by Sara Eisen
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CONTENTS
List of Contributors
Foreword
Paul O’Neill, Former U.S. Secretary of the Treasury
Preface: A System on Shaky Ground
Sara Eisen
Introduction
Bretton Woods and the Emergence of the U.S. Dollar Reserve System
Sara Eisen
1. The Dollar Will Remain on First
Gary Shilling
2. The World’s Hegemonic Reserve Currency: The U.S. Dollar Versus the Chinese Yuan
Stephen L. Jen
3. The Euro: Past, Present, and Future
Jörg Asmussen
4. What History Tells Us About the Euro’s Future
John Taylor
5. The Future of the Eurozone: An Amicable Divorce Is Better than an Unhappy Marriage
Megan Greene
6. Rebalancing Growth in China: The Role of the Yuan in the Policy Package
Anoop Singh and Papa N’Diaye
7. Currency Wars and a Growing Role for the International Monetary Fund
James Rickards
8. A Role for Gold
Peter Boockvar
9. China
Robert Johnson
References
Notes
Index
LIST OF CONTRIBUTORS
Jörg Asmussen
Member of the Executive Board of the European Central Bank
Asmussen is responsible for the Directorate General International and European Relations and the Directorate General Legal Services at the European Central Bank. Before joining the ECB, he served in various positions at the German Federal Ministry of Finance; he was state secretary from 2008 to 2011 and acted as the chancellor’s G-20 sherpa in 2011.
Peter Boockvar
Market Strategist and Portfolio Manager, Miller Tabak 1 Co.
Boockvar is also president of OCLI, LLC, and OCLI2, LLC, farmland real estate investment funds, and is a CNBC contributor. He joined Miller Tabak 1 Co., LLC, in 1994 after working in the corporate bond research department at Donaldson, Lufkin & Jenrette.
Megan Greene
Director of European Economics, Roubini Global Economics
Prior to working as director of European economics at Roubini Global Economics, Greene was the eurozone crisis expert at the Economist Intelligence Unit, an advisor to the Liechtenstein royal family on eradicating money laundering from the principality’s financial services industry, and an investment banking analyst at JPMorgan.
Stephen L. Jen
Managing Partner at SLJ Macro Partners
Prior to establishing SLJ Macro Partners in April 2011, Jen was a managing director at BlueGold Capital. He was also previously the global head of currency research at Morgan Stanley, and he spent four years as an economist with the International Monetary Fund. Jen holds a PhD in economics from Massachusetts Institute of Technology.
Robert Johnson
Executive Director of the Institute for New Economic Thinking
Johnson is also a senior fellow and director of the Global Finance Project for the Franklin and Eleanor Roosevelt Institute in New York. A former managing director at Soros Fund Management specializing in emerging markets, Johnson has served on the United Nations Commission of Experts on Reforms of the International Monetary and Financial System and was chief economist for the Senate Banking Committee and senior economist for the Senate Budget Committee.
Papa N’Diaye
Deputy Division Chief at the International Monetary Fund
N’Diaye is currently covering China. He has worked on several economies at the IMF, including Japan, Australia, Hong Kong SAR, and Malaysia.
James Rickards
Author of the national bestseller Currency Wars: The Making of the Next Global Crisis
Rickards is a counselor, economist, and investment banker and is a partner in a hedge fund based in New York City. In 1998, he was the principal negotiator of the rescue of Long-Term Capital Management by the Federal Reserve.
Gary Shilling
Founder of A. Gary Shilling & Co.
Shilling became Merrill Lynch’s first chief economist at age 29, before moving on to White, Weld and then establishing his own firm in 1978. He was the first to recognize the unwinding of inflation in the early 1980s when he predicted “the bond rally of a lifetime,” which has driven the 30-year Treasury yield from 15.21 percent in 1981 to 2.8 percent.
Anoop Singh
Director of the Asia and Pacific Dept. at the International Monetary Fund
Singh has also worked as special advisor to the governor at the Reserve Bank of India and has been an adjunct professor at Georgetown University.
