The historian in me frequently notes that too many people operating in finance assume that the “rules” are static, and everlasting. That’s the case of MPT, as argued in Getting Back to Business. It’s also the case in regard to the US dollar’s status as the world’s reserve currency. A recent Bloomberg Businessweek article by Peter Coy, “The Tyranny of the U.S. Dollar,” (October 8) reviews the status of the greenback as the dominant currency in global affairs and why it might or might not remain that way. (One factor in favor of the dollar is that there is no clear alternative to it at the present moment.)
More importantly, the article should serve to remind investors that reserve currency status can come and go. Prior to the dollar commanding the global scene after World War II, it was sterling, which dominated from the middle of the 19th century until the onset of World War II. The World Bank has traced back to Antiquity which currencies have been used outside their original historical territories, a rough proxy for reserve currency status. The Greek drachma in the fifth century B.C. goes first, followed by Roman Empire currencies, then the Arabian dinar. The Italian city-state currencies–the florino (Florence) and ducato (Venice) followed, until they were supplanted by the “modern” currencies: the Dutch guilder, English sterling, and the dollar. The lesson is simple: empires come and go. The downfall of a dominant power means its reserve currency status follows soon thereafter, usually due to the devaluation of the currency as the declining power spends beyond its means…..