Reports of the Dollar's Death Are Greatly Exaggerated

In recent days, a number of prominent people have warned of the downside risks facing the U.S. dollar.

Warren Buffett argued while aggressive U.S. monetary and fiscal policy response is necessary, Congress must bring spending back under control in a timely fashion or the ensuing inflation will undermine the value of the dollar.

Joseph Stiglitz, the former White House economic advisor and World Bank economist, warned of the downside risks to the dollar and wants a new international monetary regime because the current reserve system is fraying.

Curtis Mewbourne, portfolio manager at PIMCO, warned the dollar is losing status as the world’s reserve currency. In a report on PIMCO’s web site, Mewbourne explained:

While we have not yet reached the point where a new global reserve currency will arise, we are clearly seeing a loss of status for the U.S. dollar as a store of value even in the absence of a single viable alternative.

The Truth is Out There

The problem with most of this cant about the dollar is simply and factually wrong. Stiglitz and Mewbourne confuse assertions with arguments. The IMF is the most authoritative source of information about the currency allocation of reserve holdings. The data is unequivocal. The dollar’s share of world reserves remains relatively constant at approximately 65%. There was a little bump up as the central banks prepared for European monetary union.

The euro’s present share of world reserves is roughly the sum of its original parts. In the early 1990s, the Deutschemark, French franc, and ECU accounted for about 25% of the world’s reserves, the same as the euro’s share today. This is to say that the U.S. dollar and the European currencies and now the euro account for about 90% of the world’s reserve currencies. Where is the evidence that the international reserve system is fraying as Stiglitz claimed?

The dollar remains the numeraire of the world economy. Energy, foodstuff, and fibers are priced and traded in U.S. dollars, even if Russia, Iran and Venezuela accept other currencies for their commodities. The lion’s share of world trade is invoiced in U.S. dollars. The greenback is on one side of more than 80% of all foreign exchange transactions. Most countries continue to use the dollar as the key metric for their currency and intervene vis a vis the dollar. Where is the evidence that the dollar is losing its status as Mewbourne asserted?

It is Political Economy

Adam Smith, David Riccardo, Alfred Marshall and other classical and neo-classical thinkers thought what they were studying was political economy. Yet these days, many critics seem to be engaged in crude economic reductionism. As the psychologist Abraham Maslow observed,

If all you have is a hammer, every problem looks like a nail.

The U.S. provision of the world’s chief reserve asset, invoicing currency and unit of account is supported by many factors. One of the factors is the size, depth, and transparency of the U.S. Treasury market. There is no other bond market that comes close to it. The European bond market is too fragmented. The Japanese bond market is too insular and barriers to entry are great.

The Treasury market and dollar are also backed by the world’s strongest military might. U,S. defense spending is nearly equal to the rest of the world combined. The U.S. also controls the seas. The U.S. naval tonnage exceeds the next 17 fleets together. As Josef Joffe points out in a recent Foreign Affairs essay, China, India, Russia, Japan, and the EU cannot individually or collectively conduct a major war 8000 miles from their territory. Since 1990, the U.S. has done it three times: twice in Iraq and once in Afghanistan.

The Future

Stiglitz and Mewbourne also are too one-dimensional in their thinking about the complex issue of the U.S. hegemonic status, of which the dollar as numeraire is but an expression.

The U.S. invests more in improving its human capital and research and development. The average education level in the U.S. is 12.3 years, the highest in the world. The U.S. spends around 6% of GDP on higher education, higher than China, India, Japan, Russia and Europe. Joffe cites research that places 17 of the top universities in the world in the U.S. and 39 of the top 50. In contrast, China’s top three are in the 200-300 placed rankings.

The U.S. spent 2.68% of its GDP on research and development in the first half of the decade, according to the most recent UN data. Proportionately China spent a little more than half of that, and Russia even less. The U.S. devotes a greater share than all but a small handful of countries (Israel, Sweden, Finland, Japan, and Iceland).

The idea that the U.S. has lost its innovative edge and no longer produces goods is simply absurd. Last year, one U.S. company alone received more patents than China—IBM. It takes fewer workers to produce more goods. There are fewer Americans employed in manufacturing than at any time in the past 58 years, though output has risen, only reaching a peak when the economy did in the 2007-2008 period. It is called productivity.

