The week before last on Thursday the Financial Times published an OpEd piece I wrote arguing that Washington should take the lead in getting the world to abandon the dollar as the dominant reserve currency. My basic argument is that every twenty to thirty years – whenever, it seems, that American current account deficits surge – we hear dire warnings in the US and abroad about the end of the dollar’s dominance as the world’s reserve currency. Needless to say in the last few years these warnings have intensified to an almost feverish pitch. In fact I discuss one such warning, by Barry Eichengreen, in an entry two months ago.
But these predictions are likely to be as wrong now as they have been in the past. Reserve currency status is a global public good that comes with a cost, and people often forget that cost.
Just as importantly as a public good it requires a number of characteristics. At a minimum these include ample liquidity, central bank credibility, flexible domestic financial markets, minimal government or political intervention, and very deep and open domestic bond markets. With the exception perhaps of the euro, which may or may not emerge in the next decade on a more rational basis than it currently exists (albeit with more than one defection), no other currency has the necessary characteristics that will allow it plausibly to serve the needs of the global economy.
And no other country, not even Europe, will be willing to pay the cost. If there is any chance that the dollar’s status declines in the future, it will require that Washington itself take the lead in forcing the world gradually to disengage from the dollar.
Ironically, this is exactly what Washington should be doing. Conspiracy theory notwithstanding, claims that the reserve status of the dollar unfairly benefits the US are no longer true if they ever were. On the contrary, the global use of the dollar has become bad for the US economy, and because of the global imbalances it permits, bad for the world.
During the first few decades of the post-War period, the cost of maintaining the dollar’s status could be justified by the incremental benefits to the US of a stable and growing world economy within Cold War constraints. The trading benefits that accrued from a widely available global currency benefitted US allies and the relative size of the US economy ensured that the costs were limited. But beginning in the 1980s, trade policies in a number of countries abroad have sharply raised the cost to the US, while the end of the Cold War has limited the benefits.
This cost comes as a choice between rising unemployment and rising debt. The mechanism is fairly straightforward. Countries that seek to supercharge domestic growth by acquiring a larger share of global demand can do so by gaming the global system and actively stockpiling foreign currency, mainly in the form of, but not limited to, central bank reserves. This allows them to forcibly accumulate domestic savings while relying on foreign demand to compensate for their own limited domestic demand.
Always dollars
In practice, dollar liquidity, limited Washington intervention, and the size and flexibility of US financial markets ensure that these countries always stockpiled dollars. There is no real alternative to the dollar, and most other governments would anyway actively discourage massive purchases of their own currencies because of the adverse trade impacts. If foreigners accumulate euros or yen at anywhere near the rate they accumulate dollars, they would force Europe and Japan into massive current account deficits, and neither Europe nor Japan has any interest in seeing this happen.
So foreign acquisition of dollars automatically forces the US into running a corresponding current account deficit as foreign polices that constrain consumption at home require higher consumption abroad. Active trade intervention in countries that engineer large trade surpluses, in other words, have to be accommodated by rising trade deficits in the US.
This importing of US demand by other countries forces the US economy to respond in one of two ways. Either American unemployment must rise as demand is diverted abroad and the tradable goods sector in the US shrinks, or Americans must counteract the employment impact by increasing domestic consumption or investment.
Without government intervention, there is no reason for domestic investment to rise in response to policies abroad. On the contrary, with the diversion of domestic demand private investment may even decline.
So in order to limit the employment impact, capital flows into the US have to finance additional US consumption. Americans, in other words, are forced to choose between higher unemployment and higher debt, and in the past the Federal Reserve has chosen to encourage higher debt.
But what about the benefits to the US of reserve currency status? A lot of analysts argue that the predominance of the dollar gives the US two important advantages. It reduces the cost of imports to American consumers and it lowers US government borrowing costs.
But both arguments are seriously flawed, I think. Americans already over-consume, and so it is hard to argue that they benefit in the aggregate from lower consumption costs, especially when it comes at the expense of employment. And anyway if cheaper consumption is such a gift, it is hard to explain why attempts by the US to return the gift to countries whose consumption costs are artificially high – demanding for example that these countries revalue their currencies and so reduce costs for their own consumers – are always so indignantly rejected.
As for borrowing cheaply, what matters to a government’s borrowing cost, as countries like Switzerland clearly demonstrate, is not major reserve currency status but rather creditworthiness. Because reserve currency status actually increases US borrowing, it is more likely to undermine the ability of the US Treasury to finance itself cheaply than the loss of reserve status would.
The supposed advantages of reserve currency status are simply the obverse of the cost. As countries accumulate dollars, they force trade deficits onto the US, which the US can only manage by increasing borrowing. This borrowing is financed by the foreign accumulation of dollars.
So will it happen?
The massive imbalances that this system has permitted are destabilizing for the world because they permit large and unstable debt buildups both in countries that over-produce, like China and Japan, and those that over-consume, like the US. If the world were forced to give up the dollar, there is no doubt that there would be a cost – it would reduce global trade somewhat and it would probably spell the end of the Asian growth model – but it would also lower long-term economic costs for the US and reduce dangerous global imbalances.
