Fred Bergsten has a lengthy piece titled “The Dollar and the Deficits” in Foreign Affairs.
In brief: “The global economic crisis has revealed the folly of large U.S. budget and trade deficits, as well as the strong dollar that makes them possible. If it is serious about recovery, the United States must balance the budget, stimulate private saving, and embrace a declining dollar.”
He says that global imbalances facilitated the crisis: “These huge inflows of foreign capital, however, turned out to be an important cause of the current economic crisis, because they contributed to the low interest rates, excessive liquidity, and loose monetary policies that — in combination with lax financial supervision — brought on the overleveraging and underpricing of risk that produced the meltdown.”
He advocates reserve currency diversification: “For the United States to avoid the resulting trade imbalances and debt buildup, some of this incremental demand should be channeled into euros, renminbi, and SDRs. Both international monetary reform and a lesser role for the dollar are very much in the interest of the United States.”
Read the full article for much more.
An apt summary from Free Exchange:
The usual dynamics of any public discussion on a falling dollar are pretty well established. Lots of market watchers and pundits wring their hands over a poorly defined set of concerns, ranging from hyperinflation to wounded American pride. A number of economists respond that actually, the dollar is looking overvalued against a number of currencies at the moment, and an orderly depreciation of the dollar would go a long way toward improving America’s internal and external economic balances. And then some public official acknowledges that the economists are making sense, only to be chastised into a retraction of the statement by the market watchers and pundits. End scene.
And Martin Wolf points out that the crisis has made a subsequent fall almost inevitable:
We should start with what is not happening. In the recent panic, the children ran to their mother even though her mistakes did so much to cause the crisis. The dollar’s value rose. As confidence has returned, this has reversed. The dollar jumped 20 per cent between July 2008 and March of this year. Since then it has lost much of its gains. Thus, the dollar’s fall is a symptom of success, not of failure.
The desirability of such a decline is debated (follow the links), but the Free Exchange post accurately describes the conventional wisdom amongst economists.
In the latest Foreign Affairs, Barry Eichengreen says that the US dollar will stay the world’s top currency.
Swaminathan Aiyar and Arvind Subramanian wonder why China is pushing for SDRs to replace the dollar when it could wait a few decades and move to make the renminbi the world’s reserve currency.
Congresswoman Michelle Bachmann is clueless about the dollar’s role as the world’s reserve currency. In fact, it seems she’s clueless about what a reserve currency is. That’s why, in reaction to China’s SDR proposal, she’s introducing legislation to “bar the dollar from being replaced by any foreign currency.” And apparently a lot of people are similarly confused and need a quick explanation of the difference between legal tender and currency reserves.
If Rep. Bachmann’s office needs some assistance with international economics, I’d be happy to provide some advice over the phone at a reasonable price.
FT:
China’s central bank on Monday proposed replacing the US dollar as the international reserve currency with a new global system controlled by the International Monetary Fund.
In an essay posted on the People’s Bank of China’s website, Zhou Xiaochuan, the central bank’s governor, said the goal would be to create a reserve currency “that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies”.
Analysts said the proposal was an indication of Beijing’s fears that actions being taken to save the domestic US economy would have a negative impact on China.
WSJ:
For decades, the dollar has been a convenient medium of exchange for everyone from a central bank seeking to buy U.S. Treasury bonds to a business exporting commodities from Latin America to Asia.
To jump-start a new global reserve currency, economists say, would require someone effectively subsidizing the cost of bringing buyers and sellers together for the time it takes the currency to gain traction.
Large, deep, and highly traded markets involving a particular currency “don’t spring up spontaneously just because the Chinese central bank governor suggests this would be a good idea,” says Barry Eichengreen, an economist at the University of California at Berkeley…
In his essay, China’s Mr. Zhou proposed expanding the role of “Special Drawing Rights,” or SDRs… The SDR is “basically the Esperanto, at best, of international currencies,” says Jeffrey Frankel, an economist at Harvard University, referring to the ill-fated attempt to create a common language. “It’s not at all used.”
Everyone is investing in the dollar because they believe it will hold its value. As investors flee to the dollar, the US can print more greenbacks and maintain its value precisely because of this belief. Effectively, it is paying off previous investors (who see their trust in the currency’s stability confirmed) through the willingness of new investors to buy in. This is eerily reminiscent of what Mr. Charles Ponzi did in 1903, and ever since he first tried it, it has never turned out well.
Many on the left are boasting that the U.S. government could borrow lots more (look at the current T-Bill rate), forgetting they used to warn us that international capital flows, as amplified through noise traders and speculators, mean that crises can arrive in a single, whiplash moment, bringing countries from riches to rags virtually overnight. Somehow those old narratives are being forgotten, I wonder why.
Willem Buiter has a longer explanation.
Dani Rodrik: “Global financial regulation is a bad idea because it is neither desirable, nor prudent, nor feasible.”
