The Dollar Abides
Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System. Barry Eichengreen. Oxford University Press 2011, pp. 215, $27.95 The Great Recession, precipitated in part by excessively low interest rates in the early 2000s, has caused more Americans to pay attention to monetary policy than they have in [...]
Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System. Barry Eichengreen. Oxford University Press 2011, pp. 215, $27.95
The Great Recession, precipitated in part by excessively low interest rates in the early 2000s, has caused more Americans to pay attention to monetary policy than they have in the past. Governor Rick Perry, former Speaker Newt Gingrich, and Congressman Ron Paul, to various degrees and in different ways, all made criticism of the Federal Reserve components of their presidential campaigns. Academics and policymakers have debated the necessity and wisdom of the Fed’s two quantitative easing initiatives. Unquestionably, the fiscal and monetary outlook of the United States is not nearly as rosy as it looked when President George W. Bush took office, a time when the United States was running a budget surplus.
Is the current situation in the United States so perilous, however, that we should worry about an imminent dollar crash? And if so, who would be to blame for an occurrence that would have far-reaching financial and geopolitical implications? In Exorbitant Privilege, a nuanced study of how the dollar became the international reserve currency and what the future might hold for the dollar, Barry Eichengreen concludes with his assessment, “that the only plausible scenario for a dollar crash is one in which we bring upon ourselves.” In contrast to those who contend that China can, or will, cause the dollar to crash, Eichengreen contends that the dollar’s fate is in our hands, making it “within our grasp to avoid the worst.” The United States, it would seem, is not a passive actor, merely biding its time before it is swept away by a rising China. Not yet anyway.
In this comprehensive and clearly written academic monograph, Eichengreen argues that, while the dollar is now by far “the most important currency for invoicing and settling international transactions,” this may not necessarily be the case in the future. According to Eichengreen, the dollar’s status as a reserve currency does not make as much sense now as it did fifty years ago when the United States was more economically dominant.
For much of the period since the Second World War, the United States benefitted from what former French finance minister Valery Giscard d’Estaing critically termed America’s ‘exorbitant privilege.’ The noted statesman was referring to Washington’s ability, due to the dollar’s sole status as the international currency, to run an external deficit amounting to the difference between what it must pay on its liabilities and the rate of return on the country’s foreign investments. In other words, cheap money from abroad allowed Americans to live beyond their means.
As specific examples of exorbitant privilege in action, the author cites how, in 2008, when the financial markets were in turmoil, Washington was able to borrow at low interest rates because foreign investors flocked to the dollar, believing it to be the safest currency at the time. Likewise, in 2010, when market volatility spiked, investors went for treasury bonds, lowering the cost of borrowing for the federal government and, subsequently, mortgage interest rates.
Eichengreen criticizes what he perceives to be the conventional wisdom regarding the dollar’s current status and its likely future. He contrasts the view that widespread use of a country’s currency internationally gives it geopolitical power with his belief that “it is a country’s position as a great power that results in the international status of its currency.” He also criticizes the notion that incumbency is exceedingly advantageous in the global competition for reserve currency status, citing how the dollar began to rival sterling by the mid-1920s shortly after the Federal Reserve system was established in the United States.
Most significantly, Eichengreen argues that, “the idea that the dollar is doomed to lose its international currency status is equally wrong.” Both the euro and the renminbi, he suggests, have their problems, arguing that, “the fundamental fallacy behind the notion that the dollar is in a death face with its rivals is the belief that there is room for only one international currency.” It is the author’s belief that the late twentieth-century, when the dollar reigned supreme as the world’s reserve currency, was unique by historical standards.
Eichengreen foresees the possibility of a global economy wherein countries bordering China may use the renminbi, countries close to the Eurozone utilize the euro, and countries transacting with the United States will make use of the dollar. Reserve currency status, therefore, may not be a zero-sum game. “The world for which we need to prepare,” contends Eichengreen, “is thus one in which several international currencies coexist.” The dollar may have future international competition, he suggests, but it won’t decline just yet because of external pressure from China.
