Discussion on Dollar's Fate Draws Criticism of System

The dollar's recent fall might signal that the "fiat" money system, which has been in place since America departed from the gold standard in 1971, was something of a mistake.

That was among the arguments put forth yesterday by the four panelists who spoke at the Council on Foreign Relations on whether the falling dollar should be considered worrisome.

"Unique in the annals of money is a reserve currency that is uncollateralized," the editor of Grant's Interest Rate Observer, James Grant, told the packed house. "You can exchange the dollar into pennies, nickels, dimes, and quarters, but there is nothing else."

Mr. Grant described America's current system as a "historical anomaly, which is now being tested." He said he thinks the rest of the world is growing less sure that something substantial stands behind the greenback. A senior fellow and director of international economics for the Council on Foreign Relations, Benn Steil, described his outlook on the fate of the dollar as "pessimistic."

"I think that we're seeing a degree of foreign official concern about the roll of the dollar as a reliable long-term standard of value that we haven't seen since the 1970s, in the wake of the United States reneging on its commitment to back the dollar with a fixed amount of gold," Mr. Steil said.

He explained why the foreign holders of dollars are so concerned: Over the past 10 years, there has been an enormous buildup of foreign holdings of dollars. So, when the Federal Reserve started cutting interest rates in wake of the mortgage crisis, inflation went up and America suddenly found itself "exporting inflation worldwide."

Asia and the Middle Eastern countries, many of whose currencies have historically been pegged to the dollar, are among the countries most vulnerable to the dollar's inflation. These countries are some of America's largest creditors, Mr. Steil said, "and when they begin to lose confidence in the dollar, I think we need to begin showing some concern."

A professor of economics at Columbia University, Richard Clarida, disagreed. "I think the adjustment of the dollar to date is understandable, I think it's appropriate, I think on balance it's stabilizing for the global economy," he said. Mr. Clarida said that he has "every faith that the Bernanke Fed … will achieve a low state of inflation," and that the dollar will continue to act as the global reserve currency. A professor of economics at Stanford, John Taylor, also viewed the situation rather positively. He described the movements of the dollar with respect to other world currencies as "orderly."

Whether the movement stays orderly depends largely on what the Fed does, Mr. Steil said. "If they continue to cut rates aggressively, I think we could see a disorderly adjustment of the dollar exchange rate."