Tuesday, May 11, 2010

Zachary Karabell: The World's Dollar Drug

Another nice piece by Zachary Karabell who to most of us is simply a guy who shows up on CNBC from time to time and has some fantastical hair. Back in 2009 I highlighted another of his well written pieces [Oct 14, 2009: Zachary Karabell - Deficits and the Chinese Challenge]; today we have an op-ed piece in the Wall Street Journal outlining a theme we've been touching on for a few years now - how the United States will be the last to face the music due to the luxury of owning the world's reserve currency. But all it does is mask the rot underneath.

Via WSJ - The World's Dollar Drug:

Some excerpts....

  • For all the talk about the problems of Greece and their implications for the euro zone, there is another currency that presents equally profound problems: the U.S. dollar. is, as everyone knows, the world's reserve currency, and it widely seen as a boon and an anchor for the emerging global economic system. It The dollar is also the only thing standing between the United States and its own moment of reckoning, and that is not a good thing.
  • Bretton Woods obligated participating countries to determine their exchange rates and the value of their currencies in relation to the dollar, with gold as the underpinning. Then, in 1971, President Richard Nixon ushered in the era of fiat currency when he announced that the U.S. government would no longer allow foreign nations to redeem their U.S. dollars for gold.
  • Over the past decade, the relative position of the U.S. has shifted. It is no longer a creditor to the world but rather a large debtor. It is a net importer of manufactured goods.... Its national economy is the world's largest but is surpassed by the multinational euro-zone. And China's economy, while still perhaps not much more than a third the size of the U.S., is growing three to four times as rapidly and accumulating dollars at a torrid clip.
  • Yet the dollar remains the linchpin of the global system. The financial crisis brought global grumblings about the U.S. currency, about the toxicity of the U.S. financial system, and about the need and desire for an alternate global currency. The Chinese were vocal in their desire to find a new anchor, and the Europeans echoed the sentiment along with others. But words are easy. Even the Chinese, who have made moves toward pegging the yuan against a basket of currencies, still find that having tethered their system to the dollar they can't simply walk away because they would rather things were different.
  • The dollar's dominance has clear short-term benefits for the U.S. Unlike Greece or just about any other country, when the American federal government wants to take on additional debt it has the advantage of a world that must buy dollars. Because much of global trade is conducted in dollars, especially Chinese trade, governments and institutions throughout the world have little choice but to invest in U.S. assets. The U.S. government also has the ability to print that global reserve currency when dire straits demand it. That gives the U.S. considerable latitude to spend its way out of a crisis without confronting real structural challenges. The U.S. has been able to forestall deep reforms because it has the dollar.
  • But while the presence of the dollar keeps money flowing in and the system well-oiled, it no longer reflects the world's economic pecking order. For all the talk of currency manipulation by Beijing, it is equally true that China's peg to the dollar is currently propping up an otherwise shaky American economy. The Chinese have become the ultimate offshore bank for American capital, and there is no evidence they deploy it to less American benefit than Americans themselves do. The Chinese government invests conservatively in U.S. bonds, and spends heavily on a domestic economy that produces goods for American consumers.

Key key points here:
  • The U.S. government uses its dollars—and the ability to print them and borrow them—poorly. Large amounts of debt fund consumption of goods and health care. While today's needs are important, without sufficient investment those dollars will dissipate. You'd lend someone money to open a business or invent a new energy source, but not for dinner and a movie. Yet because of the dollar, America tends to get the money it wants. And so the dollar as an anchor of the global system forestalls fiscal crisis in the U.S. while allowing for gradual decay of the American economy.
  • This can go on for many years. The world needs a reserve currency to reduce costs and allow market players to assess value across different countries and economies. But that need for the dollar shouldn't be confused for American strength.
  • The ubiquity of the dollar allows Americans to believe that their country will automatically retain its rightful place as global economic leader. That's a dangerous dream, an economic opiate from which we would do well to wean ourselves.

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