University of Michigan Professor Mark Perry, drawing on data from the Federal Reserve and Bureau of Labor Statistics, notes that U.S. productivity reached a record high in July 2009 with each worker producing $223,000 of output (in constant 2000 dollars). Each worker’s output is equivalent to that of three people in the mid-1970s and the output of two in the mid-1980s.

Supply and Inflation

Warren Buffett’s concern is different than those of Stiglitz and Mewbourne. He does not make unsubstantiated claims. He simply observes that the deficit spending that he approves of to address the crisis has limits. He fears that the politicians will not have the backbone to cut spending on the other side of the crisis. Getting toothpaste out of the tube is easy. Putting it back in is the difficult part.

Milton Friedman famously noted that inflation was always and everywhere a monetary phenomenon. For Buffett, inflation is a political phenomenon. It can be a politically expedient way to reduce a debt burden in lieu of the less tasteful reduction in spending or raising taxes.

While Buffett may be the most savvy investor of our time, but when it comes to macro-economics, he demonstrates a firm grasp on the obvious. That the U.S. government is borrowing an incredible sum of money and the Federal Reserve is purchasing nearly $2 trillion of long term securities has been known for months. There was no real new information or insight in his argument.

Knowing full well the facts, here is what the market has done. In the past six months, with a deluge of supply and evidence that the economy has stabilized, the 10-year Treasury yield has risen 45 basis points. New supply has been fairly smoothly absorbed by a wide range of investors.

At around 3.45%, the yield is only about 20 basis points more than the perceived to be more prudent Germany, the benchmark for the euro zone. The U.S. 10-year yield is a few basis points less than what the French government must pay. The spread between the U.S. and Germany is tighter than the spread between Germany and France, who of course share a common currency.

There are many ways to monitor inflation expectations. The five-year/five-year forward (in essence taking a five year forward of the 10 year TIPS' last five years), which has been cited as a good indicator by both the Federal Reserve and European Central Bank, is hovering around 2.5% for the U.S. This is around where it traded quietly in 2007 and most of 2008. The French five-year/five-year forward, the proxy for the euro zone since Germany’s is less liquid, is about 25 basis points higher.

It seems only prudent to be concerned with the vast amount of debt the U.S. is taking on. Between the fiscal year just ending and the fiscal year about to begin, the Obama Administration has warned of a combined deficit of something near 25% of GDP.

It should be a bit comforting for Buffett and ourselves that the U.S. government debt was a significantly smaller part of our GDP than most of Europe and Japan before the crisis hit. Japan’s gross government debt is approaching 200% of GDP, incidentally, and their problem has not been inflation but its opposite.

As of the end of the first quarter of 2009, as the stock market was forming a bottom and house prices were still falling rapidly, household net worth—that incorporates assets as well as liabilities—stood at more than 3.5 times larger than GDP at $50.4 trillion. This is a painful economic crisis but it is not existential in nature.

Comments

[markfl:]

"The U.S. invests more in improving its human capital and research and development. The average education level in the U.S. is 12.3 years, the highest in the world. The U.S. spends around 6% of GDP on higher education, higher than China, India, Japan, Russia and Europe." The amount the US spends on education is not necessarily indicative of our prowess: at some of the top 2-year colleges in the USA, only a third or less of admitted students actually complete a degree, and the percentages are lower for some minorities.

Aug 30 05:41 AM

[Steven Hansen:]

Mark,
two points:
1) there is no argument that the dollar will be the world's currency for a long time to come. but like our economic "recovery", a lot of what is going on is under the surface at this time. this does not mean that there is not instability undermining the foundations.

2) since 2000, there has been a persistent degradation of the employment to population ratio - and the great recession has made this ratio significantly worse. jobs, not efficiency, is the Achilles heal right now which will effect the dollar.

Aug 30 05:46 AM

[Chandragupta:]

Marc, if everything is so hunky-dory as you point out, why is there a crisis in the first place? Are you not seeing only one side of the story?

The truth of the matter is that the US consumer over leveraged, and is now unable to repay. While this happened, the Federal Reserve (first Greenspan, then Bernanke) slept. Now, clueless as the administration is about what to do, we are going to see the demise of the dollar. It is only a matter of time, whatever you may say. The international community has already lost its faith in the dollar, how long can you rest in the belief that there is no alternative? Alternatives emerge. In US itself, five states have introduced bills to bring back Gold. If Americans are losing faith in the Dollar, why should the world believe in it?

