President Richard Nixon’s “Nixon Shock” heralded the end of the Bretton Woods system. Will President Trump usher in another global currency exchange standard?
Post WWII, a handful of countries, notably the United States, Japan, Canada, Australia and Western Europe, established the world’s first negotiated monetary standard. Known as the Bretton Woods system, the standard essentially enforced a regimen of fixed exchange rates, in relation to the U.S. dollar, amongst trading partners. That rate was in turn pegged to the price of an ounce of gold.
Under the pressure of mounting inflation, on August 15th, 1971, President Nixon changed the fixed rate system by ending the convertibility of the dollar to gold for trade purposes.
REPEAT PERFORMANCE?
With the incoming U.S Administration’s actions targeted on the role of NATO, it’s obsession with cheating trading partners, and a focus on immigration and border controls; it would seem as though they are least obsessed with the role of the dollar. Yet, the world’s attention continues to be riveted in that (the U.S. dollar’s) direction.
Today, global currency reserves stand at roughly $10 trillion, as opposed to the paltry $1 trillion they stood at during Bretton Woods. Because it is the reserve currency, much of those reserves are held in U.S dollars by foreign governments, making the role of the U.S dollar even more significant today.
But could America be getting tired of its role as the owner of the world’s reserve currency? Could we see a Nixon-era repeat under President Trump, which could yet again define how foreign trade is negotiated, accounted for and settled?
A PAINFUL ‘PRIVILEGE’
America’s role as the ‘owner’ of the world’s reserve currency gives it enormous power over other nation’s economies. By fine-tuning its own monetary policy, the U.S can send shock waves throughout the world economic order, leaving other nations without the ability to intervene. And many nations are now starting to resent that loss of control.
They see the U.S dollar as a ‘privileged’ child among sibling currencies. For instance, China has made a number of moves to (legitimately) undermine the prominence of the Greenback viz. its own currency. In fact, during the early days of the Bretton Woods era, many world leaders (including future French President Valéry Giscard d’Estaing (then Finance minister) bemoaned the unfair privilege that the reserve currency had over its competitors.
As the reserve currency of the world, the U.S dollar enables Americans to earn higher returns on their foreign assets, compared to what other nations earn on their U.S denominated reserves. This ‘privilege’ means that America is often able to run exorbitant current-account deficits with minor consequences.
However, where there’s gain there’s also pain. The painful results of this continued ‘privilege’ have started appearing in the form of lower exports, larger imports and dwindling export-related jobs that are impacted by the increased imports of foreign goods and services. America seems to be in an economic crisis, partly as a result of its currency ‘privilege’!
DANGEROUS CHOICES
Talk of border taxes and import traffic by the Trump Administration and its lawyers will only strengthen the dollar, making it even less attractive as a reserve standard. So what other options are left?
Well, some might think that it’s time for the Chinese Yaun to step in. But given the nation’s authoritarian views, and the lack of transparency in its dealings (both economic and political, domestically and internationally); the world might be unwilling to accept the Yaun as their new world currency standard.
Others may look to the Euro. But the lack of Euro-denominated debt instruments, and the fragmented legal and political systems amongst member states, poses huge risks in crowning the Euro as the next world reserve currency.
Mr. Trump’s ‘Make America Great Again’ policies could lead to even bigger deficits, and may spur inflation faster than we saw in the 1970’s, when President Nixon delivered the world his ‘Nixon shock’ which unraveled Bretton Woods. The question is: Just as Nixon presided over the collapse of the gold standard, will a ‘Trump Shock’ preside over the collapse of the U.S dollar standard?
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