The US, I would argue, should take the lead in shifting the world to multi-currency reserves in which the dollar is simply first among equals. The cost of maintaining sole reserve currency status has simply become too high in the past three decades and is leading inexorably to rising American debt and worrying global imbalances.
My Financial Times article got a lot more response than I would have expected. Some of it was in other news sources, as in this CNN report, but there were also a lot of private responses, suggesting that a larger number of people out there than I had expected were thinking along the same lines. The most interesting of the responses was an email by Kenneth Austin accompanied with an article he had recently published in World Economics. Austin is an International Economist with the US Treasury Department, and a professor at the University of Maryland.
His article was a fascinating re-reading of John Hobson’s theories on under consumption (which I remembered from my graduate school days primarily because he had so profoundly influenced Lenin’s ideas on imperialism). Hobson was a leading British economist of the late 19th and early 20th centuries, and he was one of the major figures in the “underconsumptionist” school. Here is Austin on the topic:
The basic idea is that oversaving causes insufficient demand for economic output. In turn, that leads to recession and resource misallocation, including excessive investment in marketing and distribution. This was a direct challenge to a core thesis of the classical economists: ‘Savings are always beneficial because they allow greater accumulation of capital.’
Keynes, almost 50 years after The Physiology of Industry, found there the essential ideas of the General Theory (first published 1936): the determinants of aggregate demand and the significance of savings– investment imbalances. In Chapter 23 of the General Theory, ‘Notes on Mercantilism etc.’, he lauded Hobson and Mummery for bringing the issue of excess saving to the fore. But Keynes disagreed with Hobson’s theory that excess saving leads to unnecessary investment. Instead, Keynes believed that ‘a relatively weak propensity to consume helps to cause unemployment by requiring and not receiving the accompaniment of a compensating volume of new investment’ (Keynes 1964, p. 370). Keynes attributed Hobson’s error to the lack of an independent theory of the rate of interest. Hobson (Mummery had died many years earlier) considered Keynes’ work the completion and vindication of his efforts.
Hobson took his excess savings theory in another direction in Imperialism: A Study, first published in 1902. In a closed economy, excess savings cause recessions, but an open economy has another alternative: domestic savers can invest abroad. Hobson attributed the renewed enthusiasm for colonial conquest among the industrial powers of the day to a need to find new foreign markets and investment opportunities. He called this need to vent the excess savings abroad ‘The Economic Taproot of Imperialism’.
However, increasing foreign investment requires earning the necessary foreign exchange to invest abroad. This requires an increase in net exports. So foreign investment solves two problems at once. It reduces the excess supply of goods and drains the pool of excess saving. The two objectives are simultaneously fulfilled because they are, in fact and theory, logically equivalent.*
Since industrialised countries tended to develop the same problem of excesses of savings over time, they could not solve the problem cooperatively among themselves. They needed to capture less developed economies to absorb the surplus savings and goods.
Sorry for quoting such a large chunk of Austin’s piece, but I found it a fascinating read and very relevant to understanding China. We may seem to be straying from the topic of the role of the dollar, but basically Austin argues that under-consuming countries today are able to use the dollar today for the same reason that European countries used colonialism in the past – as a way of allowing them to export capital and import foreign demand.
Post script on Black swans
On a totally different subject (and sorry for sounding grumpy), I wonder if I could propose a moratorium on the phrase “black swan.” Although it once had a very limited but useful meaning, it has gradually become one of the most popular and meaningless phrases in financial markets. Last night I watched a Niall Ferguson documentary where he kept warning about black-swan financial crises in places like Latin America. Today I got a report that begins:
The financial markets have endured a flock of geopolitical “black swans” including the devastating earthquake and nuclear crisis in Japan, widespread revolution and violence in the Middle East and North Africa, and escalation of the European sovereign debt crisis. Incredibly domestic markets shrugged aside fear from each transformational event as stocks registered their best first quarter in over a decade led by a recovery in corporate earnings and job growth.
Black swans rarely fly in flocks, and not a single one of these are black swans. They are just shocks. A black swan is an event that disproves a widely-held hypothesis – in the original case, the widely-believed hypothesis was that all swans are white. The discovery of black swans in Australia disproved that hypothesis once and for all.
The Japanese earthquake, then, was not a black swan. To have been a black swan would have required that until last month all of us believed that for whatever reason Japan was wholly immune to earthquakes. In that case the devastating earthquake last month would have resoundingly overturned all of our deepest geological convictions and so it would have qualified as a black swan. Since we know Japan is on a major fault, and everyone has been waiting for decades for the “big one” to hit Japan, the terrible earthquake that hit last month cannot possibly have overturned any hypotheses about Japan and earthquakes and so cannot have been a black swan. The fact that it may have unleashed a nuclear disaster is also not a black swan, unless most of us truly believed that nuclear disasters are in principle and in practice impossible.
