In this period of “exceptional uncertainty” (to quote Federal Reserve Chairman Ben Bernanke), where can investors turn for a considered perspective on the current environment? Produced to feed the beast of the 24-hour news cycle, the bulk of financial journalism and commentary today isn’t worth the servers it is stored on. One notable exception to that rule is Buttonwood, the financial markets column of The Economist. Philip Coggan is the columnist — arguably the most influential position in financial journalism (along with the head of Lex at the Financial Times).
Deciphering the headlines
With the developed world facing fiscal and monetary crises, Coggan’s new book, Paper Promises: Debt, Money, and the New World Order, is a veritable enigma machine for investors who wish to decipher today’s headlines (the U.S. edition was released Monday). In an email interview last week, Coggan shared his observations on some of the most pressing topics of the day. In the first of two articles, he explains why the current international monetary system is on its last legs and discusses the possibility of the Chinese renminbi replacing the dollar in a successor system:
“The thesis of the book is that economic history is a battle between creditors and debtors, with the nature of money the territory over which they fight. Money has two core functions; as a means of exchange (paying for your daily Starbucks) and as a store of value (making sure you can still afford a Starbucks in old age). Historically, those two functions have been in conflict; some groups have wanted to expand the supply to encourage economic activity; others have wanted to restrict the supply of money to protect the value of savings. Broadly speaking, the money expanders have been debtors and the money restricters have been creditors.”
Debtors and creditors: a historical struggle
As he makes clear, that dichotomy is at the root of the rise — and fall — of different monetary systems:
“Over history, creditors have tended to impose systems that control the supply of money — the gold standard, the Bretton Woods system of fixed exchange rates, the euro — that prevent borrowers from repaying their debts in debased currencies. The strain of keeping up this discipline is intense in democracies where more people are debtors. The gold standard broke down in the 1930s, Bretton Woods in the 1970s and the euro is struggling today, as is what might be called the post-Bretton Woods system of independent central banks and inflation targets. A new world order will emerge from the ashes.”
Today, the struggle between debtor and creditor pits the United States — the world’s largest debtor nation — against rising superpower China. With more than $15 trillion in outstanding public debt, Uncle Sam is in hock to China to the tune of a cool $1.1 trillion. In light of these numbers and China’s growing confidence, it’s not hard to imagine that the relationship between the two nations will be instrumental in shaping a new monetary order. How fast will it emerge and how far will it go? Could we witness the renminbi (China’s currency) replace the dollar as the world’s reserve currency? I asked Buttonwood.
A long way behind
“Could we see the renminbi replace the US as the reserve currency in our lifetime? It depends on how long you think you will live. Reserve currency status is not just a matter of having the largest economy; it is a function of liquidity and trust in the legal system. In both cases, the renminbi is a long way behind. Remember that sterling was still being used as a reserve currency in the 1950s, 60 years after the US overtook Britain.”
Nevertheless, the future stability of the dollar is at risk, as projected increases in unfunded liabilities related to Social Security and Medicare/Medicaid threaten to upend a delicate equilibrium that is based on trust and confidence. That problem — serious as it is — is compounded by a fractious political class that is unable (or unwilling) to address the problem in a mature manner. Since optimism is a trait of the American character, let’s take a “glass half-full” approach. What are the reasons to believe that the U.S. can tackle its debt problem effectively? I asked Buttonwood.
Three hopeful signs
“The most hopeful signs for the US in dealing with its debt problems are threefold; demography, economic vitality and energy. America has a higher birth rate than Europe and (at the moment) benefits from lots of immigration. Whereas in Italy there are currently 3 people of working age for every pensioner, in the US there are 4.6. By 2050, there will be only 1.5 Italian workers per pensioner but the US will have 2.6, better than much of Europe today. Secondly, the US is in the forefront of new industries like software, biotechnology and alternative energy that could boost productivity in the future. Since economic growth is a function of a) worker numbers and b) productivity, both are positive news. Third, the recent development of shale gas makes the US much more energy sufficient than Europe.”
The old continent: No question about it, Europe is in a real jam right now. In our concluding article, Buttonwood lays out one way in which the European sovereign debt crisis may play out and discusses whether a new gold standard would make a good replacement to the current regime of floating fiat currencies. Finally, he highlights the extraordinary shift by which orthodox thinking in the U.S. regarding the currency has been turned on its head — stay tuned.
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