John Taylor
CEO and Founder of FX Concepts
Taylor started with the foreign exchange market before the floating era began and was instrumental in pushing Citibank to the forefront of the market in the 1970s. In 1981, he started FX Concepts, which has grown into one of the leading global managers of foreign exchange risk and absolute return strategies. He also serves on the Fed’s FX advisory committee as a buy-side representative. In addition, Taylor has founded a Vermont bank, an international university, and a global biotech company focused on hemophilia.
FOREWORD
PAUL O'NEILL, FORMER U.S. SECRETARY OF THE TREASURY
The existing conventions and arrangements that form the framework for an ever more interconnected world economy are much like the tectonic plates in the earth’s crust, building up stresses and strains until the pressure is relieved by a catastrophic event or the creation of a new world order. It may not be possible for human beings to prevent earthquakes, volcanic eruptions, or other manifestations of movements in the earth’s crust, but since the rules that govern the world economic system are man-made, one would think that we should be able to act in anticipation of a potential crisis. We have had many recent warnings of the need for rethinking: the near meltdown to a barter economy in the United States in 2008–2009, the ongoing saga questioning the durability of the euro, and the proliferation of sovereign states living close to the edge of insolvency.
The collection of ideas in this book is a partial foundation for the architectural reinvention of the world economic order.
Essential to this needed rethinking is an open discussion of the possibilities and realities. When I was secretary of the Treasury, I was hammered by the media for saying that a strong dollar is a consequence of a sound fiscal policy, a vibrant economy, and a higher rate of productivity growth than other countries. In essence, a strong dollar is a consequence, not an independent objective. The media and the markets would have none of it; they preferred the Robert Rubin formulation: “Our policy is a strong dollar.”
If we don’t open up our thought processes, we are doomed to continue as we are, imposing the cost of failed governments, abetted by private banking interests, on the unknowing people of the world.
PREFACE: A SYSTEM ON SHAKY GROUND
SARA EISEN
The dollar remains at the center of global trade, dominates central bank portfolios around the world, and provides a shelter for nervous investors during economic storms. However, there are two sides to the dollar story. The crisis that began in 2007 has highlighted cracks in the dollar-centric international monetary system, resulting in shaken confidence in the dollar. Massive and destructive imbalances, such as the U.S. trade deficit and China’s trade surplus, threaten the world economy. Central banks and federal governments alike, including those of the United States, are finding themselves in uncharted territory, having absorbed massive debt to stimulate their economies during the crisis. For instance, in a 2009 G-20 summit, governments around the world pledged an unprecedented $1.1 trillion to tackle the crisis. In addition to stimulus spending by governments (such as the Troubled Asset Relief Program [TARP] in the United States), central banks have been spending trillions in their crisis-fighting efforts. The Fed adopted unorthodox policies such as quantitative easing, in which central banks create money to buy their own bonds—in the Fed’s case, U.S. Treasuries—pushing interest rates lower and injecting liquidity into the financial system.
Unfortunately, the goal of relief by both government-instituted stimulus packages and Fed policy can send indebted economies further into crisis. The Fed has bought more than a trillion dollars’ worth of Treasuries in quantitative easing; this has sparked a flood of criticism from politicians and world leaders, who argue that a by-product of such policies is a weaker dollar. Weakness of the U.S. dollar, though desirable domestically for growth, undermines confidence in the world’s reserve currency and boosts other currency values around the world as a direct, but undesirable, consequence to other nations. As John Connally, former secretary of the Treasury under Richard Nixon, famously said of the dollar, “Our currency, but your problem.”
But the dollar’s weakness is not exclusively a by-product of quantitative easing. The dollar’s value has declined over the past 10 years, predating the recession of 2008. This occurred as the U.S. government issued massive amounts of debt and the euro emerged on the scene. Central banks and reserve managers the world over have accumulated euros as an alternative to holding all their reserves in dollars. At the same time, China and other nations such as Brazil, Russia, and India known as the BRIC nations, emerged as the world’s fastest-growing economies and, as a result, leapt to the forefront of global economic decisions. They also have, by virtue of their economic activity, become the world’s largest holders of dollars and other foreign currencies. All of these factors, culminating with the financial crisis in 2008, have led many people to question the outsized, and perhaps outdated, role of the United States in the global monetary system. Think about this: the dollar is the currency the world depends on to price everything from vanilla produced in Comoros to precious oil—and this dependence is an issue that is at the forefront of the world stage today.
