Getting Away From the Dollar

By Steven Pearlstein
Friday, April 11, 2008

By now it should be obvious to just about everyone that many aspects of the global financial system are coming to the end of their useful life.

That's not a criticism. This system based on the free flow of capital across borders, and a reliance on the dollar as the world's reserve currency, has served us pretty well. In recent years it has generated the longest sustained period of global economic growth in the postwar period, pulling tens of millions of people out of poverty.

But in the last 20 years, this system has also produced huge and persistent imbalances and a series of asset bubbles that have created painful periods of financial instability when they burst. This instability has distorted business and investment decisions, wiped out vast sums of wealth, triggered several recessions and fueled the current outbreak of global inflation. And should the dollar suddenly collapse, it would make the recent turmoil in financial markets look mild by comparison.

Against this backdrop, finance ministers, central bankers and top financial executives will gather in Washington this weekend to talk behind closed doors about ways to prevent future crises. It seems to me that they have basically two choices.

One option is to try to "fix" the current system. There are already a number of ideas floating about, including a few that will be showcased over the weekend. Look for lots of discussion about increased transparency, greater cross-border collaboration, and more vigilant supervision and modestly higher capital requirements for banks and other financial institutions.

All of those are fine as far as they go, but if the past is any indication, that won't be very far. A real fix of the current system would require more than brave talk, vague commitments and technical tweaks.

It would require major central banks to be more willing to intervene in currency markets and coordinate monetary policies to prevent sharp movements in the value of the dollar, even at the cost of a bit more inflation or unemployment back home.

It would require the United States to take decisive and politically unpopular steps to bring down its trade and budget deficits, and to be willing to allow foreigners to continue buying companies, real estate, patents and other productive assets.

And it would mean major economies would have to agree to a tough new set of international regulations governing conduct and capital standards for banks, investment banks, hedge funds and other financial institutions.

How likely is that? Based on the evidence from the past 20 years of global economic policymaking, not likely at all.

There is, however, another choice: a system that is not so reliant on the dollar as a global measure of value and reserve currency for the rest of the world.

A dollar-based system was the obvious way to go after World War II, when the United States accounted for half the world's industrial production and had the only financial markets broad and deep enough to accommodate a large chunk of the world's savings. But now that the U.S. share of global output has declined and there are other financial markets that are large and liquid and open to foreign investment, there are other currencies that can serve as reliable measures and stores of value.

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