James Pethokoukis

Politics and policy from inside Washington

More on the erosion of dollar dominance

October 7, 2009

Justin Fox of Time echoes my thoughts on the dollar, that its currency dominance has enabled massive deficit spending by the United States:

The U.S. economy’s share of global economic output has been declining and will almost certainly continue to decline as formerly poor countries get richer. With that, the dollar’s role will need to change.

Such a change wouldn’t be unmitigated bad news for Americans. As I’ve written before, having the dollar as the world’s currency has been a mixed blessing. The dollar’s global role inflates its value, for example, which makes imports cheaper for consumers here but also makes U.S products less competitive globally. Dollar supremacy also allows the U.S. government (and until recently the private sector) to get away with wildly unbalanced budgets without paying an immediate penalty in higher interest rates, which can be nice for a while but tends to end in trouble. The global capital-flow imbalances that many economists now say were at the root of the financial crisis are in significant part a product of the dollar’s outsized role.

All of this means that it may well be in the long-run best interest of the U.S. to push for an orderly transition away from the current dollar-based global monetary system and toward one built around currency baskets, the International Monetary Fund’s special drawing rights, the bancor, gold or whatever other measure of value we can all agree on. In other words, it’s not the worst news in the world that the Persian Gulf countries are talking about moving away from the dollar. Even if they say they aren’t.

Me: Again, keep inflation low, productivity high and deficits narrow — and let the dollar worry about itself. How am I wrong on this? And Simon Johnson explains why the White House likes the current dollar decline — as long as inflation stays low:

This may, of course, turn out to be a miscalculation, but think what a weaker dollar does for the industrial heartland, where so many congressional seats will be in play and where today it’s easier to export or compete against imports because the same dollar costs convert into fewer euros, yen, or renminbi (this is what a “weaker” dollar means—foreigners can more easily afford our goods and their stuff is more expensive to us). If the dollar stays weak or declines further, our car companies, machinery makers, and turbine blade manufacturers will soon be rehiring and we’ll finally get some job growth as part of our sputtering economic recovery.

Comments

Sure, we’ve mis-used the opportunity of the dollar being a reserve currency. Instead of investing in our future and saving as a country, we spent, spent, spent.

Trying to find a silver lining to a long-term decline in the Dollar is a bit premature though. Our economy – heavy reliance on imported goods, weak manufacturing base, high reliance on foreign oil, and huge budget deficits to fund – would leave us overly-exposed to a rapid Dollar decline. You want to experience $150 oil again? How about hyper-inflation in all the wrong places – food, industrial imputs like copper, and stagnation in wages for the vast majority of the economy. Oh, and a spike in interest rates to 6, 7, 8+ – what does that do to our interest burdens as families and governments (state and local). It could all create an accelerating feedback loop to the downside.

We should be preparing for the inevitable shift away from the Dollar as a reserve – but we’re not…

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