Very clear and interesting commentary by Immanuel Wallerstein; hat-tip to Bob F. Also check out the cover story from our Jan/Feb issue.
May 15, 2009, Commentary No. 257
When Premier Wen Jiabao of China said in March of 2009 that he was “a little bit worried” about the state of the U.S. dollar, he echoed the feelings of states, enterprises, and individuals across the world. He called upon the United States “to maintain its good credit, to honor its promises and to guarantee the safety of China’s assets.”
Even five years ago, this would have seemed a very presumptuous request. Now it seems “understandable” even to Janet Yellen, the President of the San Francisco Federal Reserve Bank, although she considers China’s proposals concerning the world’s reserve currency “far from being a practical alternative.”
There are only two ways to store wealth: in actual physical structures and in some form of money (currency, bonds, gold). They both entail risks for the holder. Physical structures deteriorate unless used and using them involves costs. To utilize such structures to obtain income and therefore profits depends on the “market” – that is, on the availability of buyers willing to purchase what the physical structures can produce.
Physical structures are at least tangible. Money (which is denominated in nominal figures) is merely a potential claim on physical structures. The value of that claim depends on its exchange relation with physical structures. And this relation can and does vary constantly. If it varies a small amount, hardly anyone notices. But if it varies considerably and frequently, its holders either gain or lose a lot of wealth, often quite rapidly.
A reserve currency in economic terms is really nothing but the most reliable form of money, the one that varies least. It is therefore the safest place to store whatever wealth one has that is not in the form of physical structures. Since at least 1945, the world’s reserve currency has been the U.S. dollar. It still is the U.S. dollar.
The country that issues the reserve currency has one singular advantage over all other countries. It is the only country that can legally print the currency, whenever it thinks it is in its interest to do so.
Currencies all have exchange rates with other currencies. Since the United States ended its fixed rate of exchange with gold in 1973, the dollar has fluctuated against other currencies, up and down. When its currency went down against another currency, it made selling its exports easier because the buyer of the exports required less of its own currency. But it also made importing more expensive, since it required more dollars to pay for the imported item.
In the short run, a weakened currency may increase employment at home. But this is at best a short-run advantage. In the middle run, there are greater advantages to having a so-called strong currency. It means that the holder of such currency has a greater command on world wealth as measured in physical structures and products.
Over the middle run, reserve currencies are strong currencies and want to remain strong. The strength of a reserve currency derives not only from its command over world wealth but from the political power it offers in the world-system. This is why the world’s reserve currency tends to be the currency of the world’s hegemonic power, even if it is a declining hegemonic power. This is why the U.S. dollar is the world’s reserve currency.