What would happen if the U.S. dollar was no longer the world”s reserve currency?

I have been thinking about that question this week in light of the Russian and Chinese calls for a new world currency to replace the dominant role the dollar has had since the end of World War II. This is all we have known. We have enjoyed the world’s highest living standard due to the stability and wealth created by America’s dominate economic role in the world.

We are now the world’s largest debtor nation ($10.6 trillion). China owns more of that debt than any other nation. It is concerned it treasury bills and bonds it holds will become worthless if the dollar is devalued or the financial crisis does not turn around. They are playing a very dangerous game with their calls for a new reserve currency.

But geopolitical “chicken” is not new to the world.

Here is what would happen if we woke up one morning to find the dollar was no longer the number one world currency.

1. Everything we import would cost more. Everything. We would have to buy the new currency in order to trade in world markets. Remember last year’s $4 per gallon gasoline? That would quickly look like a bargain when we began pulling up to the gas pumps and saw it would max out our credit cards to buy that next tank of gas for our truck.

Wal-Mart would no longer be the low price leader in retail. In fact Wal-Mart would have a hard time staying in business as competition among retailers would become so fierce that most would not survive. Eventually higher prices would stabilize the field but it would appear to be completely different.

2. The credit market would collapse. Investors would flee toxic assets further locking up the economy.

3. The Fed would print more money to combat the credit squeeze and the likely result would be hyper inflation, meaning higher prices for available goods. Remember the stories of Weimar Germany where it took a wheel barrow full of money to buy a loaf of bread? Not pretty.

4. American power and influence in the world would seriously decline. Little understood today is the role of the economy in shaping and controlling world events. The dollar’s place in the world adds incalculable weight to American influence. With the dollar diminished that influence will evaporate. Russia and China are waiting for their turn to assume that power, not that they would not receive competition from the European Union.

5. Big losers from the fall of the dollar would be Japan, Central and South America. Because they hold much of our debt China and the Gulf States would see huge losses. Israel and Eygpt, because off massiive amounts of American aid would also lose. What this would mean to the Middle East calculus is unknown, but Egypt could be destabilized as a result.

6. World politics would be altered. The vacuum of power created would be contested. The EU, which would stand to gain from the faall of the fall of the dollar would be among the cheif contenders. China would no doubt make a play as well but a number factors would hinder their bid. Stability would rise from the potential period of chaos. The global economy will continue and another power will become its main engine. America’s time in the sun would be over.

7. American lifestyles will change radically. The end of cheap oil, low interest rates, and deficit spending will mean a lower quality of life and higher taxes. What this would mean to the social fabric of the nation is unkown. But our way of life as we know it would dramatically change.

This last point speaks to the character of the American people. Do we have the same qualities that helped a prior generation survive the upheaval of a Great Depression and World War II? A question for another post.