The US dollar is getting perilously close to losing its status as the world’s reserve currency. Should it cross the line, the 2008 financial crisis could look like a summer storm.
Yes, worries about insolvency in Europe dominate the headlines. Last week, Standard & Poor’s cut Spain’s bond rating to BBB+ — a clear sign that Europe’s financial crisis is far from over.
But America’s escalating debt problem is far more likely to precipitate a truly global crisis, because the dollar has for decades played such a central role in the world economy.
How bad is the US problem? Former Treasury official Lawrence Goodman recently pointed out that investors are shunning US bonds and notes; the lack of other buyers forced the Federal Reserve to buy “a stunning . . . 61 percent of the total net issuance of US government debt” last year. Like many others, he warns that ballooning debt puts the US economy at risk for a sharp correction.
But the even larger risk is the potential loss of the dollar’s “reserve currency” status — a key support of the world economy for the last four decades.
It started with the 1973 Saudi commitment to accept only US dollars as payment for oil, followed by OPEC’s 1975 agreement to trade only in dollars. Trading of other commodities came to be priced in dollars, reinforcing the dollar’s “reserve” status.
As a result, central banks worldwide have held onto large reserves of dollars to facilitate trade. That, in turn, has enabled the US to print much larger amounts of its currency, with seemingly little inflationary consequences. It’s also made it easier for Americans to import more than they export, to consume more than they produce, and to spend more than they earn.
But all that is changing rapidly.