Financial crises are not black swans. Revolutions in Egypt are not black swans. If Portugal defaults that will not be a black swan, and the fact that its government-bond spreads are widening is not even close to being a black swan. If Portugal suddenly negotiated an agreement with Australia to become an Australian state, however, that might qualify as a black swan because it would create a reality that none of us had previously thought possible and it would have dramatically changed most of our ideas about possible resolutions to the debt crisis. Widening credit spreads do not qualify.
Black swans almost never occur while shocks occur all the time, and there is no point confusing the two. And by the way while we are on the subject we should probably also call a moratorium on the phrase “tipping point”. I can’t say how many times I have been asked to predict tipping points. The whole point of the “tipping point” concept is that it is totally unpredictable. It means that small incremental inputs will have no discernable effect on output until, suddenly and unexpectedly, a single additional tiny input causes a massive change in output. The straw that broke the camel’s back is an example of a tipping point, and of course it is impossible to predict which straw will do that.
This is an abbreviated version of the newsletter that went out last week. Academics, journalists, and government and NGO officials who want to subscribe to the newsletter should write to me at chinfinpettis@yahoo.com, stating your affiliation, please. Investors who are clients of Shenyin Wanguo Securities will already receive the newsletter. Investors who are not clients but who want to buy a subscription should write to me. also at that address.
I thought these were both brilliant pieces. I think though you perhaps understate the benefits of a reserve currency. The argument is imports are cheaper, and borrowing costs lower. On the first, you point out that the US already consumes too much and no other countries seem that keen on lowering import costs. But perhaps the Chinese haven’t been asked? On the second, you say that it is creditworthiness, not reserve currency status and indeed that might imply a worse creditworthiness. But the two are also linked positively, surely? As you state the US sees demand for dollars almost automatically, which must lower its borrowing costs.
You may be interested in our piece on Foreign Affairs that discusses how to do this in a limited way.
http://www.foreignaffairs.com/articles/67810/joseph-gagnon-and-gary-hufbauer/taxing-chinas-assets
Michael,
I remember being surprised by your recommendation that the US lead the way in shifting to multi currency reserves, because I felt that it would exacerbate the imbalances: the more reserves the US holds in other currencies, surely everyone else must hold more dollars to balance the US dollar short?
Perhaps the logical conclusion is that the US should borrow in other currencies, creating short positions for others to hold long.
“However, increasing foreign investment requires earning the necessary foreign exchange to invest abroad. This requires an increase in net exports.”
I dont understand this passage, at least in terms of colonialism. Was the British pound, in gold, not the unit of exchange in India or Australia or the other colonies? So where is the need for foreign exchange there?
Prof Pettis
What would happen if nations simultaneously “left” the dollar while capital moved away from the US either by fiscal tightening or decreased investment? How likely is this scenario in your opinion?
Just FYI, black swans cygnus atratus do group together often. They can fly together in smallish groups, which you might call a flock. They are also grass-eaters and often graze together in extended “herds” as well. Well past time for a new metaphor then…
Excellent post and nothing in it to quibble about, except for something left out. I think that overlaying a balanced trade paradigm over the current free trade rules would make most of the problems you discuss melt away. If the persistent surplus countries know that they will be subject to trade sanctions if they do not get their surpluses roughly into balance in a reasonable amount of time then they will take actions to make it happen (or the deficit countries will do it for them). If a country is successful in supercharging its economy by promoting exports it can doubly supercharge by spending its export earnings internally. Ironically it seems to be widely believed that these countries rely on a trade surplus to reduce unemployment and boost their economies when in fact they would boost their economies even further if they just spent the excess export earnings internally rather than piling up excessive amounts of dollar assets or what ever the reserve currency might be in the future. Large persistent surpluses are the cause of the dangerous imbalances you mentioned, and they should simply be outlawed.
Thanks for this very intelligently written article!
Funny how americans see their looting of the world via dollar´s reserve status(exchanging printed toilet paper for manufactured goods) as providing some kind of public good to the world. So if that´s so beneficial for the world, why everyone wants to end it? The only country still clinging to dollar´s reserve status is the US. Hmmmm….
And you dont need to worry about others, supposed, unwillingness, to pay the “costs” for having a reserve currency. When the american ponzinomics collapse, the second in row, most likely the euro, will become the reserve currency by default. Ready or not.
Professor, another moratorium I would propose is on the term “bubble” for what is hopefully by now self-evident as a consequence of the free expression of human nature.
It is not too hard to de-crown the reserve status of USD. It only requires Fed to raise the rate to, say, 1-2%. Most likely, the Stock market, commodities, economy, and everything will crash and the monetary base (including credit) will shrink and we will be out of USD soon. It is a task we did not finish in 2008.
What about the US’s ability to collect a global inflationary tax because the US dollar is the global reserve currency?