The only argument Dollar supporters make is that "there is no alternative". Not a very convincing argument, I would say.

Aug 30 06:26 AM

[Leftfield:]

Like the small foreign cars that Detroit barely noticed decades ago are the bilateral deals BRIC countries are making without the dollar. Pesky fundamental problems unaddressed make for disasters later.
The many far-off wars we have conducted with our $trillion/year military give evidence that we not only can't afford it, but it gets us into trouble.
The manufacturing productivity, 3x the 70's, strikes me as an easy statistic to fudge with false inflation assumptions and other misleading inputs. How has this alleged progress improved the earnings of average Americans? Are these valid statistics?
Seems like Rome; all kinds of imperial overreach and drama on the world stage while insidious rot from within remains glossed-over and unaddressed.

Aug 30 06:34 AM

[Tony Daltorio:]

Typical article for a Wall Street guy - myopic and focused only on the very short-term. Of course, the dollar will be the reserve currency for a while longer but it may not be in 5-10 years. But I guess that's way too far in the future for a Wall Streeter who looks no further ahead than a day.

The author mentions our military might. So if countries quit using our Dollar, are we going to nuke them??

The author also mentions the productivity number which anyone with an ounce of common sense knows is another "fudged" number from the government and as phony as a $3 bill.

The problem with US education is not the "quantity" of it, but the fact that the quality of US education is among the poorest in the world. The American masses are turning into asses.

In the last paragraph, he fluffs off the economic troubles and says the stock market bottomed. Look out below when you hear that from a Wall Streeter..........

Aug 30 09:47 AM

[Danny Furman:]

"The U.S. invests more in improving its human capital and research and development. The average education level in the U.S. is 12.3 years, the highest in the world. The U.S. spends around 6% of GDP on higher education, higher than China, India, Japan, Russia and Europe. Joffe cites research that places 17 of the top universities in the world in the U.S. and 39 of the top 50. In contrast, China’s top three are in the 200-300 placed rankings."

What a phenomenally ignorant paragraph! US test scores in math and science (and English for native speakers) are pathetic compared to China, India, Japan, Taiwan and most of Europe. Yes, we are the richest and can fund the best research, but is inefficiency really worth such boastful spewing? As stated above, what good does our overgrown, money-printing, thieving military do for economic growth other than establish an entitlement for those powerful enough to pursue private interest?
The dollar's status as the world's reserve currency is enough to keep it strong (seekingalpha.com/artic...), but arguing economic strength in the US is quite silly.

Aug 30 10:31 AM

[Davewmart:]

The military strength of the US is dependent on inflows of funds from the rest of the world, or it is simply unaffordable.
How long is this overstretch sustainable?
The productivity figures likely include the financial services industry, so churning out more duff mortgages count heavily.
So far the recession tracks the 30's very well.
Since debt ratios are equally high, I would feel that it will continue to track, and we are shortly in for another vicious leg down, which would turn the assumptions behind this article to dust.

Aug 30 11:10 AM

[The Recusant:]

Aaargh...three points to counter your statements.
1. Unemployment erodes the national wealth.
2. Investors and other countries lack confidence in the US dollar.
3. Military overspending burdens the government budget.

Bye-bye dollar.

Aug 30 04:03 PM

[ManAboutDallas:]

Japan just kicked over the first applecart yesterday. The rest are going to be kicked over, one by one, like dominoes. Goodbye, dollar, ah we barely knew ye.

Aug 30 04:43 PM

[Jeff Nielson:]

This entire "analysis" is ludicrous nonsense, but let me start with this. The author states:

"The U.S. provision of the world’s chief reserve asset, invoicing currency and unit of account is supported by many factors. One of the factors is the size, depth, and transparency of the U.S. Treasury market."

All that U.S. Treasuries are IOU's of the U.S. government - for all the trillions of dollars they have borrowed. Thus, the author is putting forth the idiotic premise that the MORE the U.S. borrows,the STRONGER the U.S. dollar gets.

In the REAL world, when you increase the supply of ANYTHING, the value of each unit declines.

Yet we have an endless lists of propagandists (like this author) who continue to assert that not only is the U.S. dollar completely immune to the principles of economics, but it's even immune to the principles of arithmetic.

