article: Decline and fall of the U.S. dollar
Is greenback headed way of the pound?
Jacqueline Thorpe, of Financial Post
nationalpost.com
Investors hoping the U.S. dollar's recent rout will be but a blip in a never-ending upward trajectory should spare a thought for the Byzantine denarius, the Venetian ducat or the British pound.
While few economists predict the U.S. dollar is in any danger of losing its cachet as the world's reserve currency, the fact is history is littered with currencies that have attained cult status only to be unceremoniously dethroned.
In one of the more lighthearted and interesting reports in the glut of research that has been published on the greenback in recent weeks, Paul Donovan, senior economist at UBS Warburg in London, argues there are discernable threads that link each currency's eventual retreat -- the kind of current account deficit that now blights the United States and trade disputes being the most glaring.
"The possibility of U.S. dollar supremacy being eroded by changes in the international political environment is not exactly a revolutionary concept," said Mr. Donovan. "Countries enjoying economic primacy have been challenged over at least the last couple of millennia."
Mr. Donovan goes back to the eighth century to find one of the earliest parallels to the United States' current situation.
The Byzantine Empire was the economic superpower of the time, controlling the world's reserve currency -- the denarius. It was the only gold coin in mass production and as a result the empire ran a significant current account deficit with the rest of the world, particularly Asia.
But then the Umayyad Caliphs -- the first great Muslim Dynasty -- got into the act and started producing a gold coin of their own.
The two eventually went to war and the Byzantine Empire was further eroded by a series of trade wars with Persia, which controlled the silk and spice routes.
The end result was a gradual erosion of the economic supremacy and the denarius of the Byzantine Empire, Mr. Donovan said.
In the 15th century, it was the Italian city states of Venice and Genoa that ruled the world's economies and the ducat that became the world's reserve currency -- the currency of choice for trade and central banks.
Wars, a technological 'hollowing out' to economies with cheaper labour and a banking crisis -- the Medici Bank failed in 1494 following sovereign defaults -- eventually cost the Venetian ducat its status.
A string of economic empires and currencies rose and fell over the centuries, including Spain's Iberian peninsula, undone in part by the trade and tariff protection of the Basque iron industry; and the Dutch United Provinces, ravaged by French sovereign defaults and the fiscal drains of war.
But perhaps the most relevant parallel, Mr. Donovan argues is also the most modern -- the decline of the British pound at the end of the Victorian age.
Several factors conspired to undermine the British economy and put pressure on the pound toward the end of Queen Victoria's reign but perhaps the most damaging was that other countries began to beat the British at their own game.
"From the 1870s onwards, trade rivals were swift to adapt to the latest technologies in their industrialization process -- the costs of developing these technologies had, of course, already been borne by the U.K., and so foreign rivals started with an advantage," he said.
There was no single challenger to sterling, although the U.S. dollar was the obvious choice.
Wall Street became the most exciting place to be and the sterling bonds of the late 1800s fell out of favour. When the British government placed part of a loan to fund its campaign in the Boer War in 1900 in New York, it marked the beginning of the end of London as the world's financial centre.
The cost of the First World War did obvious damage, along with the protectionism of the 1920s and the tariffs of the 1930s, all eventually reflected in the decline of the British current account position.
"The mounting public debt, and disruption to trade, wrought by the war meant the assumption of the unassailable nature of the U.K. current account position was challenged," Mr. Donovan said.
It was forced to treble gold reserves and eventually devalued in 1931, leaving the gold standard. Current account deficits persisted and investors began to decamp for other markets. Sterling embarked on a period of structural weakness that has only really been arrested in the last 15 years.
What do all these fallen currencies have in common?
Too many wars that result in too much spending and a big runup in the current account deficit figure heavily, as do banks or sovereigns that default, leaving the economic superpower holding the bag.
Quite often, however, the rest of the world just catches up to the technology that initially gives the economy a leg up.
"The 15th-century Italian trade guilds, the Basque iron industry of the 16th century, are all examples of industries where the rest of the world 'caught up' with the superpower, and undermined its economic primacy," Mr. Donovan said.
The superpower often tries to maintain its grip through trade protectionism but this only hastens its decline by protecting outdated industries instead of encouraging continued improvements.
The parallels with the current U.S. situation, which Mr. Donovan does not spell out, are obvious.
Much has been made of the U.S. current account deficit, which stood at US$98.8-billion or close to 4% of nominal gross domestic product at the end of last year, following one of the greatest influxes of spending binges the world has seen. The running estimate is that the United States needs at least US$1.5-billion of net capital per day flowing into its economy or the dollar will weaken.
The U.S. Congressional Budget Office, meanwhile, expects the budget to swing into a deficit of US$21-billion in 2002 and US$14-billion in 2003 thanks to lower tax revenue and a massive buildup of military spending. That's up from a US$127-billion surplus in 2001.
The avalanche of subsidies and aid packages flowing out of Washington amid wide-ranging trade disputes, also fits the bill.
But one key element does not, at least not yet.
Europe may indeed now have U.S.-made high technology at its disposal but it still does not have the kind of regulatory environment or entrepreneurial drive that has allowed the United States to use that technology to drive productivity and growth forward.
Britain's inclusion in the euro could provide just the added spark Europe needs to make doing business easier and give the U.S. dollar a serious run for its money.
Asia has emerged from its 1997 financial crises but no currency there seems mature enough to be a match for the greenback. Japan is showing green shoots of recovery but if Europe needs to do more to make its economy more competitive, Japan needs to go further still.
But Mr. Donovan said: "The smart money in the 1920s would have invested in Japan's textile industry (not that of the U.K., crouching behind the tariff walls of Imperial trade). The smart money of the 15th century would have shunned Venetian trade (with its guilds and restrictions), for the freedoms of Spain. The smart money of the 21st century is also likely to follow performance rather than protection."
jthorpe@nationalpost.com |
