Michael Pettis: Dollar as Reserve Currency is Huge U.S. Burden

September 9th, 2011
in econ_news

dollar world EconintersectGlobal Economic Intersection contributing author Michael Pettis has an article published September 7 in Foreign Policy which says the U.S. would benefit greatly if the dollar were no longer used as the world reserve currency.  Pettis presents an argument which includes the idea that the current credit bust crisis in the U.S. could have been avoided, or at least have been less severe, if the dollar were not the reserve currency.

Follow up:

From the article:

According to most political commentators, there are two main 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 U.S. dollars. Second, because foreign governments must buy U.S. government bonds to hold as reserves, this additional source of demand for Treasury bonds lowers U.S. interest rates.

Both claims are muddled. Take the first. It may be correct to say that the role of the dollar allows Americans to consume beyond their means, but it is just as correct, and probably more so, to say that foreign accumulations of dollars force Americans to consume beyond their means.

Pettis demonstrates that the current account imbalances that resulted from global reactions to the reserve currency status of the dollar have created artificially high savings rates in current account surplus countries.  This forces dis-savings (deficits) in the countries with negative current account balances.  In the current state of affairs, the biggest players on the two ends of the spectrum are the U.S. and China.  The status of the dollar as the world’s reserve currency has locked the two nations into extreme current account positions.  Pettis says the monetary imbalances are only resolved if Americans consume beyond their means.

And what we have seen in the last decade is the resolution of what monetary policies have preordained.

Pettis says that Americans mistakenly view the status of the dollar as a privilege.  Instead he concludes that it is, in fact, a burden that drives public (federal) debt higher and reduces the potential output of the U.S. economy.  Pettis writes:

The fact that the world has a widely available and very liquid reserve and trade currency is a common good, but like all common goods, it can be gamed. When countries use the dollar's reserve status to gain trade advantage, the United States suffers economically -- without the benefit of exorbitant privilege. What's worse, the greater the subsequent trade imbalances, the more fragile the global financial system will be and the likelier a financial collapse.

The rest of the world, according to Pettis, is perfectly willing to enjoy the extraordinary benefit they derive from having the dollar as the world’s reserve currency and are also perfectly willing to let the U.S. foot the entire bill and even to risk a complete financial collapse.

Source: Foreign Policy

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1 comment

  1. Derryl Hermanutz, Correspondent (Member) Email says :

    The following is an excerpt from Friedrich List's 1841, "The National System of Political Economy". List criticizes the "popular school" of economics that was (and is) based on Adam Smith's twin pillars of division of labor and free trade. List argues convincingly that it is not the mere possession or acquisition of wealth that makes a man or a nation rich, but the development of the man's or nation's "productive powers". Reserve currency status allows the US to import beyond its means, while competing nations develop their powers of production and sell their surplus to the US. Powers of production are a "social" phenomenon that depend as much on the nation's cultural, religious, educational, legal and governmental systems as on the purely "material" means of production and exchange. List's thinking could be a valuable counterfoil to the current "popular economics", which is individualistic market fundamentalism. Our popular economics is myopic and serves only the interests of merchants and traders while hollowing out the foundation of our wealth, our powers of production. Here's the excerpt:
    Into what mistakes the prevailing economical school has fallen by judging conditions according to the mere theory of values which ought properly to be judged according to the theory of powers of production, may be seen very clearly by the judgment which J. B. Say passes upon the bounties which foreign countries sometimes offer in order to facilitate exportation; he maintains that 'these are presents made to our nation.' Now if we suppose that France considers a protective duty of twenty-five per cent. sufficient for her not yet perfectly developed manufactures, while England were to grant a bounty on exportation of thirty per cent., what would be the consequence of the 'present' which in this manner the English would make to the French? The French consumers would obtain for a few years the manufactured articles which they needed much cheaper than hitherto, but the French manufactories would be ruined, and millions of men be reduced to beggary or obliged to emigrate, or to devote themselves to agriculture for employment. Under the most favourable circumstances, the present consumers and customers of the French agriculturists would be converted into competitors with the latter, agricultural production would be increased, and the consumption lowered. The necessary consequence would be diminution in value of the products, decline in the value of property, national poverty and national weakness in France. The English 'present' in mere value would be dearly paid for in loss of power; it would seem like the present which the Sultan is wont to make to his pashas by sending them valuable silken cords.

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