Daily Times

Since the 1960s, few arguments in international finance have been as exciting as “the coming demise of the dollar,” but these arguments seem always to founder on the same set of mistakes. The key to global currency “domination” is not how excited the political elite say they are about having their currency dominate. It is about how willing they are to allow clear and transparent foreign ownership of domestic assets and, even more importantly, how willing and able they are to give up control of their capital and trade accounts. Most people argue that the US is about to lose its “exorbitant privilege” to countries like China. They are wrong on two counts. First, the US economy does not benefit from the dollar’s global role except for two main economic privileges. The privileges accruing to the United States as a function of the dollar’s reserve status. First, it allows the United States to consume and borrow beyond its means as foreigners acquire US dollars. Second, because foreign governments must buy US government bonds to hold as reserves, this additional source of demand for Treasury bonds lowers US interest rates. By and large, Wall Street, Owners of Movable capital and the Foreign Affairs establishment benefit on the account of weaponizing dollars to sanction its political foes through SWIFT. But so-called exorbitant privilege comes at an exorbitant burden for American farmers, workers and producers. The dollar’s global role is simply the role of the absorber of last resort of excess savings, mainly through soaring debt.

Most commentators opine countries like China, Russia and Saudi Arabia want to lead the way to a world less dependent on the dollar. In fact, those countries really want a world in which they can maintain very high trade surpluses that boost domestic growth and especially benefit the exporting elites within their domestic economies. That means that what they require above all is someone to run the correspondent deficits. How so? When foreign central banks intervene in their currencies – and otherwise repress their domestic financial systems – they automatically increase their savings rate by forcing down household consumption. As their savings rise, the excess must be exported, often in the form of central bank purchases of US government bonds. (Counterpart of Current Account Deficit) If there is no change in the total amount of global investment, and since savings must always equal investment, by exporting their savings to the rest of the world, the savings rate of the rest of the world (i.e. their trading partners, which is the US) must decline, whether or not they like it. The only way their trading partners can prevent this is by themselves intervening. If foreign governments intervene in their currencies and accumulate US dollars, they push down the value of their currency and run current-account surpluses exactly equal to their net purchases. Purchasing excess amounts of dollars is a policy aimed at generating trade surpluses and higher domestic employment. The reverse is true as well: Because its trade partners are accumulating dollars, the United States must run the corresponding current-account deficit, which means that total demand must exceed total production. In this case, Americans are consuming beyond their means.

The dollar’s global role is simply the role of the absorber of last resort of excess savings, mainly through soaring debt.

When foreigners actively buy dollar assets they force down the value of their currency against the dollar. US manufacturers are thus penalized by the overvalued dollar and so must reduce production and lay off American workers. The only way to prevent unemployment from rising then is for the United States to increase domestic demand – and with it domestic employment – by running up public or private debt. But, of course, an increase in debt is the same as a reduction in savings. If a rise in foreign savings is passed on to the United States by foreign accumulation of dollar assets, in other words, US savings must decline. There is no other possibility. So where is the privilege in all this? Ask any economist to describe the greatest weaknesses in the US economy, and almost certainly the list will include the excessive trade deficit, the low level of savings, and high levels of private and public debt. But it is the foreign accumulation of US dollar assets that, at best, permits these three conditions (which, by the way, really are manifestations of the same condition) and, at worst, causes them to deteriorate.

Oddly enough, it seems the whole world realizes this state of play – except for media frenzy and hype. Recently, certain Latin American and Asian central banks began diversifying out of the US dollar and increasing their purchases of Japanese government bonds and other countries’ debt. But did Japan think itself lucky that it was finally going to be able to share in the exorbitant privilege dominated by the United States? That foreign purchases of bonds would force up the yen, force down the Japanese trade surplus, and allow Japanese consumption to rise relative to production? Japanese authorities failed to see this as a positive. They began intervening heavily, buying US dollar assets as a way of pushing down the value of the yen – which effectively converted foreign purchases of yen into foreign purchases of dollars. They refused to accept any part of the privilege and insisted on handing it back to the United States. Consuming beyond your means, in other words, is considered a curse for other countries even as they insist that it is a privilege for the United States.

In the case of China, its capital flows are tightly regulated and the financial system is underdeveloped as compared to the US economy and financial system, which are large enough, open enough, and flexible enough to accommodate large trade deficits. But that badge of honour comes at a real cost to the long-term growth of the domestic economy and its ability to manage debt levels.

The writer is a freelancer