A terrific book is Pakenham’s “The Scramble for Africa”. It shows the Hobson ideas in brutal and terrible reality. It also shows that under the placid and self absorbed “peace” in Europe around 1902, a terrible conflict was being fought in Africa as Empires scrambled to be built and get some colonies – any colonies – before the other guy. That friction of course developed into WW I which struck out of the blue. If one watched what was happening in Africa as per Hobson’s ideas, WW I was not a surprise and Barbara Tuchman doesnt really provide any insight. Lenin was right – WW I was inevetiable.
If the US leaves the role of providing the world’s reserve currency, that mercantalism scramble and friction will once again develop.
The cost for the USA to maintain the doillar as the reserve currency may be multitudes exceeded by the cost of a world war.
Also, as in 1902, if there is one absolute shared by all academics and pundits no matter their political orientation, it is that major war will never be experienced again. This is why Europe feels they can do without hard power and why China ejoys the odd “adventure” – war is no more. And perhaps why you feel the analysis of the dollar as a reserve currency is solely one of rational economics.
If the US surrenders the role of providing the world reserve currency – then I think it will all boil down to perception (and more importantly misperception) of the player’s hard power.
What is also irony is the chess board to play this out upon may once again be Africa.
@Dennis #4
You raise a good issue:
“However, increasing foreign investment requires earning the necessary foreign exchange to invest abroad. This requires an increase in net exports.”
I don’t understand this passage, at least in terms of colonialism. Was the British pound, in gold, not the unit of exchange in India or Australia or the other colonies? So where is the need for foreign exchange there?
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First: Colonies did not always use the colonizer’s currency. Even during the British Raj, India used the rupee; Canada had the Canadian dollar very early, as Hong Kong had the Hong Kong dollar.
Second: Even among countries or regions that use specie or the same currency, whether they belong to the same currency union or empire, the ultimate result will be approximately the same. Net assets purchases in another region or country (capital outflows) will have to be paid for by net exports.
“If the world were forced to give up the dollar, there is no doubt that there would be a cost – it would reduce global trade somewhat and it would probably spell the end of the Asian growth model”
Great point. I expect China to scream blue murder over this. I think you Americans have suffered enough, and it comes from a Singaporean.
Hopefully the Obama Administration will consider the Dollar disengagement as part of the National Export Initiative.
Interesting political point of view and that’s all I consider it to be. Anyone who seems to be so lacking in understanding of causalities is not a professor of anything IMO. ‘Americans already over-consume’. And just why would that be? The USD has been the de-facto reserve currency since post WWII. The idea that the US is a pathetic victim and its over-consumption and borrowing were forced upon it is irresponsible and weak and nothing more than whining.
The costs of maintaining the reserve currency are now high simply because the US has abused its ‘exorbitant privilege’ as DeGaulle correctly labeled it.
The fact is that the USD is losing its reserve currency status. The decisions that led to this were made under the Reagan administration in the early 1980′s. One guarantee is that there is no easy way out of it. Americans of all political inclinations need to grow up and face it like men, not babies.
LOL.
“Needless to say in the last few years these warnings have intensified to an almost feverish pitch”
Have you seen debt clock lately?
“The Japanese earthquake, then, was not a black swan.”
Tell that to the guys who decided to put a cluster of Nuclear Plants over the fault lines. While you’re at it, you might want to pass on the very same message to the heads Nuclear plants in California (the next Black Swan).
Lintner, hmmmm, this is probably a little to far over your head, but if other countries wanted to stop using the dollar as a reserve currency they would simply stop buying it, but of course they are accumulating it faster than ever. It would take too long to explain, but perhaps you can figure out for yourself why you aren’t making any sense at all.
Chris, Pettis and a number of other economists have gone over this issue carefully a number of times but it seems pretty hopeless. Guys like you can’t separate simple-minded moralizing from analysis. The theory on mercantilist behavior is at least three centuries old, and the impact of mercantilism on increasing domestic savings and reducing foreign savings has been known since at least the 19th Century (Pettis doesn’t note that Hobson himself discusses it). But I bet you are wondering what savings even has to do with trade surpluses and deficits, right? Never mind. It is always much easier to make silly statements than to figure it out. I blame Fox. Nowadays all you have to do to be an “economist” is to be ungrammatically shrill and dismiss anyone who knows more than you as an elitist.
By the way, Michael Robson, do you have a relevant point, or did I miss it? Professor Pettis, I think you are slipping a little on your screening of comments.