Aug 30 04:54 PM

[whidbey:]

A good set of arguments indeed, but the dollar also a ballot on the holders view of the future of US policy. If the strain is evident the dollar will show the belief in the strain.

Second, you are confusing social capital, human capital with estimates of its capacity to sustain a monetary trend. You may be too optimistic in imputing social capital with US$ currency prospects in the global market.

Third, the reserve currency role of the $ forces even its detractors to hold dollars to trade oil, gold, softs, and some debt. It is the uniform quote and the dealers want to be exchanged in USD. A 65% percent reserve status for developed counties reflects the trade weighted value of the reserves and that varies with each economy.

Four, The slide of a currency is never quick (look at the Pound and French Frank), but gradual as it becomes clear that political will and monetary policy are not working together to support a national role. That is the danger today. We have not got time to make pretty speeches about hidden strengths, the Globe wants leadership.

Our US internal predictions are to consume, import and sell debt and that is a poisonous combination for a reserve currency.

Aug 30 08:05 PM

[Dialectical...:]

"The U.S. spends around 6% of GDP on higher education, higher than China, India, Japan, Russia and Europe."

Yet many Americans can't find these places on a map!

Aug 31 12:43 AM

[mchandler:]

Markfl raises questions aobut the quality of the US education, that I cite the highest quantity in the world at 12.3 years on average. The "smell test" here is the number fo foreign students that flock to the US for higher education. Fareer Zakaria in an essay in Foreign Affairs at the end of last year notes that 30% of all students studying globally come to the US, for than any other country.

Steven Hansen says the arugment about the dollar's loss of status is a longer term problem, not immediate. The people who's arguments I take on make it an immediate problem, but some of my argument also apply to the medium term, such as R&D spending and higher education spending and other elements of power, including military might. The ratio of labor market to population is indeed an interesting development, but as a theory of currency movement, I thinking it is lacking a robustness to make it useful.

Chandragupta suggests that I see every thing as "hunky dory". Yet That is not my argument at all. My argument is that the doom and gloom about the dollar losing its status in the world made by both Stiglitz and an PM from PIMCO is not based on facts. I certainly seem economic challenges in the US, but do not think they strike at the foundation of the United States or will bankrupt the country.

Leftfield suggests the productivity numbers my be fudged. It is not clear by whom. But this is a serious charge and requires serious evidence. Unfortunately, in this argument by innuendo, there is no such evidence to turn the "may be fudged" to they "were fudged". My arguments about the dollar's role in the global economy go well beyond their is not alternative to looking at a number of levels of power today and looking ahead.

Tony Dalterio says that my piece is typically of Wall Street. That is reducing analysis to name calling and misses the thrust of my argument that many Wall Streeters see the US in decline and the dollar's role in global economy diminishing. I challenge those Wall Street views, no ?

Danny Furman's comments are difficult to understand for me. I specifically cite the sources for my data on US education compared to other countries. Not sure what test scores he is referring to as he does not cite them. I am primarily looking at higher education. I will readily concede the point, if there was eivdence to back up the claims he makes. I am was specifically critical of a purely economic determinist understanding of power, but while the crisis has weakened the US, my argument is that it is not coupe de grace.

Davewmart--disagrees. he thinks the US empire is already overstretched and that this recession is tracking the 1930s well. He says nothing about the role of the dollar as a reserve asset or that the international monetary regime is unraveling, which is what I specifically argue against.

The Rescusant strings together a few assertions and then somehow deduces his conclusion "bye bye dollar", without addressing a single reason why I suggest this is not the case. He says that foreign investors have lost confidence in the dollar yet the dollar is much higher than a yeara go: euro is off 11%, Canadian dollar is off 12%, sterling is off 17%, Swedish krona is off 22%. Only the yen of the major currencies has done better than the dollar over the past 12 months. I cite the US household net worth at the end of my essay as of the end of Q1 that picks up the impact of rising unemployment.

Jeff Nielson says my entire analysis is "ludicrous nonesense." He says when ever you increase supply the price falls. Please Jeff tell this to the Japanese where the gross national debt is approaching 200% of GDP and bond yields have not risen in Japan, ie prices have not declined much. The same thing happened iun th eUs under Ronald Reagan where a huge build up in debt did not lead to higher interest rates. I n my essay I specifically look at the bakcing up of US interest rates and found it to be minimal compared to Germany.

