An unhealthy privilege
When the U.S. dollar ultimately loses its status as the world’s premier reserve currency it will be painful for all involved, almost certainly disorganized, and very possibly a very good thing.
World Bank President Robert Zoellick outlined the risks to the dollar’s status in a speech in Washington on Monday.
“The United States would be mistaken to take for granted the dollar’s place as the world’s predominant reserve currency. Looking forward, there will increasingly be other options to the dollar,” he said.
Zoellick went on to emphasize how choices in the United States on inflation, fiscal policy and financial system reform would help to influence the dollar’s fate.
Quite true. The U.S. cannot simply devalue its way to competitiveness, nor can it appear to be inflating away its debts without risking a run on the currency. The Chinese and others would sell dollars or fail to buy up new debt if they felt the U.S. was behaving both cynically and irresponsibly.
China has good reasons not to force a crisis and devalue its holdings of dollars, but not immutable ones. The two nations are like two men trying to swim to shore while dragging a heavy box of gold, the difference being that the U.S. is tethered to the box while China is only holding on. If China decides the water is too rough it can let go, sacrifice its dollar holdings and swim for it. The United States is not so lucky.
“Exorbitant privilege” is a term coined by an understandably embittered French Finance Minister Valery Giscard d’Estaing to describe the fact that under the old Bretton Woods currency system the United States, unlike everyone else, could simply print dollars to cover current account deficits.
Bretton Woods is gone, but the arrangements which replaced it also tended to underwrite U.S. overconsumption, as purchases of U.S. dollars as reserves by other nations kept funding rates lower despite household or government profligacy.
“The United States is incredibly fortunate that the dollar enjoys this special status,” Zoellick said. “When I work with countries struggling to pay for budgets or finance trade deficits, I reflect on how Americans do not spend a moment considering the unique advantages of being able to issue bonds and print money freely.”
My best guess is that Americans will spend quite a few moments in coming years considering that unique advantage, and that while they will miss it, they should also be sorry they ever enjoyed the right to borrow freely and seemingly without consequence.
THERE’S NO “G20″ IN “TEAM”
Of course the U.S. current account deficit has contracted massively, standing at about 3 percent of gross domestic product in the first quarter as compared to 6.5 percent of GDP in 2006. That’s the result of plunging global trade and steep falls in investment in the United States. And while the personal savings rate has jumped in the United States, which after all it had to since credit was no longer easy, the government has stepped up massively as a borrower, overwhelming households’ efforts to save.
Barclays Capital calculates that the United States now needs to attract 46 percent of the world’s net savings, i.e. the sum of all current account surpluses, as opposed to 54 percent before the crisis broke.
That 46 percent figure is an improvement, but it too is ultimately unsustainable. It’s also arguably starving lots of other places of investment that could ultimately produce higher returns.
The newly empowered G20 group of nations has meanwhile resolved to rebalance the global economy, using peer pressure to force the irresponsible to shape up and the overly tight to start spending at home.
The world’s central bankers and politicians just received an object lesson in what a good idea it is to have a bunch of reserves piled up against a bad day. Even putting China aside, responsible leaders in places like India will have a very tough time trusting in an international body to protect their own best interests. And because that body doesn’t have any real power to compel, it will be ignored. That means that there is a good risk, G20 or not, that everyone is trying to simultaneously keep their currencies low and exports high.
The only body seemingly exempt from market discipline, the United States, is not going to be in a position to resume eating up everybody’s exports. This is a recipe for very slow growth and for rising international economic tension. That doesn’t make the changes proposed at the G20 a bad idea, but they are not sufficient and threaten to be a resolve-softening time waster.
So not so much as rebalancing but a re-basing of growth expectations. Look for continuing dollar weakness alongside that, with the real drama being not the decline but the rate of decline.
–At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.–