The dollar is a major US export commodity. In no way would it be in US’ interest to give it up, I think.
http://en.wikipedia.org/wiki/Seigniorage
I think it would be in most ways, some, as in each system, benefit, and others, would lose, alterations would occur, that would be positive and detrimental, then a homeostasis or pattern would emerge, where significant benefits would accrue form such a an alteration. The perspective that Americans have unduly benefited from the system that exists is not only shortsighted, but ultimately wrong. Such is simply coupled to the similarly wrong perspectives little discussed, as also was absolutely wrong, that the Americans couldn’t produce things anymore , when in fact the can and do, perhaps still first, or closely first or second. Just not as nearly reliant on Exports as other countries, where alterations that you respect, would likely lead to reactions, possibility frontiers of manufacturing, even cost competitiveness, from innate ability to adapt and change in ways scarcely imagined in more culturally myopic circles. What would occur t the NIIP, would portend larger alterations, least likely to benefit the most in need f development, why many need to acquiesce to needed alterations or it will occur to the detriment of those suffering from group think, coupled to a serious bout with myopia, where a plethora of development opportunities exist within the towns, cities, provinces, states, nations, regions, continents of the world. Anyway, still keep rotating on tired old memes created to influence the intelligentsia, aligned with the pseudo sciences but form critical theory and the tools of oppression built from supposed empowerment perspectives, couched within the narratives of critical theory, which is dead as 10 million year old dust, which just hasn’t been carbon dated yet.
Ken,
I see what you are getting at, if I want to use the Canadian prairie to export wheat I first have to invest in port facilities/railroads and annually I also need capital to invest into harvesting/etc.
But I have problems with that argument
(1) Some forms of colonialism do not fit this model. Belgiums exploitation of Congo, as the best example. There is initial capital investment, railroads, port facilities, ammunition for the Force Publique. But after that, Belgian arms extracted rubber without sending anything back to the colonies in return.
(2) There was tremendous mal-investment in colonies. If I remember correctly, of the German colonies, only Togoland and Samoa were profitable. Everything else sucked in vast amounts of money and generated no returns. Much like the Chinese choosing to funnel their people’s and corporation’s savings into property this is equivalent to destroying money.
(3) Even profitable colonies, except for the White Dominions, could never really absorb the level of domestic savings thrown out by industrialized states because local, colonial consumption was frequently suppressed as well. [The French were not selling Peugeots to their Vietnamese underlings, they were extracting cash crops from them after the initial investments into capital goods that facilitated this.]
No one is forcing China or other trade surplus country to accumulate USD. A reserve currency basket like SDRs would be welcome. There is no way that Zhong Nan Hai is going to give up control of the RMB and let uncontrolled private investing wealth out of the country. Too much mistrust of “the market”. Must have control.
Anyone who thinks China is a market economy has a 2 second understanding of China. They buy into China’s soapbox rantings of free trade, which, in China’s mind, only applies to international trade. Look at just about every major domestic market in China and you will find either outright price controls or signinfcant government interference that results in controlling supply and demand. There is no trust of the market mechanism. This is why the RMB won’t become a reserve currency anytime soon.
Dennis,
You are absolutely correct. — Hobson argued the same thing: Imperialism is a wasteful, money-losing proposition.
Austin’s article makes the same point about Hobson on page 81:
“Hobson thought that the Imperialist System, with its expensive wars of conquest and competition for colonies, was extremely wasteful and economically
destructive.”
(If you haven’t seen the article itself, you can click on the link above and try the “free trial” offered on the right hand side. It will let you download the pdf.)
Your analysis put a mental picture in me: an overweight landlord complains that his serfs feed him too much, make him lazy, and conclude it is therefore way more costly to be a landlord than a serf. Regardless how much truth there is in such an analysis, I am not sure how practical your conclusion that US should give up reserve currency status is. You see, your are arguing that the fat landlord should improve his health by giving away his land and power voluntarily, so that he will be forced to work just as hard as his serfs in providing for himself. How likely is that?
Dear Prof. Pettis,
This is my first time posting, although I have been a long-time reader since I first dropped by one of your lectures in Beijing.
Ending the dollar’s reserve-currency status would surely eliminate one of the main tools that export-oriented economies use to sustain global economic imbalances. However, would legislation in say, the US or UK, which targets the account deficit also serve a similar function, and if so what particular form would a mediating mechanism take – tariffs? currency intervention? QE?
Though I agree with your overriding premise, I feel it might be easier politically for deficit countries to individually attempt to tackle the imbalances, which in itself would probably trigger a new equilibrium in which surplus countries switch out of dollar reserves.
Best,
Manuel
Michael:
Where there is such talk, doesn’t it seem to be counter-poised to the actual reality. All currency is Fiat. In the pas, there were a network of mints spread globally during the time of the British Empire. In some ways isn’t the sheer acquisition of reserve currencies, if at two rapid a pace, more of a buy-in to the dollar, where rhetoric might seem opposite, the decades (several decades) long talk of the weakening dollar, which, in many ways was simply a strengthening of other currencies, at one point the dollar against the Mark, Yen, Taiwanese, Won, Singaporean, and other of the currencies that freely traded was much stronger. Although production and such were strong and strengthened, wasn’t it the strengthening of the currency that enabled the country to become an advanced country, with large investment positions around the world at present. In the modern era at least. The thing with China, is the size of the country, and how itrs potential, although seen in a north south perspective is really, a limiting function for other south south development, more than a impediment to north standards, due to a shift toward south dominance in the global economy as is the common dialogue. In all actually, while unhealthy, the added pace of reserve accumulation seems more a buy-in to the dollar than otherwise. Where I would like to see the dollar not as the reserve currency, as I believe it would be good for multiple reasons, the opposite seems to be occurring.
