$H teeters
Why Dollar Hegemony Is Unhealthy
The world’s dangerous dependence on the US dollar risks hurting all
Thomas I. Palley
YaleGlobal, 20 June 2006
WASHINGTON: With US Federal Reserve chairman warning about inflation, the US dollar is in the news these days, and there’s a sense that the world economy has become excessively reliant on the dollar. This reliance smacks of dysfunctional co-dependence whereby the US and the rest of the world both rely on the dollar’s strength, but neither is well served by it.
The US dollar is the world’s premiere currency, with approximately two thirds of world official foreign-exchange holdings being dollars. Moreover, many countries appear willing to run sustained trade surpluses with the US, supplying everything from t-shirts to Porsches in return for additional dollar holdings. This willingness to exchange valuable resources for paper IOUs represents a form of dollar tribute.
Many foreign policymakers complain about the special advantage for the US, allowing the nation to run enormous trade deficits without apparent market sanction. Whereas balance-of-payments considerations constrain other countries to run tight economic policies, no equivalent constraint appears to hold for the US. This advantage is rooted in the dollar’s special role as the world’s reserve currency.
For the US, one major benefit of the dollar’s reserve-currency role is that it increases the demand for US financial assets. This drives up prices of stocks and bonds and lowers interest rates, thereby increasing household wealth and lowering the cost of borrowing money. Additionally, the US government gets seignorage, or an interest-free loan, from the hundreds of millions in dollar bills held offshore. Printing a $100 bill is almost costless to the US government, but foreigners must give more than $100 of resources to get the bill. That’s a tidy profit for US taxpayers.
Increased foreign demand for US assets also appreciates the dollar, which is a mixed blessing. On one hand, consumers benefit from lower import prices. On the other, it makes US manufacturing less competitive internationally because an overvalued dollar makes US exports more expensive and imports cheaper. Reserve-currency status therefore promotes trade deficits and de-industrialization.
The conventional explanation of the dollar’s reserve-currency status is a “medium of exchange†story. The US has historically been the largest and richest currency area, with the largest share of world output and trade. This has provided incentives for other countries to hold and use dollars. Additionally, the fact that many governments over-issue their own money and create high inflation encourages foreign citizens to protect themselves by holding dollars instead of domestic currency.
A second theory of reserve currencies, associated with the political left, is based on US military power and the Pax Americana. The argument is that US military power provides the security that protects the global market system, and New York is the new Rome. Countries, such as Saudi Arabia, hold reserves in dollars because New York is a political safe haven and because that helps cover the costs of enforcing the Pax Americana.
These two theories are mutually reinforcing. Thus, to the extent that the dollar is widely used and is also a safe haven, investors tend to rush into dollars in times of uncertainty. Consequently, central banks in other countries need to accumulate large dollar-reserve holdings to protect against financial disruptions that result from sudden exits by investors, as happened in East Asia in 1997.
There is a third unrecognized theory that can be labeled the “buyer of last resort†theory of reserve currencies. Put bluntly, the tribute other countries pay the US through their trade surpluses is the result of their failure to generate adequate consumption spending in their own markets, be it due to poor income distribution or bad domestic economic policies. This forces other countries to rely on the American consumer.
The logic of this third theory is easily illustrated. Over the last decade, while Europe and Japan stagnate, the US has grown on the back of robust consumer spending. This spending has sucked in imports, helping growth in Europe, East Asia and Latin America, and making the US the major engine of global growth.
East Asian countries, especially China, have been particularly willing to run trade surpluses with the US because this has fuelled export-led growth. These countries rely on exports to keep their factories operating. Export success then attracts foreign direct investment that advances development. Undervalued exchange rates are vital for this strategy as it keeps exports competitive. Countries have therefore channeled their trade surpluses into dollars, keeping the dollar overvalued and enabling them to sell in the US market. This explains both the continuing strong demand for dollars despite the US trade deficit and the dollar’s dominance in official foreign-exchange holdings.
Ironically, America’s dispensation from trade-deficit discipline stems from other countries’ failure to develop an equivalent of the American consumer. Countries want to industrialize with full employment, but they lack adequate internal demand. Consequently, they must rely on the US market. It is also why Germany supplies BMWs and Mercedes-Benzes in return for paper dollar IOUs.
Conventional theory says the dollar will only lose its dominance when countries become saturated with dollar holdings. At that stage they will cease buying and may even sell dollars, causing the currency to fall. The problem with this story is that countries have no incentive to sell dollars, as this would kill the golden goose of export-led growth.
Stan:
While clearly a Keynesian solution is proposed (raising consumer demand in non-US markets), and just as clearly (to some) “exponential growth in a finite system” is the province of madness or economics, the description of dollar hegemony is accurate.
Anything that shifts US residents away from commodity consumption makes a material contribution to the downfall of imperialism… which is now actualized as dollar hegemony.
