Life after the death of the dollar

ANY non-executive director with a bit of time to think strategically about the big issues facing business should pop along this evening to Gresham College off Holborn to listen to Professor of Commerce Avinash Persaud.

While most of us are aware of the surge in growth in China and the tilting of power towards the East, Persaud takes it further. His conclusion is that within the lifetime of most people reading this column, and possibly within 20 years, the Chinese economy will be bigger than America's and that will mean the dollar will be toppled by China's renminbi as the world's reserve currency. The implications of that for the US economy are dire - and they could be pretty grim too for British companies doing business and earning profits in that country.

It would be nice to think the dollar and renminbi could coexist or even share power with the euro, but that is unlikely. The reason a reserve currency comes into being is because it suits everyone to use it, just as it suits everyone to have a computer that runs Windows. The benefits arise because everyone else is on the same network. So it follows that it works best if there is only one reserve currency and that it is the one most people need to use.

Once China is the world's biggest economy and everybody's biggest trading partner business will want renminbi, not dollars and the trend will become irresistible. It can be slowed down, of course, just as the British kept sterling going as a reserve currency long after Britain ceased to be the world's number one economy, but it can't be stopped.

The pain will come because the dollar's replacement will mean the unwinding of all the benefits the US currently takes for granted and will be reminiscent of the economic stagnation, balance of payments crises, and general malaise that affected Britain as it adjusted to no longer being number one.

The great advantage if your currency is a reserve currency, Persaud says, is that you can pay for things by writing cheques nobody cashes. You can spend more than you earn to a far greater extent than anyone else. This is exactly what the US has done. In the past five years alone, US national expenditure has exceeded national income by 22% of gross domestic product. And most of it is going on unproductive consumption.

The effect of all those 'uncashed cheques' is that while America accounts for 30% of all trade, central banks on average hold 70% of their reserves in dollars. That, and the willingness of foreigners to buy US government debt, means it can run its budget and trade imbalances for far longer than any other country has been allowed to in the past.

The pain starts when this all goes into reverse. Then everyone starts to cash those cheques and resources have to be found to honour them. What normally happens then is inflation - too much money chasing too few goods and an even greater collapse in confidence in the currency and its external value. Then commodities such as oil cease to be priced in dollars, so every time the currency falls it causes a further upwards twist in imported raw material costs.

It won't happen overnight, but in terms of investment time horizons for global businesses, if not for the City's hedge funds, there is probably nothing more important than understanding the probable decline in status of the US economy within a few short decades.

Rate reverse

ALMOST no one in the City expects interest rates to go up today and the economic news this week could almost have been designed to support them in that view.

Figures from the Halifax confirmed that the rise in house prices had slowed right down over the past three months so there is now virtually no upward movement - adding weight to anecdotal evidence from estate agents and other sources. Then yesterday came news of a fall in manufacturing output, for the third time in three months. Under such circumstances and with no sign of inflationary pressures in the wider economy, it would be perverse of the Bank of England's monetary policy committee to raise rates today.

The consensus view, though the mood is wavering, is still that rates have a little further to rise before the year-end. But there are some, Capital Economics notably, who think the easing of house prices will prompt the MPC to start cutting rates again soon, suggesting they could be back to 4% by the end of next year.

Given the difficulty of what the MPC is trying to engineer - a soft landing for house prices without damaging the rest of the economy - we have done well to get this far without more disturbance. Let us hope the MPC's luck holds.