Fifty years have passed since President Richard M. Nixon changed the US monetary system by suspending the conversion of US dollars to gold and allowing the rate to float.
The elimination of the gold standard and the move to a floating exchange rate system have raised serious concerns. Perhaps the most interesting point or lesson since the change is that the US dollar has been dominant in the world and more robust than initially expected. Even in retrospect, most experts would have doubted the system could survive that long.
We now have a monetary system called the fiduciary system, which the government designates as legal tender. Some definitions can help.
Fiduciary money has no intrinsic value, while legal tender is any money declared legal by a government. Governments can issue fiat currency and make it legal tender by setting it as the standard for debt payment. The advantage of fiat money is that it gives central banks greater control over the economy, but governments can also create problems by mismanaging the money supply.
Today, the US dollar is both fiat currency and legal tender.
Global turmoil has challenged the dominance of the US dollar on several occasions. Of course, the world continues to be turbulent. And with recent events in Afghanistan, one wonders if the events that have humiliated the world’s most powerful military and largest economy will have implications for the dollar and its role in the world.
Yet the dollar has shown remarkable resilience over time.
It is tempting to dismiss America’s failure in Afghanistan as inconsequential to the dollar. After all, the dollar has survived many political failures and attempts to undermine it. Why should this time be any different? The answer depends on your expectations of the global economy and the behavior of its main financial players outside the United States, notably China and the European Union.
The current system has endured for three main reasons.
First, most countries have not chosen to let their currencies float freely against the dollar. Although more countries have floated their currencies in recent decades, others have maintained fixed exchange rates, developed their own regional exchange rate relationships, or launched a common currency, such as the euro.
Second, among the few countries with enough economic clout to influence the global monetary system, Russia has often opposed but simply lacks significant economic clout. Japan, Germany and now China have made a conscious decision to prevent their currencies from assuming a larger global role. Note that Germany has systematically opposed the idea of pan-European bonds. Without a common budget, the euro will always be prevented from competing with the dollar or from playing a much larger role in the global financial system.
Japan never had any interest in playing a global role for the yen, even when its economy was booming, and many experts predicted it would catch up with the United States.
China has also often opposed the current global monetary system, but has been reluctant to expand the renminbi’s role in financial markets, both domestically and internationally. Instead, China seems to prefer a system using Special Drawing Rights, the reserve assets of the International Monetary Fund, whose value is based on a basket of five currencies (the US dollar, the euro, the renminbi , the yen and the pound sterling).
Some find this approach attractive because it would have more global “fairness”. The practical implementation would be difficult. The basic requirements would include China allowing freer use of the renminbi; and the United States accepting the monetary system based on the SDR. None of these changes are likely to happen anytime soon.
The third reason for maintaining the current system may be of the greatest importance, and that is influence. The dominance of the US dollar has conferred benefits that many US presidents have enjoyed.
A dominant dollar is a powerful tool for pursuing diplomatic and national security objectives. The use of sanctions against countries that have done business with Iran is a recent example. If current or future American leaders use dollar dominance in the same way, perhaps against countries doing business with hostile Afghanistan, the currency of the sanctioned country could suffer. Political tools are important and are not easily abandoned.
This year, the International Monetary Fund is working on its five-year mandated review of the composition and valuation of the SDR basket. If this exercise increases the share allocated to the Chinese renminbi, it will be a sign that the global monetary system is changing. Just as China’s growing share in the global economy implies the need for fundamental rebalancing, the renminbi’s share in the SDR basket cannot continue to grow without this increase making sense for the future of the financial system. global.
China appears more and more aggressive and competitive with the United States Will China and other countries use the latest events in Afghanistan to improve their position at the expense of the United States? Watch carefully.
Mark Sievers, President of Epsilon Financial Group, is a Certified Financial Planner with an MBA from the University of California at Berkeley. Contact him by email at [email protected].