The Foreclosure Crisis Has Led to the Questioning the Validity of the Dollar as Reserve Currency

foreclosed house

It is the tiny drops that make the ocean. The foreclosure of a single borrower followed by another and then another running into millions has opened up the floodgates – so much so that the crisis has led to the questioning of the validity of the dollar as international reserve currency.

Instead of the dollar it is suggested that the reserve currency should be the SDRs or Special Drawing Rights of the IMF. In reality it would mean that the unipolar world that was functioning since the fall of the Soviet Union in 1991 would now be replaced by a multi-polar global economic era with toned down globalization.

Till 1914 the currencies of the world were expressed in gold terms. Since gold was always limited, the countries could not issue currency over and above their gold holding. The first main power to go off the gold standard was Britain in 1914 so as to be free to fund its military spending during World War I. But in 1925 Churchill returned to the gold standard.

After the close of World War I the dominant power in the world was USA. From 1946 to 1971 the rates of exchange were fixed relating to the USA dollar. Gold prices were pegged down at $35 per ounce. France made use of this to exchange dollars for gold and this depleted the gold holdings of USA. This apart USA found itself embroiled in heavy expenditures like Great Society programme of Johnson and the Vietnam War. This made Nixon remove the fixed price facet causing massive numbers of dollars to start circulating.

Since then most of global trade and monetary transactions have been expressed through dollars. The size, power and increasing productive power of USA gave the rest of the world confidence to rely on the dollar. They began parking extra funds in American treasury bonds and various other kinds of investments. This ceaseless inflow of funds allowed Bush to merrily go on spending far in excess of the country’s revenues. This led to massive increase in liquidity.

The Federal Reserve stuck to its policy of low interest rates and allowed the economy of USA to grow and grow. There was employment all round and frenetic construction activity. It was the great bubble. There were huge purchases through credit cards and banks as well as other financial institutions dizzily indulged in speculation. Not to be left behind the mortgage firms began to play around with new types of financial tools.

Then everything went bust!