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Full Circle

12/23/2010

Surviving veterans of the European front in World War II show pride in toppling Hitler. Few take any credit for establishing the dollar as the world’s “reserve currency,” but it was terribly important.

Immediately after the war, the victorious Allies met in Geneva to begin mapping the Marshall Plan for the reconstruction of Europe. One of the many things they did was to require international contracts that be denominated in dollars. In other words, if a French firm wanted to buy something from an English firm, there was no argument as to whether they would pay with French francs or English pounds. They had to pay with U.S. dollars. The thinking behind this was that it would remove any incentive for a nation to debase its own currency as a means to minimize their debt. It was a form of monetary discipline.

Because the dollar then became the world’s sole reserve currency, we needed to supply the world with enough dollars to do business, which also created a huge demand to own our bonds. We certainly took advantage of that prerogative, didn’t we?

Meanwhile, Europe witnessed the discipline imposed by a common currency, making it receptive to adopting the Euro in 1995, which immediately became another reserve currency, creating international demand for that new currency, as well as their bonds. I doubt the veterans sitting in Geneva in 1945 would have ever imagined how successful their work was. They created not only the world’s first reserve currency but also the second!

Unfortunately, the Europeans took even greater advantage of having a reserve currency and issued enough bonds to get into trouble. In 2010, there has been lots of debate as to whether the Euro will survive, given the debt problems in Europe.

But, which nation would be most unhappy to see the dollar become the sole reserve currency again? China!
Does that nation have the ability to “save” the Euro? Yes!
Will it? Yes!
Should you worry about the collapse of the Euro? No!
Do you think the WWII veterans knew China would bail out Europe, after they had saved it . . . history is like a football, it bounces funny.

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