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Is this it for the Dollar?

Since the beginning of the current economic crisis, the US Dollar has depreciated markedly, as worries mounted about the sustainability of the US government’s fiscal stance. Additionally, calls from policymakers in emerging markets to replace the Dollar as the international reserve currency highlight the importance of a fundamental ongoing shift in the global economic order. Nonetheless, the increasingly vocal debate has yet to produce a credible alternative to the Dollar. Change is likely to be gradual; however, international policy makers have a key role to play in ensuring that it does not become unduly disruptive. In the meantime, the countervailing forces represented by the Dollar’s reserve status and the increasingly widespread desire to modify its stature are likely to result in periods of Dollar weakness interspersed with recoveries.

The post-World War II era has seen dramatic changes in the global political and economic order but remarkably, little change in the dominance of the US Dollar in the global currency markets. This state of affairs has become an anachronism in view of the fact that Dollar’s share of global foreign exchange reserves was around 64% in 2008, although the US accounted for ‘only’ 11% of global merchandise trade. Following the spectacular success of globalization, a growing proportion of global trade should be denominated in emerging market currencies which, problematically, have in many cases delayed this process by maintaining a direct or an indirect link to the Dollar. Ultimately, however, an economic order, supported to a critical extent by inertia, is clearly running out of time.

The dilemma of the Dollar has been amplified by its growing inability to serve as a source of stability and strength for the global economy. Many countries are increasingly wary of tying their fortunes to what they see as a giant with clay feet. The US authorities have impressed with their decisive response to the economic crisis; nevertheless, the enormous cost and still potentially, the uncertain impact of the relief measures, are raising questions about the sustainability of such measures. Aggressive government spending during the current downturn will likely push the budget deficit to USD1.85trn, or 13% of GDP, a level not seen since World War II. The Congressional Budget Office (CBO) has projected a cumulative 10-year deficit of USD9trn by 2019.

But recognition of the demise of one system does not automatically translate into adoption of a new one. The Dollar order has survived in the face of mounting dismay and criticism because of its established and universal nature, supported by the world’s largest and most liquid financial markets. It has no obvious alternative currently; hence the speed and nature of any move away from it will have profound implications. Even as key emerging markets clamor for change, it is clear that they would prefer a gradual and controlled approach. The key question is how much global policy coordination will accompany such a transition? Just as importantly, with or without such coordination, will —and indeed can — the transition be orderly? Or will it be derailed, accelerated, or exaggerated by the market forces that it will unleash?

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