Aug 31 09:39 AM

[Albert Meyer:]

costofwar.com/

a visual.. for those who can't read...

On Aug 30 04:03 PM The Recusant wrote:

> Aaargh...three points to counter your statements.
> 1. Unemployment erodes the national wealth.
> 2. Investors and other countries lack confidence in the US dollar.
>
> 3. Military overspending burdens the government budget.
>
> Bye-bye dollar.

Aug 31 11:18 AM

[Albert Ling:]

This was a widely held urban legend that "americans are bad at geography". So Brazil's largest national magazine made a survey to test Brazilian's skill on geography and it was much much worse than expected. Only 50% could locate Brazil on the map. only 18% knew where was the united states, and amazingly only 12% of the whole brazilian population could identify Argentina, wich is the 2nd largest South american courtry and shares maybe the largest border.


On Aug 31 12:43 AM Dialectical Materialist wrote:

> "The U.S. spends around 6% of GDP on higher education, higher than
> China, India, Japan, Russia and Europe."
>
> Yet many Americans can't find these places on a map!

Aug 31 11:35 AM

[ManAboutDallas:]

Great pratfall so far this morning, eh ? Just wait 'till 77.43 gives way for good...... last rat off the ship turn out the lights, ok ?

Aug 31 11:44 AM

[Davewmart:]

mchandler sought to rebut by saying:

'Davewmart--disagrees. he thinks the US empire is already overstretched and that this recession is tracking the 1930s well. He says nothing about the role of the dollar as a reserve asset or that the international monetary regime is unraveling, which is what I specifically argue against. '

However in the article he argued:

'The Treasury market and dollar are also backed by the world’s strongest military might. U,S. defense spending is nearly equal to the rest of the world combined. The U.S. also controls the seas. The U.S. naval tonnage exceeds the next 17 fleets together. As Josef Joffe points out in a recent Foreign Affairs essay, China, India, Russia, Japan, and the EU cannot individually or collectively conduct a major war 8000 miles from their territory. Since 1990, the U.S. has done it three times: twice in Iraq and once in Afghanistan.'

So he is using the US military strength as an argument to bolster the idea that the Treasury and the US dollar will continue to have strength.
This argument seems weak since the financing for the military strength comes from abroad, IOW no strong dollar and inflow of funds to the Treasury, no military strength.

This is in dramatic contrast to the position of the US, in, say, the 1950's.
And this is the part of the argument I chose to address.

Like a stool, the whole argument for continues American dominance rests upon several legs.
Others have addressed the instability of other supports, I chose to highlight the weakness of the military support.

Since he brought the subject of military strength up, it is perhaps a little disingenuous to seek to argue that:

'He says nothing about the role of the dollar as a reserve asset or that the international monetary regime is unraveling, which is what I specifically argue against. '

when one of the arguments he presented for the continued role of the dollar as a reserve asset, and a reason for the monetary regime to continue was the military strength of the US.

I am afraid the military strength of the US has been undermined by fiscal irresponsibility and overstretch, just as have so many of the other supports the author mentions that many others have addressed.

Aug 31 02:13 PM

[xupd47les:]

