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Yes, your question makes sense, and it is a good one.

In this scenario (if it makes any sense at all), there would not have been such a huge worldwide demand for dollars to repay debts, right?

The answer is no, not right. The demand for dollars would have been the same, and that also explains why the idea of currency baskets is problematic too. The reason is that there is nothing -- or not much anyway -- contractual, legal, or otherwise, that requires banks (or other investors or creditors) to keep the currency in their vaults in US dollars today.  They can keep US dollar currency, or they can make other loans or investments, or they can buy other currencies -- it's up to them for the most part, especially in the case of central banks which make decisions about reserve currencies.  So when someone repays a loan to them, creditors have the  option of putting the repayment in vault (or in a deposit with a central or other bank) in US dollars, or they can instantaneous buy a presumably safer foreign currency and put that in their vault instead.

What we observe, however, is that each and every day investors, creditors, and central bankers (including the Chinese who complain so much about it) all decide to hold significant US dollar reserves instead of the many other options available to them.  That is why we know that the political entitlement to wealth of holding a US Dollar is the safer castle wall during a crisis like the present than others forms of securing wealth.

by santiago on Wed Sep 2nd, 2009 at 01:47:21 PM EST
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