Could the US Dollar be Replaced as the World’s Reserve Currency? What it Would Mean

by Darwin on October 12, 2009

Could a basket of currencies and gold replace the US Dollar as the primary reserve currency globally? That’s a question that’s been batted around for a while, usually amongst fringe naysayers and ranting leaders of Venezuela and middle east regions.  However, I read with interest this article from the Independent UK that rival countries were looking to supplant the US Dollar as the currency for oil trading, which would have obvious implications for the standing of the American currency as the reserve currency of choice worldwide.  How goes oil currency, so goes the global reserve currency is the thinking.  According to the article, there was a secret meeting between the central banks of Brazil, France, China, Russia, Japan and several OPEC states where they were plotting to replace the denomination of US dollars with a basket of other currencies and gold.  While there was speculation that the recent rise in gold was correlated with the meeting, it may not be prudent to jump on the gold bandwagon just yet (see other metals ETFs that may benefit from a weakening dollar more so than gold).

As unlikely as it seems, never say never.  Recall that the British Pound was the global reserve currency for quite some time until the US dollar finally replaced it following World War II.  Note however, that the US was surpassing Great Britain as the world’s financial and military superpower well before that.  Seeing a switch from one reserve currency to another doesn’t happen overnight – but it does happen.  It’s evident that the US is losing is dominance in everything from military might to trade, but experts say even if a switch is under way, this is a decades-long process, not something we’d see occur within a matter of mere years.

Why are Countries Fed up with the US Dollar?

There are some rather complex implications of an ever-weakening dollar, such as, oil-rich countries are seeing rampant inflation because while they get paid in US dollars for oil, they tend to import much of their goods and services from the EU region.  Since the US Dollar has been tanking against the Euro and other currencies, these US dollars tend to be worth less and hence, have much less buying power, stoking inflation.  (see full list of all currency ETFs to exploit this weak dollar trend).  Similar effects are felt elsewhere, namely China and other large exporters to the US.  As they are paid in dollars, an ever-declining currency, their income is artificially decreasing over time as well as the Treasuries they’re buying to satiate our debt.  How long these countries will continue to see their investments plummet while sitting idly by is anyone’s guess.  But, with the US taking on unprecedented debt with bailouts and stimulus plans while mulling over another massive entitlement in “health care reform” – another Trillion dollar boondoggle, things aren’t looking good for the dollar.

What Would Happen if the US Dollar were Replaced as the Reserve Currency?

Without US dollars serving as the reserve currency, that mandates an unwinding of current holdings and gradual transition into the new currency/gold standard.  This could result in a complete collapse of the US dollar versus virtually all other currencies.  While US multinationals may rejoice temporarily since overseas sales in foreign currencies get a boost from a weakening dollar each earnings cycle, eventually, US consumption would suffer; we wouldn’t be able to afford imports to the same degree.  As foreign economies that have been servicing our debt realize that the music has stopped playing and they don’t want to be left without a seat, they stop funding our debt.  Interest rates would rise as demand for Treasuries sends yields skyrocketing.  You think we’d ever see mortgage rates at less than 5% in our lifetime again?

How Would we Explain this to Future Generations?

Someday, we may very well tell our children that when we were their age, the US Dollar was the most important currency in the world – the most trusted reserve currency.  We were the sole military and financial superpower in the world.  We had defeated the Nazis, Socialism, Communism, Fascism and Terrorists.  Our generation then squandered the best potential any generation in the history of the world has been afforded. In spite of the culmination of all these accouterments, we squandered our opportunity and left them with generational debt they will not be able to repay.  Let’s hope it doesn’t come to that, but with the elected officials calling the shots now (both sides of the aisle), it’s evident that this is our destiny.

The Reality

This article may seem overly gloomy and may not play out at all or nearly to the degree feared.  However, we need to at least be thinking about the consequences of our indifference to our crumbling world standing.  There aren’t really any good alternatives to the US Dollar at the moment.  It’s unlikely Asia and the middle east would agree solely to the Euro as a new reserve currency without trying to interject their currencies into the mix, and keeping a basket of currencies in line involving those various regions would be next to impossible, especially given differences in their monetary policies, internal fiscal strength and lack of alliances politically.  Throw gold in there and the prospects become even less plausible.

What are Your Thoughts?  Does it Even Matter?  Will the Average American even Know What Happened?

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1 Credit Card Chaser October 12, 2009 at 9:19 pm

“oil-rich countries are seeing rampant inflation because while they get paid in US dollars for oil, they tend to import much of their goods and services from the EU region.”

This is exactly it. I would say that the above reason is one of the best reasons for this talk about moving away from the dollar and instead moving to a basket of currencies. Now, if the US was more of an exporter of the very same goods that these Arab nations needed to import then this would not be nearly as much of an issue but that is not the case.

2 Financial Samurai October 13, 2009 at 10:35 pm

It actually doesn’t matter at all whether the USD depreciates further. Nobody in America stays overseas long enough for it to matter!

3 Kevin October 14, 2009 at 2:03 pm

It definitely matters if our currency continues to depreciate. It makes things more expensive. You think the economy sucks now? Wait til average Americans who are broke have to pay $5 and up for a gallon of gas.

Inflation will slaughter average Americans…

The future is ugly I’m afraid.

4 Jim Gill November 4, 2009 at 9:46 am

Remember that the pound is still very strong against US dollars after US dollars become the reserve currency. I suspect it will the same. US dollars will become a high yielding currency as US rise interest rates in the not so distant future.

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