With the onslaught of the European debt crisis in 2010, driven by nations’ excessive borrowing and explosive debt, the questions facing the international monetary system are now even greater and more complicated than ever. Since it was adopted in 1999, the euro has grown to become the second reserve currency to the dollar, meaning that it is the second most widely traded and held currency in the world, in use by 17 nations in Europe. This common currency area has inherent flaws, however, including gaps in competitiveness, language differences, and disparate fiscal policies among the nations that share the euro and the European Central Bank. The debt crisis has highlighted these structural flaws and is leading to questions about the euro’s sustainability and viability.
Since 2010, waning confidence in the world’s two major currencies, the euro and the dollar, has caused money to pour into faster-growing economies with more sustainable debt loads, including Brazil, Russia, India, China, and other emerging nations. This investment has led their currencies to strengthen, and consequently, we see them resorting to intervention and other policies aimed at weakening their currencies against others to promote domestic exports. This phenomenon, known as competitive devaluation, has the potential to lead to retaliatory action, resulting in trade wars—a highly undesirable and disruptive consequence of such policy. An example is the currency war of the 1930s that resulted from competitive devaluation by the United States, the United Kingdom, and France. During the Great Depression, each attempted to expand its own economy by devaluing its currency in order to maintain exports and reduce trade surpluses. However, the impact on all was negative, and international trade suffered. This history lesson was not lost on the former chief of the International Monetary Fund, Dominique Strauss-Kahn, who warned in 2010, “There is clearly the idea beginning to circulate that currencies can be used as a policy weapon. Translated into action, such an idea would represent a very serious risk to the global recovery.”
Now, more than six decades after the world’s major nations drafted new rules for the international monetary system in Bretton Woods, New Hampshire, and almost four decades since those rules were severed in favor of a new system, world governments are again debating whether a major shift in the global currency regime is needed. Nobel laureate in economics Joseph Stiglitz maintains, “A new global reserve system is absolutely essential, if we are to restore the global economy to sustained prosperity and stability.” And former French president Nicolas Sarkozy, who held the rotating presidency of the G-20 nations in 2011, stated that the international monetary system, which is still based on the supremacy of the dollar ratified in the Bretton Woods Agreement of 1944, when the United States was the only world superpower, is stale. He stated, “My question is: Are we still in 1945? The answer here is, ‘no.’” In fact, Sarkozy had pledged to create a new “fina
ncial world order,” but this goal was thwarted in 2011 by the emergence of the European debt crisis, which has dominated G-20 and other world economic meetings since 2010.
Some experts wonder whether gold should play a role in currency once again. While most economists do not advocate a gold standard, confidence in gold has grown as its price has climbed steadily for decades, further fueling the debate about whether gold has a role to play. In fact, in the fall of 2010, Robert Zoellick, former president of the World Bank, wrote in the Financial Times, “The scope of the changes since 1971 certainly matches those between 1945 and 1971 that prompted the shift from Bretton Woods. Although textbooks may view gold as the old money, markets are using gold as an alternative monetary asset today.”1 Finally, it is notable that the major fiat (paper) currencies, based on confidence in governments, are exhibiting a distinct decline while confidence in gold has been on the rise.
Alternatively, in a report issued in February 2011, the International Monetary Fund (IMF) suggested a possible replacement for the dollar as reserve currency, claiming that Special Drawing Rights (SDRs) could help stabilize the financial system. SDRs represent potential claims on the currencies of IMF members; they can be converted into whatever currency a country needs, and at exchange rates based on a basket of international currencies, as opposed to the dollar exclusively.
The following questions will define and dominate world meetings, including those of the G-20, IMF, and other high-profile gatherings of superpowers in the coming years as leaders debate a new world order. These questions are among many others that are tackled in this book: Will the dollar maintain its leadership role in the global economy? What would replace the dollar as the reserve currency? Is there a role for gold? Is there a role for an IMF currency? Will the euro survive? How can leaders restructure the euro to make it more viable as an international reserve currency? How can China reform its exchange rate to make the yuan more tradable in and accessible to the world? Will China’s currency dethrone the U.S. dollar as the world’s reserve currency? Will currency wars and competitive devaluations escalate into trade wars? What would a Bretton Woods of the future look like?