High time world thought of a currency basket

This article appeared originally in Gulf News: link to original article

The US shutdown was never about the loss of $160 million (Dh587,680 million) a day. And it definitely wasn’t about the associated costs that brought the final bill to a total that exceeds $20 billion.

In a recent piece in ‘Foreign Policy’, there was a very interesting list provided. In short, the list was of what could be bought or done with the money lost due to the shutdown. The list included, but wasn’t limited to, the equivalent of constructing 16 Burj Khalifa towers, organizing two London Olympics, the equivalent of El Salvador’s GDP, the equivalent of two times Iceland’s GDP, and half of what Warren Buffet is worth.

And you can also finance the entire lifestyle of Iron Man 15 times over.

However, the real cost cannot be easily evaluated for the very simple reason that the hit to the dollar’s credibility cannot be accurately quantified even if an article in Bloomberg estimated this to be 2 per cent of the US GDP.

The drag in reaching a deal on debt ceiling was frustrating everyone. Emerging economies were not ready to face currency devaluations especially after just surviving what an announcement to taper the Fed’s quantitative easing caused in its immediate aftermath.

Even though a default didn’t occur, credibility lost is lost forever. No matter how much everyone trusted Uncle Sam to carry on his role of providing the world’s reserve currency in the most optimal way possible; this is no more the case even if everyone is not yet that heartbroken. It’s very cool to be able to sell Treasuries and then print currency whenever you want to pay interest or principal, but up to when? Countries that are heavily invested in these, like China, are not at ease with what has happened, especially as the deal reached could lead to yet another battle early next year over the same issue.

Let me tell you why. According to a piece by Stephen S. Roach, China’s holdings of US debt has increased from $60 billion out of $3.3 trillion in 2000 to a $2 trillion exposure out of $16.7 trillion, including US government and quasi-government securities, by July 2013.

And China isn’t doing this out of pure love, rather to support an export-led growth for 33 years which won’t have been possible with a stronger Chinese currency. As for the US, such a deal helped keep interest rates down while American consumers enjoyed low-priced Chinese imports.

What if there were no treasuries? Can we imagine such a scenario or even afford one? To answer this, two points need to be discussed.

The first is the investment part of it. Treasuries are the safest investment out there, and their rate is what is used as the risk-free rate in a given investment’s return as well as asset pricing calculations. In that sense, there is no alternative or at least not one that is as liquid and as widely traded as Treasuries.

It is essential to point out here that despite their safety, since 1946 Treasuries accumulated a real loss of 91 per cent. This can be justified with return being below inflation and with a loss to the dollar’s value. The second point is the advantage of printing the dollars.

What can we substitute the Treasuries with? Keep in mind any replacement means taking over the role of providing the world with a globally accepted currency… which no other economy can assume right now. China is long way from transforming its economy from one that is export-led to one that is consumption-led, before which it can qualify as a candidate for the role.

The US is losing its advantage of borrowing in dollars whichever way you look at it. The uncertainty of its fiscal policy, the fact that Treasuries are not inflation-linked, and risk of a shutdown/default all add up to everyone’s dissatisfaction with the role of the US as the world’s central banker. If the dollar is such a safe currency, why can’t one of the US key allies peg their currency to the dollar?

Instead, they found their own treasuries by depositing money in banks of their neighbours. As this is basis for lending and economic activity, imagine the bargaining power that comes with it.

At the moment, Japan can borrow at rates lower than Treasuries, and Germany’s long-term bonds are also cheaper. If all is put in the right perspective, a change in attitude is taking place with a recent suggestion to create a basket of world currencies rather than just the dollar.

But then, which global institution would manage this if it happens?

Now the thought I want to leave you with is this: why did the Chinese government sign currency swap lines with 22 countries? (Hint: a plan enacted in 2011 is to have a more balanced growth model with increasing dependence on private consumption).

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