It’s about Wall Street over Main Street

The Carnegie Endowment for International Peace has an interesting analysis of how the US dollar's status as a reserve currency has inflicted enormous costs on ordinary American people.

Because the US Dollar is the world's reserve currency, the currency is overvalued, because people want to hold it as a safe haven, and because it is overvalued, imports are cheaper and exports are more expensive, resulting in the movement of manufacturing off shore.

But Wall Street makes out like a raped ape, because they get to manage the money from people who want a safe haven.

Rinse, lather, repeat:

This may be excessively optimistic on my part, but there seems to be a slow change in the way the world thinks about reserve currencies. For a long time it was widely accepted that reserve currency status granted the provider of the currency substantial economic benefits. For much of my career I pretty much accepted the consensus, but as I started to think more seriously about the components of the balance of payments, I realized that when Keynes at Bretton Woods argued for a hybrid currency (which he called “bancor”) to serve as the global reserve currency, and not the US dollar, he wasn’t only expressing his dismay about the transfer of international status from Britain to the US. Keynes recognized that once the reserve currency was no longer constrained by gold convertibility, the world needed an alternative way to prevent destabilizing imbalances from developing.

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Until then, like most people, and because of its role in Latin America, I had pretty much taken the role of the dollar as a given, and assumed vaguely that its dominance gave the US some ill-defined but important advantage – after all they did call it the “exorbitant privilege”. But after a few years in China (I moved to Beijing in 2002) I became increasingly suspicious of the value of this exorbitant privilege.

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The creation of the euro provided another illuminating variation on the impact of reserve currency status. When German institutions – government, businesses and labor unions – negotiated among themselves at the turn of the century a sharp reduction in wage growth for its workers, they were obviously attempting to reduce German’s high domestic unemployment by gaining trade competitiveness. Because these polices forced up the savings rate, and perhaps also explain why the investment rate dropped, they resulted in huge current account surplus (or which is the same thing, excesses of savings over investment) that were counterbalanced within Europe. These policies “worked”, and they worked probably far better than anyone expected. The sick man of Europe, with its high unemployment and large current account deficits, turned the corner almost immediately.

It turns out that it wasn’t just good luck or brilliant economic policy-making that accounted for the speed of the turnaround. Without anyone’s realizing it, the simultaneous imposition of a single currency on a group of countries that clearly did not belong in a currency union had reduced or even eliminated the monetary adjustment mechanisms in those countries, mechanisms that would have automatically counterbalanced the resulting increase in German capital exports. Instead of multiple currencies slowing the impact of German wage policies, the creation of the euro gave these policies far more traction than they would have otherwise had.

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The one thing both sides agreed on, however, was that the US enjoyed an advantage because of the reserve currency status of the US dollar, with some people even assuming that the US was somehow repressing the ability of Europe, China and Japan to gain the advantage for themselves. No matter how many times the US engaged in policies that tried to shift the benefits to those countries, or these countries engaged in policies that prevented them from receiving the benefits, it was somehow clear to both sides that reserve currency status is a wonderful thing that everyone wants but only the US is allowed to have.

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Conditions have changed however, and the potentially destabilizing effect is no longer so distant. In a recent essay I tried to show that if we have not already reached the point at which the dominant reserve currency status of the US dollar is harmful to the US and potentially destabilizing to the world, logically we will inevitably reach that point, and probably soon.

At the start of this essay I said that I am optimistic that we are seeing a change in the way the world thinks about the role of the US dollar, and I think this is because the 2007-08 crisis in Europe and the US, the start of Abenomics, and the extremely difficult adjustment that China faces have all focused attention on the nature and structure of savings imbalances and their effect on the global balance of payments. It is becoming increasingly obvious, I think, that Keynes was right. Several years ago, I received an email from Kenneth Austin, a Treasury Department economist who had read one of my articles. He himself was working on the same set of ideas and over the years we have had a running conversation about this topic.

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While recognition of the exorbitant burden had been growing in recent years, Austin’s article focused a lot of new attention on this topic, and it seems that finally Keynes’s insight is attracting the kind of acceptance that might eventually modify future policy. In August in a much-commented-upon article in the New York Times, Jared Bernstein explained one of the corollaries of Austin’s model, pointing out that

Americans alone do not determine their rates of savings and consumption. Think of an open, global economy as having one huge, aggregated amount of income that must all be consumed, saved or invested. That means individual countries must adjust to one another. If trade-surplus countries suppress their own consumption and use their excess savings to accumulate dollars, trade-deficit countries must absorb those excess savings to finance their excess consumption or investment.

Note that as long as the dollar is the reserve currency, America’s trade deficit can worsen even when we’re not directly in on the trade. Suppose South Korea runs a surplus with Brazil. By storing its surplus export revenues in Treasury bonds, South Korea nudges up the relative value of the dollar against our competitors’ currencies, and our trade deficit increases, even though the original transaction had nothing to do with the United States.

This is a key and much misunderstood point. The inexorable balance of payments accounting mechanisms make Bernstein’s claim – that “Americans alone do not determine their rates of savings“ – both necessarily true and joltingly shocking to most economists. How many times, for example, have you heard economists insist that the US trade deficit was “caused” by the fact that Americans refuse to save, or, even more foolishly, that “no one held a gun to the American consumer’s head and forced him to buy that flat-screen TV”?

The fact is that if foreign central banks buy trillions of dollars of US government bonds, except in the very unlikely case that there just happen to be trillions of dollars of productive American investments whose backers were unable to proceed only because American financial markets were unable to provide capital at reasonable prices, then either the US savings rates had to drop because a speculative investment boom unleashed a debt-funded consumption boom (i.e. household consumption rose faster than household income) or the US savings rate had to drop because of a rise in American unemployment. There is no other plausible outcome possible. Americans cannot wholly, and sometimes even partly, determine the American savings rate.

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We need to keep this argument in mind. As US policymakers take steps to extend free trade through various bilateral and multi-lateral agreements, it is important both that the exorbitant burden is addressed before it becomes much more destabilizing but it is also important that the exorbitant burden not become an argument against free trade. To argue in favor of constraining unlimited purchases of US or other government bonds is not the same as arguing that the US or other countries should not engage in international trade, as many commentators have bizarrely claimed.

Let me note that this is a very long, and extremely self referential, read, and it is rather tentative in its assertions, but considering that it has found its way into a mainstream publication from the Carnegie Endowment is significant.

Personally, I would just mint the damn platinum coin, about 100 Trillion worth, which would mean that the US government would not have to borrow money, or refinancing bonds that reach maturity for about the next 20 years.

It would make the US status as a reserve currency impossible, and the dollar would fall, and trade rebalance in a way that benefits the American people.

The fact that this would have a few thousand brokers and hedge fundies jumping out of windows is just icing on that cake.