When the Rest of the World Stops Hoarding US Dollars

U.S. Dollar reserves continue to build up in the Middle East, China, and other parts of the world as well. Good for them. Isn’t it great that they have all of those foreign currency reserves to draw on?

Well, maybe. This leads to the question: Who do they sell the dollar assets to, and at what price? When many nations hold an excess of dollar claims - more than they need for trade purposes - the desire to have more dollar claims declines. Thus the dollar falls in value versus other currencies. Eventually the day will come when U.S. goods are irresistible, but we aren’t there yet.

And, we are putting out more dollar claims. Witness the trade deficit and the record U.S. government budget deficit (and that’s with Social Security on-budget, and the wars and other “emergencies” off-budget). Let the rest of the world fund our spending by lending to us in depreciating dollars.

Well, that creates inflation in the U.S., with import price rises feeding that. It feeds inflation in the countries that insist on keeping their currencies artificially cheap versus the dollar to subsidize their exporters. It feeds recession, or at least economic slowing in nations that allow their currencies to rise to restrain inflation.

So, back to my title. Hoarding U.S. dollar reserves brings no advantage after a certain point, particularly when many are doing it. There is nothing scarce about dollar claims. Now ask yourself this: Would you play a game with someone who can change the rules against you? Lending to the U.S. in U.S. Dollar terms is exactly that. The U.S. mouths a strong dollar policy while pursuing a weak dollar policy. Who in the U.S. government cares about the budget or trade deficits at present, enough to do something about them? No one significant. Both parties are spending like there is no tomorrow, out of a sense of financial crisis.

What will impose discipline on the system? A falling U.S. Dollar, and a lack of willingness for foreigners to accept payment in U.S. Dollars. Or massive foreign demand to buy U.S. companies, not debt. Or nations that stop subsidizing their exporters, because the inflation becomes too great, and instead allow their currencies to appreciate. Maybe we will see this in a few years time, certainly by 2020.

Comments

[john haskell]

this is a very timely article for say 2002. There is a risk of a falling dollar dampening foreign demand for USD denominated assets? You don't say!

[flow5]

The U.S. dollar has no bottom. A flight from the dollar will generate hyperinflation in terms of dollar-denominated assets.

[syruppy]

This is the new world-wide "silver-standard" with the oil-rich but otherwise poor nations of the world as the new monopolists, leading of course to a necessary realignment--either for good or for now (who knows)--of all of the basic factors of production, labor, energy, capital, etc. Ask not when the dollar will strengthen; ask when the cost of oil will fall due to increased production or increased investment in nuclear power.

[gordon]

Is'nt it logical, the foreigners have already curbed buying Treasuries and GSE paper, they will demand a higher interest rate. How long can the "flight to safety" into Treasuries artificially thwart the demand for higher rates in the 10-yr? Would not a utility sector decline show it first?