February 11, 2011

A proposal for strengthening the sustainability of the dollar as an international reserve currency

Sir I refer to the recent discussions on international reserve currencies.

There are only two possibilities for an international reserve currency, it is either backed by something physical or it is backed by some sort of metaphysical faith. In the latter case it would be really hard to envision an international organization being able to substitute for a nation in generating the required faith, since that would really have to mean it becomes stronger than any country. I ask, except for in some global citizen´s dreams, when will the IMF or even the United Nations mean more than, for instance, the USA? The SDR´s recently being much re-discussed are based on a predetermined mix of some countries, and as an average, it all finally depends on the how the individual members of the basket do.

And so the fact is that, for the time being, the world has deposited its faith in the USA, which on its currency declares in its turn having deposited its faith in God. And that´s it! While the music plays, as someone recently spoke about a different situation, you have to keep dancing, no matter how untenable it all can seem to be… that is of course unless you want to try to create chaos by decree.

Meanwhile if there is anything we could do, that is to discuss how the faith in the currency of a country could be better harbored, so as not to provoke some of the difficulties for the trusted country, which could provoke the world losing its trust in it earlier than necessary.

In this respect I believe that the most important part to achieve more sustainability is to make a clear distinction between the long term faith in a country and its economy, and the short term faith in its government, perhaps with a sort of a Chinese wall.

Since even the safest harbor can become dangerously overcrowded the US should think of having the Fed collecting a toll from anyone wanting to anchor in their safe-dollar harbor, and not pass along that toll to the US government by means of lower interest rates on its debt, and as is currently the result. That safe-haven toll would align much better the incentives, especially for the US citizens, because no citizen would like to have his government´s finances subsidized by foreign interests. It would in fact be an effective way to combat the safe-haven resource curse.

There would be no problem in having the Fed later sharing the revenues of the toll with the government but those revenues would then be seen as being generated by the strength of the nation and not by the strength of the government.