When Currencies Collapse

Will We Replay the 1930s or the 1970s?

Courtesy Reuters

The international monetary system rests on just two currencies: the dollar and the euro. Together, they account for nearly 90 percent of the foreign exchange reserves held by central banks and governments. They make up nearly 80 percent of the value of Special Drawing Rights, the reserve asset used in transactions between the International Monetary Fund (IMF) and its members. Of all debt securities denominated in a foreign currency, more than three-quarters are in dollars and euros. The two currencies together account for nearly two-thirds of all trading in foreign exchange markets worldwide. They are the essential lubricants of global trade and finance. Were they not widely accepted, the global economy could not sustain current levels of international trade and investment.

That is why the problems now faced by both currencies are so alarming. Today, more than at any time in recent memory, analysts and investors are voicing doubts about the stability of the dollar and the euro and the international monetary system that depends on them. Consider first the dollar. Faith in its reliability was seriously undermined last summer when the debt-ceiling imbroglio in the United States revealed a seemingly unbridgeable gap between the political parties and raised concerns about the capacity of U.S. policymakers to put the country's financial house in order. Foreign investors, who hold slightly less than half of all marketable U.S. Treasury debt, saw the crisis as proof that members of Congress would rather let the country default on its obligations than compromise on their own partisan objectives. And foreign governments were spooked. As the debate reached a peak, Chinese officials lectured Washington on the need to act responsibly, China's state-run news agency disparaged the negotiations as a "madcap farce of brinkmanship," and Russian Prime Minister Vladimir Putin characterized Americans as "living like parasites off the global economy and their monopoly of the dollar."

Doubts about the euro are even graver. The eurozone is divided into a relatively vigorous northern tier with sound finances and a

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