A broad-based movement in the US toward self-sufficiency (beginning with food and energy self-sufficiency) is now as strategic as the development of the CIO was in its day… perhaps moreso. The goal should possibly not simply be to get people jobs, but to begin now helping people to end their dependency on jobs.
22 June 2006, 10:25 pmstephanie weiner:
Hi, I’m an activist and an artist in Chicago. I have a website called Revolutionary Lemonade Stand. I hope that you check out the site and buy stuff and decide to link my website on yours. I look forward to hearing from you! Thanks, Stephanie Weiner
23 June 2006, 1:26 pmhttp://www.revolutionarylemonadestand.org
Ian Nouvel:
As to the otherwise sound economic analysis of Palley, this seems to have it both ways:
“Over the last decade, while Europe and Japan stagnate, the US has grown on the back of robust consumer spending. This spending has sucked in imports, helping growth in Europe, East Asia and Latin America, and making the US the major engine of global growth.” (Europe both stagnates and grows contemporarily?!?!)
I believe that the petrodollar phenomenon (http://en.wikipedia.org/wiki/Petrodollar) also merits mention as creating excessive dollar demand.
As to the immediate future, a little diatribe… The reserve currency status that has underpinned much growth as a source of seeminly endless global financial security is a double-edged sword that will soon cut the other way. Much analysis has pointed to the dependence of the US economy on the housing sector (where 50% of job creation has been originated over the last 5 years), a sector that is more than almost any other dependent on low interest rates, which reserve currency status maintains as artificially low. This artificial strength has allowed for record indebtedness (read mortgages etc…) in the US. Now, if you don’t already know, interest rates have been going up for some time. We’ve had 14 consecutive hikes, and expectations are certain for at least two more. Rates are going up due to Wall St fears of inflation (due to inflationary changes in the consumer price index, purchasing power index and increasing import prices.) In my view, the rate hikes could and probably will result in record bankruptcies, killing US consumption and consequently, the US economy, wiping a whole lot of ‘value’ off (think the end of Fight Club). The crucial moment occurs when a foreign central bank ‘blinks first’, causing a ‘run’ on the dollar, a self-perpetuating scenario that would only lead to further rate hikes, further strangling US consumption…
And if you don’t believe me, listen to the US ‘Auditor in Chief’, Comptroller General David Walker: http://news.bbc.co.uk/1/hi/programmes/hardtalk/4857646.stm
PS Whomerver linked to that ‘revolutionary lemonade stand’ has a fantastic sense of irony.
23 June 2006, 3:02 pmSks:
Interesting concept, economic drowning of imperialism from within.
There is one issue tho, which is that both the dollar, and the mainstrays of US hegemonic economic power are supra-national, dominated as they are by trans-national corporations which while owned mostly by US shareowners, generate most of their economic activity overseas.
Even corporations such as Walmart, which seem intimately tied to the fate of the USA, are already diversifying geographically, following both the inherent tendency of capitalism towards market monopolization (in a global marketplace this tendency is global) and as preemption of the doomsday scenario of interest rate hikes and cathastrophic lowering of purshasing power in the USA.
This means, essentially, that global capitalism, and imperialism, will not be weakened by the diminishing of the US economy, but rather that its center will change.
I could think right of the bat about Brazil, China, and to a lesser extent the EU and India, as places towards which these power shifts could happen.
This I see as a much more plausible scenario than a movement towards internal self-dependency as a model of where US imperialism might head if the doomsday scenario continues.
Nevertheless, call me a pessimist, I think the USoinian model of capitalism has proven robust in more than one occasion, and hence I am weary of predicting its dismissal.
25 June 2006, 12:17 amRobin Hering:
Sks, good point. The humanity within the (currently) political boundaries of the U.S. will be first looted and then forsaken, left behind, which accelerates the “world is flat” flattening, esp in terms of consumption and wages.
Meanwhile, “U.S. Product” has nothing to do with a country, America, as we’ve known it, but only with the earnings of entities which had been considered until recently, U.S.corporations, now supra-nationals.
Isn’t capitalism constrained by the availability of resources?
The current U.S. geographic region is depleted of resources. Except for coal… And labor…
But that doesn’t mean that the human beings within the geography can’t create internal self-sufficiency and interdependence, separate from the supra-nationals.
I hate to think of the direction into which this line of thought takes us.
27 June 2006, 12:01 amRobin Hering:
At what points are dollars injected into the system? Not who launches or prints them, but who gets them firstand what’s given in exchange for them, if anything?
27 June 2006, 7:41 pmSks:
Got Kim Il Smith?
Autarky, nevertheless is quite difference from self-sucifiency and self-dependency.
For example, Cuba is quite self-suficient and self-dependent and nevertheless has a huge trade network that spans the word.
Thing is, its a defensive self-relaince. Whic is basically my point… are we as anti-imperialist reduced to opting for the strategic defensive forever?
27 June 2006, 10:57 pm