Sunday, December 2, 2007

Is History Repeating Itself?

As we watch the dollar continue to free fall, one thing that really strikes me is how similar these recent developments are to those taking place before the break up of the Bretton Woods System in the early 1970s. Back then, the periphery countries were importing a loose, inflationary monetary policy from the dominant anchor economy, the U.S. The periphery countries also had piled up large amount of dollar reserves that eventually lost value when the system cracked in 1971-1973. Today, the dominant anchor country once again is the U.S. and is exporting a loose, inflationary policy to the periphery countries (i.e. Asia and the Gulf States) who have acquired vast dollar reserves. These countries too are now taking a huge capital loss as the dollar falls. Will this system, called by some the Bretton Wood II System, also crack like the original? Are we living through a time where economic history is repeating itself?

Part of what got me thinking about these historical patterns was the lead article and a subsequent longer piece in the Economist on the dollar's fall. These articles do a nice job explaining the structural reasons--the pressures from the huge U.S. current account deficits are finally being felt--the and cyclical reasons--the increasingly probability of U.S. recession and further rate cuts--for the falling dollar. The Economist also provides an interesting discussion of whether this decline means the U.S. dollar will lose its reserve currency status (answer: not necessarily) and what it means for the global economy. I then followed up by reading Brad Sester's discussion on these same Economist articles. He especially makes a good case that contrary to conventional wisdom, central banks can have a meaningful influence in foreign exchange markets--just look at the influence of the BRICs and the Gulf States.

What a fascinating time to be alive... as long as I keep my job!

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