The demise of the dollar as the world’s reserve currency has been predicted for a long time now. Yet it is still way surpasses other currencies, such as the euro and yen, as the main reserve currency of most countries. Also it still dominates world trade with much of international trade being priced in dollars. Indeed, as the eurozone reeled from the Greek debt crisis in early February (see A Greek tragedy and Debt and the euro) so investors sold euros and bought dollars. The dollar gained 12 per cent against the euro from December 2009 to February 2010 (from $1 = €0.66 on 1/12/09 to $1 = €0.74 by mid February).
But a number of economists, investors and officials argue that the dollar’s dominance is gradually being eroded:
As the United States racks up staggering deficits and the center of economic activity shifts to fast-growing countries such as China and Brazil, these sources fear the United States faces the risk of another devaluation of the dollar. This time in slow motion – but perhaps not as slow as some might think. If the world loses confidence in U.S. policies, “there’d be hell to pay for the dollar … Sooner or later, the U.S. is going to have to pay attention to the dollar”, [said Scott Pardee, economics professor at Vermont’s Middlebury College and formerly on the staff of the New York Fed].
So what is likely to be the future of the dollar? Will it remain the number one world reserve currency? Will its position be gradually, or even rapidly eroded? What will happen to the exchange rate of the dollar in the process? Finally, what is the significance of the trade and budget deficits in the USA? Are these of benefit to the rest of the world in providing the necessary dollars to finance world trade and investment? Or are they a source of global imbalance and instability? The following article look at these issues.
How long can the U.S. dollar defy gravity? Reuters, Steven C. Johnson, Kristina Cooke and David Lawder (23/2/10)
Is greenback’s dominance coming to an end? Stuff (New Zealand), Tony Alexander (24/2/10)
Reconstructing The World Economy Eurasia Review, John Lipsky (25/2/10): see final part on Reforming the International Monetary System. See also the following conference paper referred to in this article:
The Debate on the International Monetary System Korea Development Institute / IMF Conference on Reconstructing the World Economy, Seoul, Korea, Isabelle Mateos y Lago (25/2/10)
Questions
- To what extent does the world benefit from having the dollar as the main reserve currency?
- What is the role of US current account and budget deficits in supporting this reserve currency role? How important is the size of these deficits?
- What is likely to happen to the exchange rate of the dollar against other major currencies in the coming years?
- What alternatives are there to having the dollar as the world’s main reserve?
- Does it matter if China holds $2.3 trillion in foreign exchange reserves, with nearly $800 billion in US Treasury debt?
- Why is the value of its currency a less urgent problem for the USA ‘than it would be for other borrowers who borrow and pay for imports with dollars’?
- What are ‘currency swap accords’ and why are they important for China?
- What are the implications of the Chinese yuan being undervalued against the dollar by as much as 40%?
As the news item, A Greek tragedy reported, the level of debt in Greece and also in Portugal, Spain, Ireland and Italy, has caused worries, not just for their creditors, but also for the whole eurozone. Here we give you the opportunity to listen to a podcast from the Guardian in which some of the paper’s main economic columnists, along with Observer commentator, William Keegan, discuss the effects of this debt on the euro. To quote the introduction to the podcast:
“In Brussels, European leaders have pledged ‘determined and co-ordinated’ action to help Greece – they won’t let it fail. Our Europe editor Ian Traynor says the announcement of a deal was designed to keep the markets happy.
But leaders of wealthier euro nations like Germany are hoping they won’t have to ask their voters to bail Greece out. Kate Connolly, our Berlin correspondent, explains why Germans are so reluctant to provide financial assistance.
It’s being seen as a defining moment for the euro. Economics editor Larry Elliott says not signing Britain up to the single currency was the best decision Gordon Brown ever made.”
The debt crisis facing the Euro Guardian daily podcast (12/2/10)
Questions
- To what extent is Greece’s debt a problem for the whole eurozone?
- Consider the arguments for and against bailing Greece out (a) by stronger eurozone countries, such as Germany and France; (b) by the IMF.
- What support for Greece would minimise the problem of moral hazard?
- How would you set about establishing whether the current eurozone is an optimal currency area?
- How do the current problems of debt affect the arguments about whether Britain should adopt the euro?
Over the past week, Greece has been hogging the headlines when it comes to debt crisis. However, there is concern that there are a number of other countries ‘where credit defaults swaps are unusually high, suggesting there is risk in terms of default’. Greece’s deficit stands at 12.7% (£259bn), which is over 4 times higher than EU rules allow and its debt levels are expected to reach 120% of GDP this year if help is not given. Furthermore, if Greece’s debt problems are not tackled, there is a worry that other countries with big deficits, such as Portugal and Spain will become vulnerable. Public spending in Greece had been rising for some time but the tax revenue hadn’t increased to match this. As government spending rose and tax revenues fell, the growing debt was inevitable.
