In the 1960s, the Belgian-American economist Robert Triffin pointed out something that I would like to bring into the sunlight today, and which soon will be a popular topic around the water cooler, if I'm correct.
Triffin observed that when a national currency also serves as a world reserve currency, a dilemma arises: the issuing country must choose between “store of value” and “reserve status.” A country whose currency has reserve status must be willing to supply the world with sufficient currency to meet world demand for foreign exchange reserves, and thus dilute the “store of value.” Meeting this demand will also be reflected in fundamental imbalances in payments, specifically the current account.
I will focus on the dilution of the dollar's value since Nixon severed its gold backing in August 1971.
As I explained in my February 2012 World Money Analyst article, the dollar has completed four alternating weak/strong trends since 1971, shown in the chart above. The current weak trend in the dollar began 11 years ago; could this one be the trend to end all trends?
Prior to the current US dollar stint, the currencies of five countries each held world reserve status for an average of 95 years. This data goes back 563 years, folks, so we're not just looking at a single example. Here's the list and approximate time frames:
As you can see, the US dollar has held reserve currency status for 88 years… just seven years shy of the average of 95 years. Of course, the 95-year figure is just a historical average; the actual time till expiration of reserve status could be longer… or shorter!
I found the graphic below on the Casey Research site and thought that it played well with my point here.
Notice that the sand that represents the time the dollar has left is moving through the hourglass right before our eyes. To borrow and adapt a line from a soap opera, “Like sands through the hourglass, so are the days of the dollar's life.”
I travel and talk to people throughout the US, Canada, Mexico, and Panama. Wherever I stop, I try to explain what deficit spending and debt has done to the US dollar's value, and how regardless of what country they live in, they should not have 100% of their investment portfolio allocated to their home currency.
For over 3 years, I have warned that the US dollar's term as the world's reserve currency will expire by the end of this decade. That message, it turns out, aligns well with the historical average that dates the end of the dollar's reign as 2020.
And now, the US must deal with another debt ceiling debacle. I truly believe that the US will eventually relinquish its reserve currency status in order to avoid an outright default.
So, if the dollar loses its reserve status, what will that mean to dollar holders? Gloom, despair, and agony come to mind. It took the UK over 50 years to recover from their loss of the reserve status.
Remember, the country with the reserve currency gets to receive loans at discounted borrowing costs.
Also, commodities are priced in the reserve currency, meaning central banks around the world must hold the currency in their reserves to facilitate trade. When these benefits are lost, a country's economy becomes stagnant at best, and the value of the currency is depreciated, mainly because the world's central banks no longer need to hold it.
I am frequently asked which currency will replace the dollar as the reserve currency. I respond that the real concern is not speculating about the next currency king, but about the consequences of the dollar's lost status!
When pressed, I speculate that it will be the Chinese renminbi. China was the first country to state as its goal the replacement of the dollar standard. Since making that claim, China has taken multiple steps toward making its currency, the renminbi or yuan (same currency), eligible to become the next global reserve currency. China still has a long way to go but has moved quickly.
I also believe that whenever China allows the renminbi/yuan exchange rate to float against world currencies, which is essential to gaining reserve status, it will issue the currency with partial gold backing. That would render its currency the most attractive in the world and spark global demand and wide distribution!
The euro was once considered the dollar's main challenger. That was before the markets woke up and realized that Greece, Spain, Italy, and Portugal can't pay their debts, and that their debt shouldn't be issued at the same yield as German debt. The euro may one day rebound to once again be a challenger, but not before China moves to the head of the class.
Another alternative could be that the reserve currency becomes a basket of currencies with each the “king of the hill” in their respective regions. But that wouldn't save the dollar from a loss of value that would follow its lost status.
I write a daily newsletter called A Pfennig for Your Thoughts in which I always remind readers to have at least 15% to 20% of their portfolio allocated outside of the dollar in select foreign currencies and precious metals. One day, when the dollar gives up its reserve status in order to stave off a debt default, non-dollar holders will be thankful they heeded that advice.
Chuck Butler is president of EverBank World Markets. EverBank is an FDIC-insured US-based bank specializing in WorldCurrency® Certificates of Deposit and deposit accounts denominated in select global currencies. Contact: www.EverBank.com