The ‘top dollar’ could soon be history

The post-G20 fall-out continues. Robert Zoellick, president of the World Bank, warned yesterday that America's days as an unchallenged economic superpower are numbered and that the dollar is likely to lose its No. 1 spot as the global reserve currency to the euro and the Chinese renminbi.

"The United States would be mistaken to take for granted the dollar's place as the world's predominant reserve currency," he warned, offering the euro as a "respectable alternative" for international transactions and predicting that the renminbi would "evolve into a force in financial markets".

Some commentators believe Zoellick is being purposefully provocative. At the same time, he's amplified the main lesson of the Pittsburgh summit: as the global economy undergoes a kind of de-centralisation, so the global system of currencies will shift.

Zoellick's larger point has been made many times before: while the dollar remains the global currency of choice today, the US lack of discipline over spending and its budget deficits will ultimately diminish or even collapse the currency.

Further, there is growing belief that the US consumer is blown out as the pre-eminent engine of global economic growth and economists are keen to talk of "re-balancing", a scenario under which the US cuts spending and the Chinese consumer takes up the slack.

The plan is theoretical at best. The dollar, hurt by low interest rates, is still on the way down. That may be fine while the Fed keeps the dollar-spigot wide open, but what happens when money supply tightens?

Pre-eminent among the new thinkers is Harvard economist Ken Rogoff. Over the past several months, he's been floating the idea - clearly with the Obama administration's backing - that a period of inflation would be the best way of reducing the massive US debt.

With the US economy still too weak to support itself unaided, "it is time for the world's major central banks to acknowledge that a sudden burst of moderate inflation would be extremely helpful in unwinding today's epic debt morass," Rogoff holds.

Inflation, he believes, "is an unfair way of effectively writing down all non-indexed debts in the economy. Price inflation forces creditors to accept repayment in debased currency.

"Yes, in principle, there should be a way to fix the ills of the financial system without resorting to inflation. Unfortunately, the closer one examines the alternatives, including capital injections for banks and direct help for home mortgage holders, the clearer it becomes that inflation would be a help, not a hindrance."

Of course, inflation is a difficult thing to engineer, especially when there is still so much excess in the system. And there are other dangers.

"True, once the inflation genie is let out of the bottle, it could take several years to put it back in," Rogoff has acknowledged. "No one wants to relive the anti-inflation fights of the 1980s and 1990s. But... unless governments get ahead of the problem, we risk a severe worldwide downturn unlike anything we have seen since the 1930s."