What is just as concerning is the cost of servicing this debt. This is costing Greece about 11.6% of GDP and the Greek government has estimated that it will need to borrow €53bn this year to cover budget shortfalls. Strikes by public-sector workers have also affected the country, as figures show that the unemployment rate has increased to 10.6%.
However, there are now reports that an agreement has been reached at the EU summit to rescue Greece and help it tackle its debt problems. Herman Van Rompuy, the European Union’s President, said that an agreement had been reached. The news was immediately welcomed by jittery markets, with the euro regaining some of its losses. Initially, it was thought that British taxpayers would be a part of any bailout package, but Alistair Darling, said there was no plan to use UK taxpayers’ money to support Greece. When asked about the comparison of the UK with Greece, Alistair Darling commented that:
“I don’t think you can compare the UK with Greece. We have different policies. We have a very good track record and, most importantly, the maturity of UK debt is much longer.”
The EU summit was officially meant to cover medium-term European economic strategy, but it was dominated by the Greek crisis. Germany and France are likely to stand together and pledge to come to Athens’s aid by guaranteeing Greek solvency, but only time will tell whether this will happen or will work.
EU leaders reach deal to rescue Greece from debt crisis, President Barroso says Telegraph, Bruno Waterfield (11/2/10)
Mervyn King on Greece, Britain’s deficit and a hung Parliament Telegraph (10/2/10)
FTSE rises amid Greece rescue hopes The Press Association (11/2/10)
Greece’s unemployment rate hits 10% BBC News (11/2/10)
Debt crisis: Experts see more skeletons tumbling News Center (11/2/10)
EU deal ‘agreed’ on Greece debt woes BBC News (11/2/10)
Greek bailout deal reached at EU summit Guardian, Ian Traynor and Graeme Wearden (11/2/10)
Greek bailout would hurt Eurozone – Germany’s Issing Reuters (29/1/10)
Greece must meet deficit target to get aid Reuters (11/2/10)
Could bailout be on the cards for Greece BBC News (10/2/10)
Germans must start buying to save Europe’s stragglers Financial Times, Martin Wolf (10/2/10)
Thinking the unthinkable BBC News Blogs, Stephanomics, Stephanie Flanders (11/2/10)
Angela Merkel dashes Greek hopes of rescue bid Guardian, Ian Traynor (11/2/10)
Greece faces devaluation, default or deflation. Next stop the IMF Guardian, Larry Elliott (11/2/10)
Germany demands austerity, not bailout, for spendthrift Athens Guardian, Ian Traynor (11/2/10)
See also the Guardian podcast in the news item, Debt and the euro
See too the news item from October 2008, The eurozone – our economic saviour?
Questions
- What is the cause of Greece’s debt problems?
- According to the European Central Bank chief economist Otmar Issing, a Greek bailout would weaken the euro and hurt the reputation and image of the eurozone. How can we explain this?
- What do we mean by servicing a debt?
- How could Greece’s debt problems cause problems for other countries with large debts, such as Ireland, Portugal and Spain?
- Which country is better off: the UK or Greece?
- Who will be the loser from a bailout?
- Are the EU rules about debt and deficit levels a good thing or are they too restrictive to be helpful?
- What are the arguments for and against the ECB increasing its target rate of inflation, say to 4%, as a means of stimulating recovery?
In several of the posts in recent months we’ve considered the possible use of a Tobin tax as a means of reducing speculation in financial markets and possibly raising substantial amounts in tax revenue. See, for example: Tobin or not Tobin: the tax proposal that keeps reappearing and A Tobin tax – to be or not to be?. Although James Tobin’s original proposals referred to a tax on foreign exchange transactions, recent proposals have been to impose such a tax on a whole range of financial transactions.
Added impetus has been given to the move to adopt Tobin taxes by the publication of a video from an organisation known as the Robin Hood Tax Campaign. To quote the site “The Robin Hood Tax is a tiny tax on bankers that would raise billions to tackle poverty and climate change, at home and abroad. By taking an average of 0.05% from speculative banking transactions, hundreds of billions of pounds would be raised every year. That’s easily enough to stop cuts in crucial public services in the UK, and to help fight global poverty and climate change.”
So would this version of a Tobin tax work? The following videos and articles examine the proposal.
