Currency fiddlers wrong to cry foul
By Peter Morici
As the US dollar falls against the euro, yen and other major currencies, China
and other emerging economic powers holding lots of dollars and US securities
are crying foul, and for an end to the dollar's central status in global
commerce.
If they are truly disgusted, they should look to themselves for answers.
Since the end of World War II, the dollar has largely replaced gold as the
reserve asset central banks hold to back up national currencies. The supply of
mineable gold is too limited, and efforts to back up currency with gold would
result in severe shortages of liquidity and global deflation.
When a merchant moves goods, for example, from Thailand to Mexico, the market
for pesos into baht is thin or non-existent, and the merchant sells pesos for
dollars to buy baht. Similarly, many
other cross-boarder trades, financial contracts and debts are denominated in US
dollars, although the euro is coming into greater use.
Over the years, governments and traders gravitated to the dollar, because the
United States has the largest and most diversified economy. Virtually anything
made or grown around the world is traded in the United States, and money
invested in dollars is secure from political upheaval and state confiscation.
Until recently, the dollar has been a well-managed currency. The US government
resisted the temptation to borrow too much and flood the world with too many
dollars and Treasury securities, which provide liquidity the same as do
dollars.
The current market determined system of exchange rates emerged by default in
the early 1970s, when the Bretton Woods system of government-enforced fixed
exchange rates failed, and the United States ended the convertibility of the
dollar into gold.
This system has no rules or effective governing structure. Consequently, some
governments seized opportunities to manipulate the system to gain competitive
advantages in trade. For example, since 1995 China has maintained an
undervalued currency by selling huge amounts of yuan for dollars to merchants
and currency traders.
The undervalued yuan makes Chinese exports artificially cheap and foreign
products too expensive in Chinese markets. China enjoys huge trade surpluses
that create millions of jobs and double-digit growth in China. Japan and others
have pursued similar strategies.
These policies impose huge trade deficits and unemployment on the United
States, create enormous imbalances in the global economy, and contribute
importantly to the Great Recession.
The US trade deficit grew from about 1% of gross domestic product in 2001 to
more than 5% from 2005 to 2008, and this should have created a shortage of
demand for US goods and services and a recession.
However, China invested the dollars obtained suppressing the value of the yuan
to purchase US securities. US consumers borrowed those dollars, against their
homes and on credit cards, and kept the US economy going.
Finally, the credit bubble burst and an even bigger recession resulted. Huge
federal borrowing is now required to finance massive US stimulus spending,
bailout banks and otherwise rescue the US economy.
All this borrowing floods capital markets with Treasury securities, which
provide the same liquidity as dollars, and pushes down exchange rates for the
dollar against every major currency except the Chinese yuan. This reduces the
value of the dollars, as expressed in euro and yen, held by China, Russia,
Saudi Arabia and others.
Hoisted on the consequences of their own mercantilism, China and others would
like to see the dollar replaced by a basket of currencies.
A global currency poses enormous diplomatic and technical challenges, including
creating an international body to control its supply and persuading governments
to issue debt denominated in this global currency. Without those, private
merchants and financiers would still seek a central national currency to
facilitate trade and denominate private cross-border contracts and debts.
Even with a global currency, China could still buy dollars with yuan to keep
its value suppressed against the dollar and boost exports into the United
States. The United States would still have to run large federal deficits to
avoid economic meltdown.
China would still be stuck holding dollars that chronically fall in value
against other currencies.
If China and others want that problem fixed, they need to abandon currency
manipulation and let their populations purchase more US goods and services.
The US economy would grow robustly, federal borrowing would subside and the
threat of too many dollars compromising the dollar's role in international
finance would vanish.
Peter Morici is a professor at the Smith School of Business, University
of Maryland School, and the former Chief Economist at the US International
Trade Commission.
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