currency auguries

the london g20 summit obviously got me thinking, first in terms of a new world order, see my previous post, and now in terms of what it would mean to world currencies.

we have now lived for roughly sixty years with the $ as our world currency, the us being the only global power. a helpful tool which the us has yielded to further its global interests whether economic, diplomatic or military. my guess is that such an era is closer to its end that its beginning.

now that a new world order is slowly shaping up, further eroding us global power, it is not unrealistic to posit, even predict that currency markets will see changes ahead, notably with various challenges to the $ as the world currency. for sure, any major change seeing the rise of one or several reserve currencies will not happen overnight, so let’s project ourselves ten years hence to 2020 – mere baby forecasting steps for chinese strategists mind you.

i see two natural challengers to the $: the euro and the yuan.

1) the euro: the eu has emerged as a slight winner from the g20 summit in london. what with the deft handling of the georgian crisis, the diplomatic expertise dealing with russia, the coordinated response towards the global crisis, further political, diplomatic, economic and now even military integration, the eu – with growing pains – will become even more powerful on the world stage. this will bring about more clout to the euro, to the point where it will become an instrumental tool either political or economic in the hands of eu politicians, much like the $ has been for every us administration since the end of ww2. i expect increased currency, options, swaps, futures, debt markets in euro, increased euro denominated trade, and if the european central bank keeps to its ideologically bent german roots, an enhanced status as a reserve currency. two factors will combine to make the euro a credible challenger. first, continued enlargement of the eu with more eastern european countries joining and at some point north african countries de facto pegging their currencies to the euro – or even accepting tighter economic integration. second, the uk will join the euro and finally ditch the pound – maybe not tomorrow but certainly within the next ten years. the latter move will provide an incredible boost the the euro. i also see two wild cards, in the form of a) a potential inclusion of turkey to the eu which is being talked about with much emotions everywhere in europe – this automatically bringing closer some middle eastern countries closer to the euro than the $; and b) a tighter integration of russia with europe whether this results in the euro being the quasi official currency of russia or not will de facto reinforce the euro. after much turmoil enlarging the eu, expect european businesses to come out more competitive on world markets, low inflation in the euro zone, more stability, higher investments and higher employment, and also expect more diplomatic might overall.

2) the yuan: china has already flexed its muscles and fired a few salvos, asking for a new global currency to replace the $ – presumably because chinese officials are terrified by potential losses to their $ assets if the $ were to depreciate over the coming years. the yuan is of course far from being a credible world currency, but i suspect the chinese government has already drawn a long term plan to further the reach of the yan, make it tradable in open markets across the globe and recognized as a credible alternative. it will take time, but that is their master plan. as proof i am interested to read about efforts by chinese officials to draft bilateral agreements to expand currency swaps involving the yuan with most of its asian neighbors, forcing chinese provinces to settle trade withe the yuan rather than the $, and consolidate hong kong and shanghai as dominant financial centers for the future. undoubtedly china will face many obstacles, but the wheels are already in motion and the practical and symbolic results will be far from minute when the yuan becomes a recognized currency internationally.

what does this mean for the $, what does this mean for the us over and above diminished global might? nothing will happen overnight of course. but over time, this means further erosion to us dominance, lower fiscal and monetary flexibility for future us administrations, and a completely different playing field for us corporations doing business abroad, whether selling or buying. expect more currency risk, relatively less attractive us assets for foreign buyers, and even more focus on productivity and creativity as competitive factors for us businesses. also expect further erosion of the $ over the next ten years – much like the slow erosion of the pound once british might started to weaken on the world stage.

an alternate option would have the world powers strengthen even more the imf and focus on special drawing rights – sdr – as the new world currency, which the chinese have hinted at. a forward looking us administration may see the writing on the wall and try to avert the rise of the euro or the yuan by insisting the new world order rely more on sdr. a tricky gambit, but one that might smoothen the ride for the us while softening the rise of other trading/political blocks. this would require chinese like long term thinking in the us. the benefit might be less instability globally.