Actor Nighy backs Robin Hood banking tax campaign BBC Breakfast News (10/2/10)
Robin Hood banking tax ‘would raise billions’ (includes article) BBC Breakfast News (10/2/10)
Robin Hood tax on banks ‘would raise billions’ BBC News, Richard Westcott (10/2/10)
Celebrities launch ‘Robin Hood’ tax campaign BBC News, Hugh Pym (10/2/10)
Richard Curtis and Bill Nighy team up in new film urging Tobin tax on bankers (includes article) Guardian, Nick Mathiason (9/2/10)
Articles
Robin Hood tax offers a way to deal with our pressing problems Guardian letters (10/2/10)
Call for ‘Robin Hood tax’ on banking transactions Independent, James Thompson (10/2/10)
Joseph Stiglitz calls for Tobin tax on all financial trading transactions Telegraph, Edmund Conway (5/10/09)
I’m happy to play my part in the great Robin Hood Tax Telegraph, Bill Nighy (9/2/10)
The world’s greatest bank job! Ethiopian Review, Ian Sullivan (10/2/10)
Robin Hood tax could shrink currency markets by 14% ShareCast (10/2/10)
Don’t leave Greece to face the speculators alone Guardian, Larry Elliott (9/2/10)
Global support for a tax on banks is growing, says Gordon Brown Guardian, Helen Pidd (11/2/10)
Global bank tax near, says Brown Financial TImes, George Parker and Lionel Barber (10/2/10)
Get behind Robin Hood Guardian, Austen Ivereigh (19/2/10)
Questions
- Explain how a ‘Robin Hood tax’ would work.
- How would such a tax differ from Tobin’s original proposals?
- What would determine its effectiveness in stabilising financial markets?
- Would it be effective in raising tax revenue?
- Compare this tax with other methods of stabilising financial markets.
- What considerations would need to be taken into account in setting the rate for a Tobin tax on financial transactions?
No, I’m not talking about the UK suffering from snow and becoming a land of ice! Towards the end of 2008, Icelandic banks hit the headlines and for all the wrong reasons. Icelandic banks were key lenders to some of the key businesses and entrepreneurs in the UK and an online bank held the accounts of over 150,000 Brits. The Icelandic government tried to rescue their banking sector, but with little success and we saw it collapse, sending shockwaves through UK banks. The UK economy lost millions and this contributed to the worsening financial system within our shores.
Iceland’s President has been under serious pressure, from the UK and Dutch governments on one side and from the Icelandic people on the other. A quarter of voters in Iceland have signed a petition against plans to repay money lost by foreigners when an Icelandic online bank collapsed. When the Icesave scheme collapsed in 2008, British and Dutch savers lost approximately £3.4bn (€3.8bn). Although they were compensated by the British and Dutch governments, this still meant that the taxpayers in these countries were owed the money by Iceland.
Iceland’s Parliament approved the plans to reimburse the money, but the people are encouraging their President to veto the bill. They argue that repaying this money will cost the Icelandic taxpayers: the compensation is some 12,000 euros for each of Iceland’s residents. Campaigners say that the Icelandic people are being forced to pay for the mistakes of the banks. Whilst UK taxpayers lost out, the Icelandic people’s arguments have something of a déjà-vu about them: after all it wasn’t long ago that the UK people were asking why we should have to suffer from higher taxes and future cuts in government spending to bail out the banks, when it wasn’t our fault that they collapsed in the first place. The following articles consider this issue.
Icelandic bank with British savers’ money enters crisis talks Telegraph, Rowena Mason (4/10/08)
Town Hall’s £830m Iceland shortfall This is Money, Daniel Martin (6/1/10)
Iceland leader vetoes bank repayments bill BBC News (5/1/10)
iIceland blocks repayment of £2.3bn to Britain Times Online, Robert Lindsay (5/1/10)
Iceland petition against pay-out over Icesave collapse BBC News (2/1/10)
Iceland’s President under pressure over Icesave Telegraph, Angela Monaghan (3/1/10)
Peston’s Picks: We’re all Icelanders now BBC News (7/1/10)
Iceland President says country will pay UK government BBC News (7/1/10)
Questions
- For the Icelandic people, what are the arguments (a) for and (b) against repaying money owed to the UK and the Netherlands?
- For the British and Dutch people, what are the arguments (a) for and (b) against repayment?
- How will this repayment (or lack thereof) affect the recovery of the British economy?
- Will the repayment of this money adversely affect the Icelandic economy? Explain your answer. Think about tax cuts and the effect on consumer incomes.
- Why is this a key example of international policy interdependence?