Sudip Bandyopadhyay’s Blog

Athenian owls, Roman denarii, British sovereigns, US dollars.  There have been many pseudo reserve currencies down the ages.  Now the governor of the People’s Bank of China has called for a new global currency “disconnected from individual nations”.  Russia, too, wants to move away from a world dominated by the dollar. Kazakh president Nursultan Nazarbayev suggests such a currency  could be called the acmetal – an amalgam of “acme” and “capital”.  But is there a case one?  In theory, yes. Although no one was banging the table for change when emerging growth rates were still being powered by deliberately undervalued domestic currencies.  The reserve currency status of the dollar helped to  create nasty global imbalances –one of the main culprits of the current downturn.  As China, for example recycled export earnings back into dollar denominated assets, the US could happily run profligate trade deficits with impunity.  That helped push up the price of US assets, particularly house prices. Now surplus countries are stuck.  They cannot diversify fast enough and a rapid sell down of US assets would destroy their portfolios.  Not only that, global central banks holding about two thirds of their reserves in dollars are hostage to the Obama administration.  Unsurprisingly, huge budget deficits and the Federal Reserve’s leap into quantitative easing have foreigners fretting over the longer term health of the dollar.  Theory is one thing, however.  In realty, currencies live and breathe more than just short-term economic air.  The two other life forces for a reserve currency are sovereign credibility and power.  China, Russia and others simply do not have long enough economic track records to justify backing a reserve currency.  Find a single investor in this crisis that has panicked out of dollars into roubles.  Of course, if China one day emerges as the dominant economic and military power, the status quo will change.  Until then, investors cannot be rushed.

The other relevant issue today is “Who is going to pay”? Most of the world’s major economics are trying to spend their way out of the sudden collapse in financial activity using borrowed money. While contentious, there are ample defences for this policy.  But working out who pays is a harder question, which will be aired when the G20 heads of state meet in London next week. The air is thick with verbal bards – from the Chinese central bank’s interest in a new reserve currency, to the Czech prime minister’s anger with the US deficit.  Last week  showed that the market is listening.  First, the auction of 40 year gilts in the UK saw the first “failure” since 2002.  In other words, it was undersubscribed, with bids only for 93 per cent of the bonds on offer.  The instant response was as though the UK could not fund its deficit, as the Bank of England warned this week.  The yield on 10 year gilts rose from 3.35 per cent to 3.53 per cent almost back to where it was before the BoE said two weeks ago it would buy gilts.  Then the BoE bought some gilts, and the yield came all the way down to 3.27 per cent. Auction failures are not unprecedented, and the extreme reaction showed that investors are nervous.  Sterling barely moved on these developments.  Instead, it rose and fell on comments by Tim Geithner, the US Treasury secretary.  He said first that he was “open” to China’s proposal that the dollar should be superseded as the reserve currency.  Minutes later he said he expected the dollar to be the reserve currency “for a long time.”  Between his comments, the dollar dropped by 1.1 per cent, and then rebounded.  Again this is about who pays.  If the US inflates out of the crisis, and the dollar falls, those holding assets in dollars will lose and in effect, pay the bill.  That is why politicians are talking so much about these issues.  With markets scared, they should mind their words.