The United States’ dubious privilege of being a key currency country
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The world economy needs a world currency.
That crucially important vector of global commerce and finance has been provided by the U.S. since the end of WWII. And that also made it necessary for America to act as a benevolent banker to the world.
Partly as a result of that, the U.S. continues to make half-a-trillion dollar net annual contributions to the growth of global demand, output and employment through its trade deficits. The big beneficiaries of that dollar-based international monetary system are the European monetary union (a.k.a. the euro area) and Japan; they are now taking more than $600 billion of net annual trade income from the rest of the world.
In spite of that, the Europeans keep talking about America’s “exorbitant privilege,” a deadly serious joke attributed in the 1960s to the French finance minister (and later president) Valery Giscard d’Estaing. The “privilege” in question consisted of America being able to pay its bills in its own currency.
The Europeans apparently have nothing to say about the other side of the coin: The U.S. net foreign debt of $10.6 trillion which has provided an instrument of growth to the world economy.
Reading the comments of the Federal Reserve last week, they will probably say that the U.S. does not care about its debt because, being a key currency country, it can continue on its merry way of “deficits without tears.”
It’s unfortunate that the Fed used the key currency argument to imply that it was helping to avoid problems of a growing debt burden – a music to politicians’ ears, many of whom believe that “deficits don’t count.”
Indeed, using the same logic, the politicians might now ask why the U.S. is raising hell with China and the European Union about its trade deficits since they seem happy to accept America’s IOUs in exchange for providing real goods and services. As of last August, $6.9 trillion of U.S. Treasury’s bills, bonds and notes were held overseas, and nearly two-thirds of that amount was part of foreign currency reserves.
America’s creditors need no reminders that deficits do count, and they are increasingly testing options by diversifying out of their dollar holdings. Over the two years to the second quarter, the share of world dollar reserves fell by more than 3 percentage points to 61.6%, marking a systematic decline from 70% at the beginning of the century.
To be sure, the dollar will not be rapidly dethroned as the world’s key currency, because no other legal tender offers the same advantages as a universally accepted unit of account, means of payment and store of value.
But being a national currency serving as the world’s ultimate reserve asset, the dollar should not be used as a vehicle for America’s runaway debts and deficits, or a sanctions instrument in economic warfare. The first will erode its store of value function. The second will hasten the search for alternative settlement systems and promote the use of local currencies.
Both issues transcend the narrow considerations of economic analysis by their importance for America’s national security and the Western world order.
The U.S. net international investment position shows that only during the first half of this year America’s foreign liabilities increased by an alarming $1 trillion.
Those are our creditors’ assets. What if some of those creditors also happen to be strategic competitors that Washington wants to contain and isolate?
Absurd, isn’t it? The U.S. is enabling its strategic competitors with trillions of dollar assets (and the associated technology transfers) to take its markets and weaken its long-standing alliances.
Weaponizing the dollar and the dollar-based international monetary system is another effort to undo the damage of America’s “exorbitant privilege,” compounded by Washington’s related policy blunders that ignored decades of increasing trade deficits. That, however, is fracturing America’s alliances, and the trans-Atlantic community in particular.
The best that can be done now would be 1) for the Fed to run a stable dollar with firmly anchored inflation expectations, 2) for the administration to prod trade surplus countries to stimulate their economies, and 3) to narrow the U.S. trade gap by leveling the global playing field for American businesses.
Commentary by Michael Ivanovitch, an independent analyst focusing on world economy, geopolitics and investment strategy. He served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York, and taught economics at Columbia Business School.