Jay: As to the US being bloated, well, I believe you significantly underestimate the possibility, and entirely mis-state the probability of what the future holds. The very system that the US helped create, the institutions that it supported, which have created the potential for what we have today, especially considering the vast march forward of technology, is in many ways what ails the US. A minor cold for the US, that has been a boon globally, if the more remote control inclined of us, have an innate need for everything to be perfect now, as if we are in the last 5 minutes of a Hollywood romantic comedy.
The argument that the US has mis-stepped, and is bloated, and is now contemplating, because of one writer’s perspective that it should, from a sycophantic relationship that it has with the globe is not only shortsighted but ultimately wrong. The system that has been built post WWII is very different then had existed previously. Both because of the intent and desire of players, despite some common mass delusion to the opposite, and because, even despite, some vast enhancement in the development of technology. In previous era’s where complete factories were dismantled, entire treasuries were emptied, the homes of the wealthy and poor alike were stripped of everything from paintings to chickens and cattle in the yards of peasants, the system that eventuated after WWII was different. Whether it be feeding supposed enemies (the USSR) or providing technoogy and admittance into the global economy of NME’s, (China), the US has worked a system that has sought inclusion under global rules and norms, even if some aspects are left un-ratified by their own Congress.
As we are moving into an era where issues such as Population and Demography will finally hit the pages as one of the main drivers of what will be occurring over the coming decades, assuming even lessor advancement of the human peoples as regards living status than is generally expected, the common mass delusions as to empire and over-benefiting from a system which hasn’t been able to create 100% universal prosperity among vast oceans of prosperity in a world where some still live at subsistence levels, is more a counter-reaction to our interpretations/translations/understandings/expectations/desires rather than a real and true possibility in the time frames considered, where massive global improvements have occurred. The introduction of China into the global system, begun nearly 4 decades ago (at least), is a greater challenge to the developing nations, than too the developed. Where the US has given the world (although contentions as to inventions exist, contentions as to promulgation and reduction in costs thus making increasingly available shouldn’t), anyway, everything from the radio and airplane, to the transistor, computer, cell-phone and ipad. Further, to a desire to act less on 19th century Balance of Power politics, coupled to market based beliefs of self-interest than is usually had. It seems, rightly so, that the memes that were promulgated during the cold war, have successfully mixed the focus on free market, with grander intentions in the global world, where even personifications of Hollywood, Gordon Gecko, have found resonance and antimony, in pockets and factions globally. The intentions of propagandists, and the fanciful, way in many ways have, are influencing the masses in many and profound ways.
But, Jay, back to your point, the world will see a resurgent America. The ratio between Manufacturing and Services will unlikely change, although much common mantras about the US producing nothing. Despite being until very recently being the number one manufacturer, it seems the power of mass delusion, stronger than the reality of fact. I guess a better question, than who is the largest manufacturer, is, does that fact matter or have relevance today, as it had a hundred years ago? Perhaps, less so, especially where a plethora of development opportunities exists in sovereigns globally. My typewriter mind is slamming against a digital wall. Could the US convert Knock-Down commercial retail sites into local manufacturers, as quickly as removing the interior walls, and installing the required electrical and ventilation systems. Will it, that depends on the way that which has been built moves. Either way, I have little fear for a culturally diverse nation such as the US, despite the constant and consistent interplay, and calls of demise, more often from within its own borders. As live and have lived in the places that are rising in prominence, have experience with how things work in such paces, am cognizant of the many problems besetting nations globally, and am a curious reviewer of what things are actually against how they are played in common dialogues promoted in the news media globally. Most often from within the confines of a nation where people have the ability to speak freely. So, whether the world develops, as it has, off of exporting to the US, or that lessens and replacements rise up in their stead within the borders of the nation, more importantly are the very many problems confronting a vastly overpopulated world, relative to the simple requirements of man, water, food, air and space. I should imagine the world, despite the desires of some for america to alter to this position popularly highlighted within their national media, or that position highlighted in other national medias, will want an engaged US, especially if it wants to meet the development goals that have been postulated as to the rise of the global middle class, etc.. Can the global middle class rise, yes, under the time frames postulated, most likely they will be extended or the size of the class lessened.
But, were citizens globally to be happy that their country were seemingly rising, where they themselves were not, then the world absent an engaged US might be preferable. Be sure to look more carefully at these things.
What would be the mechanism for ending the reserve currency status of the dollar?
Matthew, raising the value of the currency would have the effect of lowering consumer costs for China or any other country.
Joseph Gagnon, it seems to me that it is very difficult and probably unnecessarily provocative to tax the Treasury holdings of any single lender. I would have thought that in that case they would simply switch their holdings from direct to street names. At any rate I don’t think the problem is China. I think the problem is a monetary system that can easily be gamed by anyone.
