.</font>
<font face="Verdana, Helvetica" size="2">
<hr align="left" width="33%" SIZE="1">
<p class="MsoEndnoteText">Antony Mueller is a professor of economics at
the Universidade Caxias do Sul in Brazil and a member of the Institut fĂĽr
Wirtschaftswissenschaft of the University of Erlangen-Nuremberg in
Germany. He is also an adjunct Scholar of the Mises Institute.</font> <font face="Verdana, Helvetica" size="2">Antonypmueller@aol.com</font>
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