Weekly “fun with controversies” topics Free Trade v. Protectionism

Day #3 – Currency “issues” Is the dollar losing its credibility as the world’s reserve currency? If yes, what do we replace it with? Although it may seem like a minor question, a reserve currency of sum form is need to rationalize international trade in goods.

Bretton-Woods and the Dollar Standard Bretton-Woods System Henry White (U.S.) negotiated with John Maynard Keynes (U.K.) to establish the post-war economic arrangements

Famous Plaque on the Door of the Bretton Woods Resort

Bretton-Woods established both the IMF and the World Bank – Both had very specific (and separate) goals Recognizing that Europe could not be the basis for a new monetary system, the “dollar system” was adopted

System worked by indirectly linking currencies to gold All currencies backed by gold, but only through dollar FF  $  Gold – Only the U.S. was in danger of a currency attack (gold outflow)

System stable until 1971 (Smithsonian Accord) – Then, U.S. formally departs gold standard in 1973, leaving $11B in gold at Fort Knox, valued at $42/oz. – $335 billion at today’s price of gold World now uses Fiat (funny) money – Recent fiscal carelessness and high money supply expansion led to devaluation of dollar until euro-zone looked even worse after the crisis with the PIIGS China is now using a market-basket of currencies Has even started using a complete substitute with Australia

The Currency Issue and the “Search for Stability” After the collapse of the dollar-standard, nations immediately began searching for another way to stabilize currencies Gave birth to the ecu (the precursor to the euro) – Nations of EU formed the European Monetary System (EMS) Pegged their currencies against the ecu, which indirectly pegged them against each other’s currencies

Currencies only allowed to move in a narrow band around a fixed value to the ecu Initially thought that the ecu would be common currency, but “European Currency Unit” didn’t have a very good ring to it. When euro adopted, ecu eliminated.

In end, because many countries didn’t join the EMS (or joined and then left), a common currency was considered a better option Euro came into being in 1999 (as a unit of account) – Became a full currency in 2001

What are some other potential reserve currencies? SDR

Why do we need a reserve currency? Currency cross-rates would become meaningless without a hard currency Hard-pegging and soft-pegging systems impossible Several nations (e.g. Ecuador) have dollarized – not sure what a replacement would look like – Resulting instability for developing nations that prefer a system like this.

Maybe SDR (IMF “dollars”) or commodity money – How commodity money works (Benjamin Graham): 1 cocoadollar (CO$) = 1 pound of cocoa – If price of cocoa ↑, people trade in CO$ for stockpiled cocoa – market price comes back down again – If price ↓, people trade in cocoa for CO$s, removing the excess supply and raising prices.

What about return to gold standard? – $11 billion in gold at Fort Knox per ounce) Actually = $314 Billion at $1200/ounce – Could be used as a start to backing up a currency, but gold-standards are unstable also Or the world will adopt a multi-currency model

This is most likely outcome Nations will begin using a basket of currencies as a “peg” ($, euro, British Pounds, with a smaller component of the C$, Japanese Yen and Swiss Franc). – As a side benefit, it substantially reduces exchange rate risk.

End of Day #3 Questions and Suggestions? – International trade is on the agenda for next time.