Here's a follow-up to Thomas Palley's argument that the dollar is in no immediate danger of losing its status in the world. This takes a somewhat different position:
Dollar signs, by Howard M. Wachtel, Commentary, LA Times: Has the tipping point arrived when the U.S. dollar ceases to be the preeminent reserve currency in the global economy -- a status it has held for 60 years? Such conjecture has been triggered by the recent dip in the dollar against the euro...
Since World War II, the dollar has been held as reserves by other countries in their financial portfolios because of its universal acceptance in the world economy and its stable value.
For the country whose currency achieves this status, there are considerable advantages. The United States can run large trade deficits, buying more than it sells in the world, because the selling countries are eager to acquire dollars as reserves. Such trade deficits are in reality debts whose reconciliation can be postponed as long as countries seek dollars as reserves. Political power also derives from this financial reality, as countries become willing to accommodate the reserve currency country in order to gain access to that currency.
The euro's introduction was not unmindful of these political and financial power configurations. Today, Hugo Chavez of Venezuela and Mahmoud Ahmadinejad of Iran have joined a group of Europeans waiting and hoping for the dollar's demise. In the backrooms, where financial-political diplomacy is discussed, similar desiderata are expressed by some influential leaders in Russia, China and the oil-exporting countries of the Middle East.
Countries make decisions to hold their trade surpluses in a reserve currency based on several considerations: the rate of return, degree of risk, relative strength of economies competing for reserve status, and a more subjective determination of the confidence in a country's decision-making. Risk pertains to exchange rate stability. ...
Over the last several years, and especially in the last six months, these factors have turned against the dollar. Exchange rate risk has risen rapidly. The euro zone economies have started to grow faster, restoring confidence in their near-term economic performance. The rate of return has gone against the dollar, with the three interest rate cuts in fall 2007. Finally, there is a general malaise about the solidity of U.S. policymaking. It started after the Iraq war in 2003 and has deepened with each revelation of new problems raised about American governing competence.
Is it any wonder that there would be speculation about the future of the dollar as the dominant reserve currency? Seen from Asia, the Middle East or Russia, those in charge of reserve portfolios must be asking: ...why not place more of our new surpluses into euros? Indeed, the question should be asked: Why haven't major dollar reserve countries diversified more into euros than they have? ...
While there are no clear movements out of dollars, anecdotal musings have surfaced.
For example, Cheng Siwei, ... caused financial markets to tremble when he said that China ... would invest outside the dollar. Cheng's comments were "clarified" a few days later by Chinese financial officials.
The explanation for apparent continuity in holding dollars as reserves can be found in the idea of sunk costs. It is costly to diversify out of the dollar. Any sharp movement would cause the dollar to fall even faster and further, hurting the dollar holders even more than the U.S. ... Some gradual portfolio adjustments at the margin, with more of new dollar surpluses placed in euros, will occur, but this will appear as a continuation of trends and foreshadow a soft landing for the dollar. It could be a hard landing if the Fed continues to cut interest rates.
The U.S. cannot be complacent... Further interest rate reductions will only hasten the dollar's decline as a reserve currency; continuing trade deficits do the same. Restoring confidence in the United States as a 21st century nation is of the highest priority, and not just for global financial reasons. There is a point, we know not where, at which the cost of holding dollars exceeds the cost of jettisoning them.