Rick, whether or not other countries hold US dollars there is no need for the US to change its net holdings of foreign currency reserves and anyway the US, like most rich countries, holds very little in the way of reserves.
Actually Dennis the colonies did hold reserves and they also had their own currencies, which of course were linked to sterling, but the key point is the need for net capital flows to match the current account. As long as a country runs a net capital surplus, it must run a current account deficit. (After writing this I see the Ken has made the same points.)
RS, I am not sure I understand the question. One way to address any such question is to remember that if net flows to the US decline, either US investment will have declined or US savings will have increased. Net capital inflows are exactly equal to the current account surplus, which is itself exactly equal to the excess of investment over savings.
Thanks, Zardoz. I confess I don’t know a lot about real black swans, but I can tell you that metaphoric black swans are solitary birds. Great movie, by the way.
G. Stegen, you are absolutely right. The problem automatically disappears if there is some sort of mechanism that prevents trade imbalances. Remember that this is what Keynes wanted. He was worried that under the existing system, imbalances could only be resolved by contraction in the deficit countries, which implied slower global growth.
Peter, I am not sure you have a very good understanding of the way the balance of payments works. The only country that has tried to end the accumulation of US dollars as reserves is the US by repeated demands that countries stop intervening by buying USG bonds. The countries intervening are the ones who refuse to let it end. As for the euro, I wish you were right but not only do you wholly ignore European political reactions to foreign accumulation of euros, but by the time the current mess is finally resolved, the European economy will probably be much smaller than the US and China. European demographics alone suggest this outcome, and I don’t even mention the much slower productivity growth.
Mobi, to “dethrone” the US dollar we need not only for perceptions of the dollar to weaken, we also need countries to give up export-led growth strategies, and I am not sure that is going to happen very soon.
Ignacio, of course to the extent that foreigners are net holders of US bonds there is an inflationary tax, but I am not sure the implicit ‘revenues” are high enough to warrant unleashing domestic inflation. Americans, not foreigners, hold most US debt.
Chris, it turns out that notwithstanding your opposition, I actually am a professor of something. But whether or not my argument is correct, you don’t seem to have any understanding at all of how reserves and balance of payments works. It is strange that this is one of those topics on which everyone feels they can have a strong opinion without knowing even the basic arithmetic. I don’t have a problem with that, but it is strange to me that someone would be so willfully rude on a subject that he must realize he knows nothing about. To put it another way, I might be foolish enough to disagree with Brian Greene on the subject of string theory, but I wouldn’t call him an idiot on the subject – at least not until I knew an awful lot more about string theory than I do now. I am no Brian Greene, as you helpfully point out, but you must have some idea that you don’t know anywhere close to enough about the subject to dispute anything anyone would say.
Stefan, every estimate of US seigniorage that I have seen suggests that the numbers are tiny. I am not sure that it is meaningful to say that the dollar is an “export commodity” except in the sense that the US runs a capital account surplus. In which case this is exactly my point. The capital account surplus requires a current account deficit.
Jay Chiang, I don’t think I am arguing that at all, and I am not sure your colorful metaphor indicates that you have thought much about this. It seems more like the kind of analysis one gets from those guys on Fox News who indicate their seriousness by yelling at each other. These kinds of ‘debates’ are helped enormously by colorful and simple metaphors, but of course they are almost wholly useless in explaining anything. I think I am starting to repeat myself in these comments, aren’t I?
Manuel, yes, addressing the imbalances directly would also work. The problem is that so far we are only discussing voluntary limits, but unless a formal mechanism is put into place, it doesn’t really resolve the underlying problem, and within twenty years we’ll be having the same debate again.
CSteven, normally rapidly growing countries are associated with rising currencies, but we have to be careful about the direction of causality. If a country is growing quickly because worker productivity is growing quickly, its currency should appreciate just to prevent real depreciation from taking place. In many cases, however, the countries whose currencies should have appreciated because of rising worker productivity did not experience nominal appreciation for very long periods because of currency intervention. That seems to be what is happening now.
Mike,
That is exactly my point. It won’t happen until we’re forced to. However, the way I see it happening is not through currency debasement. It will happen more likely through a combination of US credit contraction and tariff that we lose the ability to export USD so the world has to give up USD.
Another great post, but instead of thinking of the dollar’s reserve status as a public good, I prefer to think of “deep, open capital markets” as the public good, and the reserve status of the dollar is a by-product of this openness as well as the trade-openness of the U.S.
The U.S. isn’t going to be able to disengage the rest of world away from the dollar as long as it maintains open capital markets and relatively free trade. NB “relatively” free, trade with the U.S. only needs to be more free than trade with the rest of the world. That is also something that the U.S. does not unilaterally control.
The rest of the world, if they change their development strategy, might choose to disengage on their own, but I don’t see how the U.S. can force anything to occur without first sacrificing the sacred cows of open capital markets and free trade.
