[Epaphras]

There is a lot of talk about the potential for the US dollar losing it's status as the world's reserve currency. Indeed, this is probably the only thing saving us from a major economic catastrophy. In other words, any other country in as bad of fiscal shape (debt, deficits, unfunded mandates, etc) as we are in, would've collapsed economically by now.

How likely is something like this, and what would the world's reserve currency become?

[Ridley's Own]

Well, I'd quibble with the notion that "any country in as bad a shape as we're in" would've collapsed. Don't forget that we were at spending 150% of the GDP during WWII and the country didn't collapse. We've been here before, and we did just fine.

The problems that other countries have had is that they were unable to sell debt in other people's currency; so, the greeks were no longer able to sell debt in dollars, not just euros. We're not even close to that; people are still willing to buy dollars.

Fundamentally, the world will always keep buying US dollars and keeping it as a reserve currency because of our military. No one wants the job of replacing US projective power, but they are willing to pay for someone else to do it. Our biggest export (security) is always in demand, and gov'ts are willing to pay for it in the form of buying our debt and keeping the dollar as the reserve.

[normajean777]

For all the talk of the Euro replacing the dollar as the dominant currency [in the past few years], the global recession seems to simply indicate that Europe is as weak or weaker than the US, and that their currency is not significantly more stable than the US to make a shift worthwhile.

[Epaphras]

The way I see it is that fiat currency, while not backed by hard assets, is backed by what we'll call "soft assets". If we are the world's reserve currency, it's because people think we're good to repay our debts. They think that because a US dollar has the US economy behind it, which is still the largest in the world. As long as there is faith in the US economy, there will be faith in the US dollar.

I skipped the part in the middle - "faith in the US economy" involves fiscal responsibility, where debt and deficits don't spiral out of control. As long as the US economy can remain robust and the US government get a handle on deficits and the national debt, we don't have to worry about a currency devaluation.

If it starts to cost the US Treasury more money to sell government debt, that very quickly drastically changes the fiscal outlook and the faith investors have in the US economy and political leadership to make good on it's commitments. This is reflected in higher interests rates the Treasury must pay to sell debt. Interest payments could quickly overwhelm the federal budget and force deep cuts elsewhere, which would impact the economy and thus the faith in the US dollar.

[Ridley's Own]

I think you're right; what's interesting is that both too much debt and no debt at all actually result in the same thing: no one buying T-Bills in the market, and no one knows what that looks like.

I think our 'soft assets' also include things like our diplomatic/military power, things that no other country has the capacity to build, let alone possess and use. I just don't see the IMF/World Bank/WTO, all three US-lead creations, moving away from the dollar without our consent or leadership into something else. No one's going to simply stop buying treasury bonds because they loose access to US hard and soft power.