The King is Dead, Long Live the King: “Exorbitant Privilege” Review

1:18 pm - March 31, 2011

When will King Dollar be kicked off his throne?

Calls for the death of the dollar – and reference to the U.S. as a great nation gone “banana republic” – date back to the early 1970s.

The fact that dollar doomsayers still rely on arguments put forth forty years ago should be enough to give one pause. If they were wrong in 1973, why should they be right today?

The question is not whether America is in financial crisis, but whether current conditions – along with sweeping change in emerging markets – will be enough to shock the international monetary system into a new form.

There are powerful reasons why a highly liquid reserve currency is needed for the purpose of facilitating global trade. There are also powerful reasons why the $USD has few true challengers.

(As for the euro, one need only look to Greece, Portugal and Ireland – and Europe’s lack of true political union – to get a sense of the troubles there. Meanwhile the yen is in its own world of hurt, and the renminbi is far from ready for prime time.)

In this surprisingly compact and readable book, Eichengreen adds much needed nuance and subtlety to the U.S. dollar debate. His main message appears to be that, despite appearances, it will not be some form of external shock that will end the dollar’s role as sole reserve currency. As with the majority of empires, downfall is a combination of gradual change at the margins and gnawing decay from within.

Eichengreen’s views have potential to upset folks on both sides of the aisle. Those who picture the greenback as a disaster waiting to happen, for example, will be disappointed to hear the traditional imminent doom scenarios are not all that realistic.

On the other hand, those who think everything is fine will be disappointed by Eichengreen’s view that out-of-control budget deficits really could present a long-term problem, and possibly trigger a dollar crash, by way of investor capital flight.

(Though the question still remains as to what investors will flee into, on leaving the $USD behind. The precious metals markets are microscopic in comparison to international trade flows, and a more official recognition of gold / silver would make supply even scarcer by way of hoarding. Various emerging markets, meanwhile, could not handle undue strengthening of their currencies – the flipside of a dollar rout — without seeing their own economies hobbled. The U.S. has an ace up its sleeve not just in terms of size and superpower status, but in its vital role as trading partner and the asset side of its balance sheet.)

Sign Up For the Mercenary Dispatch

Get our best content delivered FREE to your inbox!

Check out the Mercenary Dispatch page to learn more.

Eichengreen draws many instructive lessons from the rise and fall of sterling, the one-time world reserve currency of Britain. Unsettlingly for America bulls, one lesson via Britain’s experience is that downfall can in fact happen relatively quickly – not overnight, but over a period of, say, ten years.

Eichengreen points out that China, too, is a student of monetary history, with Chinese policy makers laying the early groundwork for an eventual renminbi challenge (though they still have a long way to go).

The book further presents evidence that, as economic prosperity reaches more corners of the globe, we will naturally edge towards a more multi-polar currency world. This would be a world in which currency competitors do not necessarily challenge the dollar head on, but become increasingly more important to regional trade.

In addition to summing up the current situation, “Exorbitant Privilege” is a pithy and amusing history of the international monetary system (including the story of where the phrase “exorbitant privilege” actually came from).

Some may find it dry, but for those fascinated by historical figures and events, behind-the-scenes machinations, and the logistical elements that make a complex currency and trade system work, the telling is very well done.

p.s. Like this article? For more, visit our Knowledge Center!

p.p.s. If you haven't already, check out the Mercenary Live Feed!