The current dollar-based system is broken and can't be repaired, despite the efforts of governments and central bankers. A new currency and monetary order would fix the problem and boost growth.
The financial crisis, the 2008/09 recession, the banking scandals that have followed, and today’s limping recovery are all linked. The common factor is the absence of a real international monetary and banking order. Only when such an order is restored will companies and consumers feel confident to open their wallets again.
At the heart of this revamped order should be a new world currency, one that irrevocably ties money to the real economy. The current dollar-based model is broken and can’t be put together again. The trouble is, governments have yet to recognize this. That failure is the main source of our continuing problems.
After the demise of the Bretton Woods system in the early 1970s, governments built a monetary order round two pillars – central banks and financial regulators. Central banks were charged with ensuring low and stable inflation; regulators were instructed to reduce risks to financial instability (in some countries the central banks doubled up as regulators). This system helped the world economy through the big shocks and geopolitical shifts of the late 20th century – notably volatile energy prices, the collapse of the Soviet bloc, and the emergence of China, India, and other emerging markets. The fact that it proved adaptable and flexible was due in no small part to the “glue” provided by the global use of the US dollar. The euro took its place inside a dollar world.
However, around the turn of the millennium, this order began to fray. Confidence in the US dollar – and, crucially, in the monetary standard it provided – declined as a result of the huge build-up of US foreign indebtedness and growing fiscal problems. Just as important, the major players in the system – governments, banks, financial intermediaries – started to exploit the opportunities offered by the system for their short-term ends.
Governments of countries ranging from the US to Japan and the eurozone found it just too easy to borrow. Bankers were happy to oblige. Households joined in, vastly increasing leverage as property prices continued a seemingly never-ending ascent. Currency values were at the mercy of unpredictable capital flows and often artificially manipulated by governments to server their short-term ends. Western governments pointed the finger at China, but were equally blameworthy for excessive borrowing while regulators simply failed to realize how quickly innovation was leading to a lowering of standards.
Within a very short time, notably in 2005 and 2006, every link in the chain of credit designed originally to provide security for the ultimate lenders became loose. Intermediaries of all kinds fattened profits by lowering credit standards, neglecting due diligence, and buying and selling dodgy derivatives.
Success bred complacency and foolish risk-taking. Yet the resilience of the expansion during Alan Greenspan's tenure as chairman of the Federal Reserve (1987-2006) silenced critics. People who tried to raise concerns were ignored.
Since the crisis, governments and banks have tried to patch up the old model. They have pretended that more regulation would make the banks stable, and that more central bank liquidity could restore growth. These are dangerous delusions, as a growing number of central bankers privately admit.
We need to go back to basics. The dollar is unlikely to be able to provide that key benchmark for the world monetary system in the future. American politics has become too fractious to allow an early resolution of its fiscal problems. Quite apart from that, the world has become too multipolar and diverse to allow one national currency to provide the common currency platform of the future. Nor is providing the world’s main reserve and trading currency any longer unambiguously in the US national interest.