[DEBATE] : Digital gold as replacement for dollar is cited in Washington Post

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Digital gold as replacement for dollar is cited in Washington Post
	
Submitted by cpowell on 08:39AM ET Monday, November 12, 2007. Section: 
Daily Dispatches

The Dollar in Danger

By Sebastian Mallaby
Washington Post
Monday, November 12, 2007

http://www.washingtonpost.com/wp-dyn/content/article/2007/11/11/AR200711...

For a quarter-century after World War II, money was based on a loose 
version of the gold standard. The U.S. dollar was pegged to gold; other 
currencies were pegged to the dollar; stable prices underpinned the 
prosperity and soaring trade of the 1950s and '60s. Then in 1971 Richard 
Nixon balked at the high interest rates necessary to maintain the 
dollar's link to gold. For the rest of the decade, inflation ripped. The 
cure, starting in 1979, involved two recessions in the United States and 
the Third World debt crisis.

Now we face another potential watershed in the world's system of money. 
Since the breaking of the gold link, the dollar has become the world's 
primary measure of value, so much so that bank deposits in Uruguay and 
bribes paid in Russia are mostly denominated in dollars. But the dollar, 
like the gold standard before it, is under pressure. Last week even 
Giselle Bundchen, the world's top supermodel, was reported to be 
steering clear of greenbacks.

Inflation was the cause of the gold standard's collapse as well as its 
main consequence. As long as the dollar was convertible, investors could 
choose between owning one dollar and owning one-35th of an ounce of 
gold; when inflation eroded the greenback's purchasing power, gold was 
the more attractive option. Foreigners traded in their dollars until 
U.S. gold stocks were close to exhaustion. Higher U.S. interest rates 
could have lured foreigners back into dollars. But Nixon wouldn't 
tolerate high rates the year before an election.

Today's problem is different. The Fed has kept a lid on inflation, but 
the dollar's vulnerability is caused by debt -- the debt of the federal 
government and of American households. Year after year, foreigners have 
provided Americans with the savings that they refuse to generate 
themselves, and this stream of money has supported the U.S. currency. 
But if foreigners tire of handing over their savings, the unsupported 
dollar is almost bound to fall. That is what has happened recently.

You can hardly blame the foreigners. They sent their money to the United 
States because they thought the U.S. financial system was transparent 
and sound; the subprime mortgage mess has forced them to think 
differently. They sent their money to the United States because the 
greenback was expected to hold its value, but its purchasing power has 
fallen sharply against oil, metals and other commodities. Once a 
currency ceases to act as a store of value, its days as a reserve 
currency -- that is, a currency in which foreigners are happy to hold 
savings for the long term -- may be numbered.

As in 1971, the Federal Reserve could do something. It could keep 
interest rates high enough to entice investors to hold dollars. But as 
in 1971, this is not an attractive option. The U.S. economy is reeling 
under the impact of an oil shock, a housing shock and financial turmoil. 
Forced to choose between upholding the dollar's role as an international 
store of value and avoiding domestic recession, the Fed is likely to 
prioritize recession-avoidance.

Nixon's Treasury secretary, John Connally, told furious Europeans that 
the dollar was "our currency but your problem." The same could be said 
for today's dollar trouble, which is why French President Nicolas 
Sarkozy said plaintively last week that "the dollar cannot remain 
someone else's problem." For the United States, a falling dollar means 
pricier imports but also an export boom that could carry the U.S. 
economy through its housing bust. Yet for France and other countries 
that use the euro, a weak dollar means a loss of competitiveness -- not 
only against U.S. producers but also against dollar-pegging Asian exporters.

The falling dollar is a headache for the dollar-peggers, too. Their 
problem is the mirror image of the European one: Countries such as China 
and the Arab Gulf states are already experiencing an export boom that is 
overheating their economies. As a falling dollar drags down their 
currencies, this overheating gets worse. Meanwhile, they have 
accumulated vast piles of dollar assets that are now losing value. 
Saving on America's behalf turns out to be expensive.

So the world faces a dilemma. The last thing it wants is more dollar 
weakness, which is why central bankers in East Asia and the 
petro-states, which control most of the world's official reserves, are 
not about to dump U.S. bonds and trigger a collapse in the greenback. 
But the world may also draw the lesson that an alternative global 
currency needs to be the long-term goal. Households don't like saving in 
a currency that won't hold its value. Companies don't like building 
global supply chains based on a unit of account that fluctuates unstably.

Most economists assume that the dollar will continue to act as the 
global currency because there is no alternative. But one of my 
colleagues at the Council on Foreign Relations, Benn Steil, has proposed 
another option -- a privately created currency that would confer an 
inflation-proof claim on gold or a basket of commodities. Steil calls 
his idea "digital gold," which has a nice back-to-the-future ring. The 
more the dollar slides, the less Steil's suggestion sounds like a 
fantasy from a movie studio.