Michael:
I’m amazed that some of the people who have commented here are doing the very “Fox” thing they complain about, and seem like they’re yelling at you instead of actually commenting. Odd.
Anyway, it seems like there’s a perception out there that the greenback is the world’s reserve currency because we somehow forced it down people’s throats.
On the contrary. I don’t think anyone wanted it, or fiat money, but I don’t have any way of knowing that, nor does anyone else. We can only guess as to motivations.
But, the fact is, it is the world’s reserve, and it became so by default, really. We were the only one left standing after the World War II. We didn’t really have anything to rebuild, and everyone else did. We increased foreign investment, increased net exports, reduced the excess supply of goods (and used up excess manufacturing capability) and drained our pool of excess savings…. and we did it for like, 50 years. I guess Hobson would say that’s why people now call us Imperialists. We tapped the root of it.
Took a while, but now we see the results.
After the war, we rebuilt Japan. When their economy started humming along like ours, they repeated what we did, in a fashion. Increased investments and exports, drained savings… now they’re kind of stagnant, like us.
At present, all the money is stuffed in the mattresses of the People’s Republic of China. And now they seem to have earned the necessary foreign exchange to invest abroad and increased net exports, reduced excess goods, and they’re draining their savings and have growing debt. Why would they fare any differently than any other country who has done this? One reason might be that theirs is not a free market. Another might be that economies are not subject to theories presented by economists – its the other way around. But they probably will have the same thing happen to them. We just won’t know because they won’t tell anyone.
Michael, this is a dumb question that you’ve perhaps covered elsewhere, but I thought I’d ask anyway, in hopes of getting an answer. What happens if China starts recycling its dollar surpluses into the world economy instead of continuing to pile them up? Would that affect the yuan dollar exchange rate?
A response to Kenneth Rogoff’s article in FT today.
Kenneth Rogoff is like many other Anglo-Saxons (“The Global fallout of a eurozone collapse”) predetermined to “talk” Euro out of becoming a reserve currency. The language used is “..Euro experiment..”, “…If the euro survives…”, “…Euro torn by centrifugal force…” and many more negatively marked expressions.
The US is scared to death of losing its reserve status and the UK equally so in losing its “special realtionship” with the US, both happening right now. Mr Rogoff is in fact stating in the article what the Euro currency is triggering as we speak, “…a strong trend towards consolidation elsewhere…” with blocs like Canada, US and Mexico on the one hand and Japan, China on the other.
The Euro experiment is no more experiment than the Dollar experiment, which took a 100 years to establish. And Greece is as linked to the Euro as California is to the Dollar.
The Euro is not a Texas redback.
That said, several currencies are currently in formation of reserve status
Magnus,
You obviously either did not read or did not understand the post or Mr. Pettis’ FT article.
It said that being the reserve currency is not necessarily a good thing:
“Ironically, this is exactly what Washington should be doing. Conspiracy theory notwithstanding, claims that the reserve status of the dollar unfairly benefits the US are no longer true if they ever were. On the contrary, the global use of the dollar has become bad for the US economy, and because of the global imbalances it permits, bad for the world.”
You also did not read JC Trichet’s Le Monde interview where he said:
“L’euro n’a pas été créé pour lutter contre le dollar des Etats-Unis ou pour se substituer au dollar comme monnaie de réserve internationale. Il a été créé pour parachever le grand marché européen, et donner à l’Europe stabilité et
prospérité.”
(Quick translation — That’s a problem (reserve currency status) we don’t want either. America can keep it.)
So if Europe wants it, it would be a blessing to the U.S. Take it Magnus! Take it Europe!
Ken,
I think I understand Mr Pettis’ article and Mr Trichet’s I have not read. In fact I agree with Mr Pettit but maybe I didn’t express myself clear enough.
My comment is rather at Rogoff’s article and many other Anglo-saxons that I interpret have a very US centric view of the world. I believe that view largely stems from the relative strength of the USD (read reserve status) in the past and a strong defense. Don’t get me wrong. This is not bad or something I disagree with but right now that structure is being challenged by several other big regions in the world. This new development is a bitter pill to swallow for some but as Mr Pettit states maybe benefit the US economically but erodes its influence.
To translate: “The Dollar is our currency but your problem” doctrine is approaching a cross-road.
Magnus,
I am quite befuddled by your comments. I suppose that you lost me with the Anglo-Saxon stuff (makes you sound French — but I don’t think you are — Magnus is a nice Swedish name?) The French envy the dollar’s position as a prestige issue. What you see in Rogoff is not there. The prestige issue is not the subject of the article.
The more apt criticism of Rogoff’s article is that the academic discussion of the reserve currency issue never really asks why the world needs a reserve currency at all or why there are any significant benefits to being the issuer of the reserve currency. Why should the U.S. supply a reserve currency just so countries like China can manipulate their exchange rate and sustain dangerous global imbalances? Unless you ask that question first, Rogoff’s article is a bit silly.