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Tuesday, May 26, 2009


Today's Buggy Topic Is . . . Well,

a little wonkish, but not to worry: no math or anything --- just more of an abstract set of comments by buggy, which do manage toward the end to deal with the US trade balance and the related role of the $US as the key currency in the world: for trade purposes (even, say, between Brazil and China), for quote-purposes --- the dollar the base-currency in which all other currencies are calculated as exchange-rates --- and above all its pivotal role as a reserve currency.

Even today, about 65% of all foreign exchange held by the Chinese, the Japanese, the other Asian manufacturing exporters, the Arab oil-exporters, and trade-surplus countries like Germany are in dollars still.  About 25-30% are now in euros.  The rest are tiny amounts of British pounds, Japanese Yen, and Swiss Francs. 

The Reserve Role of the Dollar Entails Benefits and Costs

Yes . . . for both sides: those countries like China and Japan with well over $2 trillion dollars that their Central Banks hold as a result of long-term trade surpluses, and the US on the other side.


For the trade-surplus countries, their dollar-holdings reflect their governments' interests in maintaining a lower value of their currencies --- Yen and Renminbi (Yuan for trade purposes) --- in dollar terms, precisely in order to run up a trade surplus with the US and other countries using dollars.  In return, the dollars that flow into their banking system end up mainly in their Central Banks.  They then deposit these in a variety of US financial assets --- US Treasury bills or long-term bonds, Fanny Mae and Freddie Mac bonds, stock-market equities and bonds, or real estate.  These pay them a certain interest return . . . or in the case of stock equities and real estate, possibly capital gains.

The downside for them? 

If the $US depreciates noticeably against the Yen or Renminbi --- say, 25% --- they lose 25% of their American financial holdings in terms of their own currencies.  And if --- as the dollar depreciates --- they try to sell off their dollar holdings, that would only accentuate the rush out of dollars, its fall in exchange-rate markets against those (and maybe other) currencies, and their losses.  On top of that, a noticeably depreciated dollar would undermine a major pillar of their economic growth yearly: huge trade-surpluses with US businesses and consumers.

The US Side: Benefits and Costs

The big benefit for the US is that the US financial system --- including our Treasury, at any rate when it has to finance government fiscal deficits with monthly sales of US Treasuries (bills or bonds) --- is that we can as a country use foreign financial investments in US Treasuries and semi- and fully private financial assets to keep our interest rates lower than otherwise.  That stimulates investment . . . though, of course, as the huge runaway housing market in the US showed by the middle of 2007, the extravagantly high housing boom (in which foreign private and Central Banks were involved) could suddenly collapse --- with big losses for both the US and foreign economies, including their private and Central Banks.


The downside for us? 

Well, contrary to what you hear, it has nothing to do with overall employment rates.  Those are determined by the supply and demand of labor and wage-adjustments.  What has happened --- as long-term trade deficits always entail --- is a reallocation of labor and capital out of declining industries hurt by a growing lack of competitiveness in markets both abroad and at home . . . above all, in the US case, an accelerated decline of the manufacturing industries' employment.

A more flexible exchange rate --- a steady appreciation of the Chinese Renminbi in dollar terms, say (which could easily have occurred if the Chinese leadership wanted it by floating freely the Renminbi or managing a wider depreciating band around the $/Rmb rate  --- would have slowed down the decline as our comparative advantage shifted to newer, more high-tech industries in areas where we have experienced major technological breakthroughs over the last three decades or so: in communication and information technologies, computer software of all sorts, heavy machinery, aerospace, pharmaceuticals, chemicals, petrochemicals, and biotech, plus of course agriculture.  In fact, contrary again to urban myth, the US produces $2.50 worth of goods for every $1.00 China does.  And we export the large bulk of them.

Enough Said

Click here for the buggy commentary, left last week at Economist's View.