In conclusion, the dollar is not about to crash tomorrow. Eichengreen is most likely correct in his contention that, “the plausible scenario for a dollar crash is not one in which confidence collapses on the whims of investors or as the result of a geopolitical dispute but rather because of problems with America’s own economic policies. The danger here is budget deficits out of control.” Sobering words indeed.
Jon Lewis (c) 2012
Eclipse: Living in the Shadow of China’s Economic Dominance. Arvind Subramanian. Peterson Institute for International Economics Press, 2011, pp.216, $21.95 It is too soon to ascertain whether the latest attempt by Europe’s political elites to deal with Greece’s public debt, and to salvage the Euro in the process, will result in anything remotely resembling a [...]
Eclipse: Living in the Shadow of China’s Economic Dominance. Arvind Subramanian. Peterson Institute for International Economics Press, 2011, pp.216, $21.95
It is too soon to ascertain whether the latest attempt by Europe’s political elites to deal with Greece’s public debt, and to salvage the Euro in the process, will result in anything remotely resembling a success. Although some in Europe hoped that Beijing would rescue the Continent from its economic morass, Chinese President Hu Jintao has downplayed a Chinese leading role in bailing out Europe.
Nevertheless, the recent statement by the head of the European Financial Stability Facility that the European bailout fund might one day issue bonds denominated in yuan is yet another indication that many observers increasingly perceive China as the world’s economic power broker. Furthermore, some Chinese officials have reportedly floated the idea of European borrowing in renminbi to lower China’s foreign exchange risks and to bolster China’s monetary policy internationally. This suggests that there are strategic-minded policymakers in Beijing who see the European debt crisis as an opportunity to advance national goals and is particularly interesting in light of China’s recent investments in non-dollar assets.
In Eclipse, Arvind Subramanian (Peterson Institute for International Economics and the Center for Global Development) contends that China is well on its way to being the world’s dominant economic power, and advocates for multilateralism as the best means of protection against China in the unlikely event that Beijing would decide to use its future economic dominance for less than benign means. This timely academic monograph begins with a chilling scenario set in 2021: a recently inaugurated Republican president heads to the office of the International Monetary Fund’s Chinese managing director to secure IMF financing. China is able to utilize its economic muscle within the IMF to make the removal of the U.S. Navy from the Western Pacific as a precondition for funding; the terms of the IMF agreement itself would force the United States to engage in tax increases, entitlement reform, and a substantial reduction in defense spending.
While Subramanian doesn’t necessarily believe that the situation will come to pass in this exact manner, he indicates that he does not believe it to be out of the realm of possibility either. Indeed, in the book’s postscript he writes as follows: “To clarify, the 2021 scenario described in the introduction is still very low probability one. But stranger things have happened, as the recent global financial crisis showed.”
That said, Subramanian does challenge the notion of American exceptionalism and, more significantly, the idea that if only the United States got its fiscal house in order, it could withstand China’s challenge to American economic dominance. Subramanian is skeptical of this line of argument; he is not convinced that Washington can successfully arrest China’s emergence as the dominant economic power. Readers will have to decide for themselves whether the author gives far too little credit to the quintessential American ability to overcome seemingly insurmountable obstacles, even if the cards are stacked against the United States.
What sets the author’s work apart from an already significant corpus of scholarly literature on China’s economic rise and America’s decline is his skillful utilization of quantitative methods. Subramanian creates an index of economic dominance in which resources, trade, and external financial strength are the three determinants. He employs that index both to compare several prominent economic powers past, present, and future. The results are sobering and should garner attention from both American policymakers and investors. Subramanian projects, for instance, that by 2030 China will likely become the dominant world economic power, eclipsing the United States much like the upstart former colony eclipsed the United Kingdom. