Geithner Let's the Secret Out: The Coming New Reserve Currency

The dollar jackknifed Wednesday on comments by Treasury Secretary Geithner as he accidentally sent out a dollar sell signal and was given the opportunity to correct his question under friendly questioning.

This could have been an even greater faux pas if it wasn't corrected quickly.

As for the correction, they have obviously brought in some heavy duty handlers to protect Geithner. As I have pointed out, his briefings with the press are now, mostly, pen and pad deals.

This morning when I posted that Geithner would be speaking at the Council of Foreign Relations, Bob Murphy (Who else?) asked in the comment section:

Are these talks going to be pen and paper only? Check your iPhone at the door?

Since, Bob is an economist and not a reporter, and I wear both hats at various times, in the comment section, I provided Bob with a bit of background on what was going on:

Oh Bob,

I have to update you in the subtleties of reporting. This is not a "press conference," so reporters are banned from asking questions. It's Q&A from the audience where you likely have a moderator who has the questions written down from the audience on index cards and he picks and chooses which questions to ask. Geithner would be glad to field questions all day with this set up even if it is being streamed live over CNN, given Geithner usually brings along the moderator's last tax return, and there's a big yellow stickie on the front that says, Audit, yes or no with a big question market.

At FFI, I tried to ask Prime Minister Rudd a question and the WSJ staff nearly tackled me

My point being, the reporters are there as stenographers and the moderator is friendly. I wrote this before I was aware of who the moderator was. Since then I have learned that it was Roger Altman.

Coincidentally, the evening before I had a talk with Altman, at FFI. Altman is as sharp as a whip, but he is really a true gentleman. Whoever is handling Geithner made a perfect choice in Altman as moderator. Altman would never try to embarrass someone in public, and indeed as this FT report shows, Altman actually managed to bail Geithner out of a potential worldwide embarrassment:

The dollar fell briefly on Wednesday after US Treasury secretary Tim Geithner said he was open to exploring a Chinese proposal to reduce reliance on the US dollar as the world’s reserve currency.

Mr Geithner told the Council for Foreign Relations that he had not studied the proposal by Chinese central bank governor Zhou Xiaochuan for greater use of Special Drawing Rights in international reserves, but said “we are quite open to that”.

The dollar fell 1.3 per cent against the euro as headlines saying “Geithner open to SDR currency” flashed across traders’ screens. With the currency falling, Mr Geithner’s interviewer – Roger Altman, a deputy Treasury secretary in the Clinton administration – gave Mr Geithner the chance to clarify his remarks.

The Treasury secretary said: “I think the dollar remains the world’s dominant reserve currency”. The dollar subsequently recovered much of its losses.

Now the reaction of the dollar to Geithner's comment shows you that there are still a lot of traders that need to be reading EPJ, since I have been reporting, for at least two months now, the fact that the U.S. was not against a new reserve currency. This should not have come as a surprise to traders.

Interestingly, at FFI, when I brought up the question of a new reserve currency, many pooh, poohed the idea. Others seemed to be more in the know and felt something was starting to happen, but were very hazy on details.

As best I can tell, here's what is going on. The Treasury is fully aware that the dollar could collapse at any time. It's like the expected southern California Big One earthquake. Earthquake specialists tell us that it will happen, only the timing is uncertain. It's the same with the timing on the collapse of the dollar, the dollar will collapse at some point given its current condition, only the date is just unsure.

The thinkers at the Treasury appear to have reached the conclusion that the best way to handle the inevitable is to accept reality and make the best of it. The "best of it" appears to be a new reserve currency that the U.S. somehow stick handles. This could be SDR's, or some other basket of currencies formula.

I call it the "gin and tonic formula." Suppose you are looking for a good strong drink and all you have is a glass of tonic. Now one option is to throw away the tonic, and get yourself a shot of whiskey, but another option would be to add gin to your glass of tonic. This is what the U.S. is going to attempt to pull off. A shot of whiskey means the dollar has collapsed and a new currency will emerge. The gin and tonic approach means the dollar (the tonic) stays right where a lot of it is, with central banks around the world, but it is mixed with stronger currencies (the gin) in some new basket of currencies.

If the U.S. can pull this off, it would calm markets. Of course, if the Fed prints money at a faster rate than other currencies in the basket, the basket will fall apart.

Geithner's comment on China's plan is the first public acknowledgement that the Treasury is thinking in this direction. The reaction in the markets clearly means the markets had no clue. In terms of realeconomik, a market basket protects the dollar from total collapse. The dollar should have rallied on the news. The traders were just taken by surprise by Geithner's off hand method of launching the debate. And, I am very sure that the Treasury insiders are very glad that Altman was in the boat doing the steering when necessary.

One more comment must be made with regard to the gin and tonic formula. This does not cure all the economic ills. If the madman Bernanke continues to print money as though he is trying to seduce Robert Mugabe's wife away from Mugabe, a gin and tonic formula will be patchwork that will collapse within two years. And let's hope there are other countries besides Germany and the Czech Republic that will likely fight any structure that will tend to promote global inflation.

Thus, the real key is responsible money supply management. In realeconomik terms, the ideal would be a money supply that is not increased or decreased. I am not sure there are even many supporters for that in Germany or the Czech Republic.

Expect the G-20 meeting to be a launching pad for the formation of study groups. Who is on the groups will provide a good sense as to the direction a new reserve currency is likely to take.