What, exactly, is a “dollar”? Answer: Nobody really knows because the modern dollar is undefined. And therein lies the foundation for our current economic predicament. Our current economic problem begain in 1934 when President Roosevelt removed gold-backed dollars from domestic circulation. The problem was aggravated in 1968 when the government-corporation stopped redeeming paper silver certificates with silver dollars and thereby removed all tangible definition from the domestic dollar. The problem was further exacerbated in 1971 when President Nixon closed the “gold window” in international trade and thereby left the dollar without definition in both the domestic and international spheres. Once the dollar was completely undefined, the U.S. should’ve soon suffered a massive economic failure. However, Nixon and Kissinger devised a brilliant deal with Saudi Arabia whereby the U.S. guaranteed the Saudi’s security and the Saudi’s guaranteed to sell their crude oil for dollars only. OPEC quickly followed the Saudi’s lead and for the next 30 years, any nation that wanted to purchase oil on the international market could do so only with dollars. Result? The dollar—no longer expressly defi ned in terms of a physical mass of gold or silver—became implicitly and vaguely defined in terms of crude oil. This scheme was brilliant but ultimately too fragile to last. Enter Saddam Hussein who, circa 2000, dared to sell Iraq’s oil for euros rather than dollars. In doing so, Saddam threatened the “de facto definition” of the dollar and the foundation of the world’s economy. Saddam Hussein precipitated today’s global financial crisis by stripping the dollar of its last quasi-tangible definition in terms of crude oil. Our gov-co responded to Hussein’s denial of the dollar’s quasi -definition by invading Iraq and hanging Hussein—but too late. The genie was out of the bottle and the world’s petroleum-producing nations began selling their oil for euros, yen or other currencies. Once the dollar was no longer the only currency that could purchase crude oil, the dollar lost its last claim to tangible definition. Without a gold-, silver- or oil-backing, the dollar became undefined, irrational and surreal. Completely untethered from tangible reality the dollar’s value became “relative”. For example, if you want to know what a dollar is, you might look at the Foreign Exchange market. Today, $1 is worth 1.1182 Canadian dollars, 0.7077 euros, or 13.554 Mexican pesos. Tomorrow, those numbers will change and the dollar will be worth something else. The dollar’s “value” is uncertain and only “indicat ed” as a ratio relative to the other currencies. That relative ratio’s wouldn’t be so confusing if at least one of the other currencies had a fixed, tangible definition, but they don’t. We don’t have definitions; we have ratios—and even the ratios aren’t usually fixed. Same thing is true with the metals commodities. Today, $1 = 1/957.20th of an ounce of gold; 1/14.29th of an ounce of silver and 1/1161st of an ounce of platinum. Tomorrow, those ratios will be different and we’ll have a new mix of “indicators” rather than definitions.20I believe the dollar’s lack of definition is the cornerstone for today’s global economic crisis. I believe the current financial crisis and cannot be resolved until the world returns to a currency with a fixed and defined value. I’m convinced that the international calls for replacing the dollar as the “world’s reserve currency” are the logical consequence of a pure fiat dollar without any tangible definition.

The modern “dollar” will die. Not because it’s been “weakened” by inflation, but because it is undefined and therefore irrational, unreasonable and conducive to national madness.

Aug 31 03:17 PM

[Lightrider:]

Any argument that contrast US military and economic greatness as a foundation for the Dollar's strength is founded upon fantasy. How much "US naval tonnage" would we have if we paid for it with money we actually have. After you factor in what the US owes in foreign debt, it becomes clear that our Navy, Air Force ... our country, is floating on foreign money. Given the extent of our debt, it could be argued that we own nothing. We took in less than $1 Trillion in taxes last year and owe over $11 Trillion and climbing fast. In real terms, we are a paper power.

Aug 31 11:52 PM

[mchandler:]

Lightrider and Davewmart misconstrue my argument. I think that US hegemonic power is supported by a number of elements. I cite spending and quality of higher education (tests about geography and knowing sofa from couch are elementary school issues and appear to have a great deal to do with the disparity of income and wealth in America), research and development, the depth and breadth and transparency of the Treasury market, and I cite US military strength. All hegemonic powers have dominated militarily. As much as suspect the war in Iraq to be folly and the escalation of the war in Afghanistan, the fact is that the direct costs of the wars are about 1% of GDP. At its peak in 1970, Vietnam consumed 1.6% of GDP. The US defense budget as a whole is a little more than 4% of GDP, which is lower than most years during the Cold War (peaked under General Eisenhower near 10% of GDP).

Is America really a paper power as Lightrider concludes ? A paper power ? Come on...Does any country in the world believe that ? Should our enemies? Why should our friends ? Why should we ? The US debt to GDP ratios began the crisis much lower than most of the other large industrialized countries. The debt burden is rising. No doubt. The US is not bankrupt by any real meaning of that word. Debt does not equal bankruptcy. The US has assets too. It is true that foreign investors as of the end of last year owned about $3.5 trillion more of our assets than we owned of theirs. $3.5 trillion is about 25% of GDP. Since the US consistently reports an income on the investment account, when doing the math of assets and investment income and liabilities and investment payments, it appears the US pays about 3% on its liabilites and collects about 4% on its assets. It is the function of banker of the world, backed by its role as the gendarme.

Sep 01 06:33 AM