Barry Eichengreen, an economist at the University of California, Berkeley, and author of “Exorbitant Privilege: The Rise and Fall of the Dollar and the International Monetary System,” fielded questions from The Wall Street Journal’s David Wessel earlier this week. An edited excerpt:
In your book ,you predict that we, our children and grandchildren will live in a world in which the dollar is not the predominant world economy. Why should I believe that either the euro or the Chinese renmimbi, of all things, will grow up in the next decade to rival the dollar?
Eichengreen: People have been predicting the demise of the dollar for half a century. I do think the world is changing now in a couple of fundamental ways.
First, our children and grandchildren will live in a world where the Chinese economy is larger than the U.S. economy. Demographics, if nothing else, dictate that. It will make no sense for the dollar to be the only true global currency in a world where the U.S. accounts for 15% or 20% at most of real economic activity.
Second, the technology of finance is changing. Once upon a time, you could make the argument that there was only room in the world for one true global currency. The arguments in favor of the dollar were stronger than the arguments favoring the alternatives. I think the technology of finance is becoming more open. In a world where you can compare currency values on your smartphone, it’s easier for several true international currencies to coexist. So the question is which ones?
What would the Chinese have to do over the next decade in order to make the renminbi a serious rival or competitor to the dollar as an international currency?
Eichengreen: Step number one would be to encourage their firms and foreign firms to do their cross-border settlements – to settle their trade in China’s own currency. And you’re beginning to see that now, from a year ago when there were virtually no firms that did that. There are upwards of 40,000 firms now that are doing cross-border settlements in China’s currency.
Secondly, you would have to give firms that acquire Chinese renminbi through that means a way of investing them. China would gradually have to open its financial markets to foreign investors. They experiment with that in Hong Kong… a petri dish for financial innovations that they bring onshore. Subsequently, they would have to gradually open financial markets in Shanghai to offshore investors.
And the caboose on the train, the final step, would be to encourage foreign central banks to hold deposits and bonds denominated in China’s currency.
So the first step is happening now – the trade settlements. The second one, bond issuance in China’s own currency, is happening in Hong Kong. And I think in a matter of a few years they’ll experiment with that onshore. Ten years from now I continue to think is a realistic horizon for thinking about their currency being widely used in all manner of international transactions.
Will it be used as widely as the dollar? Probably not. We have a head start and we have the advantage of those deep and liquid markets. There’s another side to that coin, if you will: that we in the United States have to do the right things in order to preserve that advantage.
Is this a good thing for the U.S. if the dollar’s role in the world economy shrinks relative to Europe and China?
Eichengreen: It’s a mixed blessing. On the one hand, it has always been a considerable advantage – convenience to U.S. businesses and banks and individuals travelling abroad, that they could do their business in dollars. …
The other side of the coin is that I think it will also be a safer financial place for, among others, Americans. We had a period in the middle of the last decade when foreigners lent to us very freely. We were prone to financial excess: We engaged in frenzied real-estate speculation and they gave us more rope because they had an appetite for our dollars in order to finance their transactions – in order to hold those dollars as a form of insurance.
So I think in the future, they will not lend to us so freely. Market discipline will be felt more intensely in the United States. And if we’re again inclined to climb out on some financial limb, foreign investors won’t permit us to do that so freely.
But we’ve just been through an enormous recession where we were able to do huge fiscal stimulus and borrow gobs of money, largely from Asia, at low interest rates. If something went wrong here, if we had a Japanese-style natural disaster, wouldn’t we be handicapped, less able to borrow cheaply?
Eichengreen: We would be less able to borrow cheaply. We still would be able to borrow in response to a disaster if we had our fiscal and financial house in order when we entered it — a big “if” and another argument for why putting our fiscal and financial house in order is important….
At the same time, I think you have a point. There was the irony in the financial crisis, after Lehman Brothers failed in the autumn of 2008, the dollar actually strengthened. So we had created, in the U.S., the mother of all financial crises and yet there was capital flight toward the dollar as a safe haven. The future is going to be one in which there will be alternatives to the dollar. And unfortunately, we’re not going to be able to count on that effect.
In your view of the world, if things go right – if the euro gets its act together, if the U.S. gets its fiscal house in order, if the Chinese learn how to run a modern, capitalist, internationally engaged economy – this could be a gradual transition to a new world order. But my reading of history – much of it comes from your work – is that things don’t tend to happen as neatly as we hope. So what could go wrong? What do you worry about?
Eichengreen: Well, in terms of a dollar crash, I worry first and foremost about our own economic policies in the U.S: that there will come a point several years from now – “several” is an imprecise phrase – where there could be a crisis of confidence in the dollar. And a rush out of U.S. Treasury bonds – a sharp fall in the dollar – could be seriously disruptive. We had something on a smaller scale that looked like that back in 1994. Take that and magnify it. That would not be good news.
While my best-case scenario, the one to which I attach the highest likelihood in Europe, is European leaders getting their act together, they could fail to do that. There could be a disorderly debt default, political recrimination and a crisis of confidence in the euro.
And finally, in China, I would worry about a sharp growth slowdown with unknown financial and social consequences.
What difference does it make to the yen and the Japanese economy that they’ve just had this horrible earthquake-tsunami-nuclear power disaster?
Eichengreen: Japan has a very sophisticated, interconnected economy that’s deep into global supply chains. So I think the kind of even localized supply disruptions that they’re likely to experience will be quite negative for their economy in the short run. The authorities also have limited room for maneuver. They are committed to fiscal consolidation. They come into their post-earthquake crisis with an awful lot of public debt. It is said that the repatriation of earnings by overseas Japanese individuals and corporations will be good for the yen, maybe in the very short run. But I think once the longer term consequences of the crisis sink in, they have to be yen-negative.
You’ve been both very supportive of the euro as a project and very critical of the way European leaders have handled the crisis. Do you think they’ve fixed what ails them or do they still have a lot more to do?
Eichengreen: They still have a lot more to do. A lot of the euro doom and gloom that we’ve been hearing is overdone: The euro area is not going to collapse Neither Greece nor Germany are going to reintroduce their national currencies. European leaders have not solved their problems. I, for one, continue to think that the Greeks are going to have to restructure their debts and the need for debt restructuring may not stop there. European leaders have not addressed that eventuality. Addressing that will mean fixing their banking systems, first and foremost. …. European leaders are being dragged, kicking and screaming, almost against their will, but inevitably, in the direction of deeper cooperation, euro-area governance and limited fiscal transfers from the strong to the weak countries.
To be optimistic about the euro as a currency, what three things have to happen?
Eichengreen: Number one: Fix the banking system. Number two: Put in place a sensible emergency financing facility for countries that get into trouble down the road. And number three: Strengthen the surveillance, the oversight of national policies.
Part of that has to be done at the level of the union: Transfer more responsibility to the European Commission. Part of it needs to be done at home by strengthening fiscal arrangements, enhancing fiscal transparency, giving finance ministers and prime ministers more agenda-setting power over the budget.
Europe is a complicated place. And I think neither reform at the European level nor reform at the national level alone will be enough. ….It’s taken too long. I think there still is denial in some circles. But I am reassured that we’ve seen more evidence that when their backs are against the wall, European leaders understand that they have to deepen their union because the alternative is too dire to contemplate.