Does Ben Want the Dollar to Remain the World's Currency?

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Fed Chairman Bernanke should consider his audiences when criticizing the gold standard, assuming he wants the U.S. dollar to remain the global reserve currency. In particular, he should consider the concerns of the managers of U.S. Treasuries at global central banks, particularly those in the emerging markets.

These are the largest owners (other than the Fed itself) of the Fed's key asset, U.S. Treasuries, and the Fed's liability against these assets is obviously the U.S. dollar. Current students in U.S. economics programs may happily buy U.S. debt when they eventually work at the Fed (note to students: never challenge central banking if you want to work at the Fed).

External creditors, though, for example China, have a very different perspective on money and debt, and also have a much broader perspective - geographically and historically. It is certainly not a perspective taught at U.S. universities, and the last time I checked, these institutions and their students are not major creditors to the U.S. (although student loans are an attractive Fed asset, if current U.S. frameworks continue).

First, Mr. Bernanke's initial framing of the issue was nonsensical to those with any experience in emerging markets. Nobody chooses a currency board, which is the functional parallel to a gold, or hardmoney standard. Instead, countries are forced into hard money standards such as currency boards.

In countries ranging from Bulgaria to Argentina, a collapse of confidence in the money, and its resultant inflation, and the destruction of savings, forced the authorities to abandon the fiscal and monetary levers that were previously at their disposal. In particular, domestic and foreign creditors saw that the fiscal authorities would never balance budgets and that the monetary authorities were essentially co-opted by the fiscal authority in buying endless amounts of government debt.

The key point, though, is that these moves to currency boards were forced by populations and creditors who lost confidence in the fiscal and monetary authorities (who generally become the same thing in these crises), and had no other choice. In these situations, countries didn't face a choice between a depression and a long recession, as many status-quo economists in the U.S. characterize the present situation, they faced a choice between a depression and social collapse.

Second, true inflation is of much more import to emerging market policymakers. The so-called Arab Spring, while recognizing that it had a broad range of causes, was significantly triggered by food price inflation. There is much discussion of the causes of food and energy price inflation in China as well, but many outside the U.S. (without referring to Milton Friedman's "inflation is always and everywhere a monetary phenomenon") worry that too great a portion of this inflation is the result of money creation by the manager of the world's reserve currency.

Perhaps financialization of commodities - that is, buying hard assets as a type of financial asset - is a proximate cause, but even that is largely due to investor needs to have some store of value function exist in their money or asset. The bottom line here is that most emerging market policymakers interact with populations whose consumption baskets incorporate more than twice the amount of food and energy than ours do. They are, as a result, unable to popularize "core" inflation metrics that exclude food and energy, and buy time as money works its way through the system.

Third is a more emotional issue. Namely, during Asia's crisis (and during all other emerging market crises that I've been involved in), U.S. authorities gave the precise opposite advice that those same authorities are now giving themselves. That advice involved fiscal austerity (or at least a long-term plan towards balance), structural reforms (essentially reducing state agencies and selling state assets), and tight monetary policy to anchor inflationary expectations. And, if banking systems were over-levered, only protect depositors and congratulate bank debtors as equity owners in newly well-capitalized banks. And, if the government itself had a debt overhang, default quickly. This advice actually worked, which is why Asia is home to so many of our creditors, not to mention higher growth rates.

I'll end with an anecdote. I met with a member of the Board of Governors of the Federal Reserve System, and I was part of a group of about 5 financial professionals, most of whom had some experience with money and debt outside the U.S. and UK. When I asked him whether he worried about the loss of confidence in the U.S. dollar, and some of the emerging market scenarios I referenced, he responded that he worried about that "every night".

I relaxed immediately - policymakers knew what could go wrong and presumably had discussions and ideas on how to prevent them. But to be extra-sure, I asked him whether a single one of his Fed or Treasury colleagues shared this worry, and he responded that unfortunately they believed their "beautiful excel files". My point is not to endorse or oppose hard-money standards such as a gold standard. My point is that in disregarding the potential concerns of your major creditors, you are only underlining their fears. That particular Fed Governor left in 2011.

Eric Fine is a managing director at Van Eck Global. 

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