"Well the eagle's been flying slow, and the flag's been flying low, and a lotta people say that America's fixing to fall."

There is an interesting article on page C12 of today’s Wall Street Journal by Berkeley Professor Dr. Barry Eichengreen entitled: “Why the Dollar's Reign Is Near an End”. In the article Dr. Eichengreen states that the U.S may have to share its role as the world’s reserve currency with the euro and, eventually, the yuan.



He argues that technology has made it easier to exchange one home currency for another. Previously, determining exchange rates between two specific currencies of smaller countries was not easily accomplished. Now, electronic trading platforms have made FX markets much more liquid and transparent.



He also makes the argument that the euro and the yuan will rival the dollar in the future as the EU and China rise as trading blocs. His theories are based on his belief that the EU and its member countries will become more fiscally responsible and that China will open up its markets, loosen its grip on the yuan and become less of a command economy.

A counter article authored by the Journal's own Michael Crittenden entitled: "The Case for the Dollar's Continued Dominance" discusses why the dollar could remain the world's reserve currency. Many economists interviewed support this belief:



University of Wisconsin economics professor Menzie Chinn states:

"How much of a financial center can they be if they insist on continuing to control the financial sector? Until Beijing frees up its financial markets, who wants to have a lot of assets denominated in renminbi?”



Pimco’s Tony Crescenzi states:

“We try to think of the alternatives, and none exist of any consequence."

Even members of the ECB believe that dollar may still reign supreme. ECB Vice President Vitor Constâncio said, "I do not see a major reform of the international monetary system on the horizon, as there is no real substitute for the U.S. dollar in the medium term."



Like it or not we currently live in a world of fiat currency. A currency’s value is only as strong as the system which issues it. During times of turmoil one does not wish to go to sleep at night and worry that a government may change exchange policies or even collapse altogether overnight. Things look rosy for many emerging market economies, but one still must be concerned about their abilities to deal with inflation and the potential civil unrest which could occur.



China has given us indications of how it will deal with inflation. Basically it isn’t addressing inflation, at least not its causes. For the most part it has ordered (it is a command economy) banks to reduce lending and CNBC reported this morning the China’s government is considering ordering salaries raised so consumers can better afford higher prices. Not exactly steps toward a freely-floating currency. A freely-floating and portable yuan would significantly reduce government control over China’s economy. It would likely reduce China’s comparative advantage in manufacturing.



What about the EU? The EU, as of now, is not a United States of Europe. Although it does have a central bank (the ECB) which dictates monetary policy. Fiscal policy is set by the individual sovereign nations. The EU has no authority over sovereign fiscal policies. This can handcuff the ECB.



The ECB has a single mandate of price stability. However, inflation and economic conditions are not the same throughout the EU. On one hand there is Germany with a booming economy and record-low unemployment. On the other hand there are the PIIGS. Spain has unemployment in the area of 20%, and there is unrest in Greece due to proposed wage and benefit cutbacks to government workers. In a perfect world, troubled EU members would ease monetary policy to reinvigorate economy. However, EU sovereign nations cannot print money. Policies which help reinvigorate the PIIGS could lead to inflation pressures in Germany. Anti-inflation policies designed to keep prices in the stronger EU economies in check could be catastrophic for the PIIGS.



The dollar is not pre-ordained to be the world’s reserve currency. The dynamics of other economies and societies could change in ways which enable their economies and currencies to rival the U.S. However, until those changes are implemented (if they are ever implemented), the dollar will probably remain the world’s reserve currency ("the same as it ever was...").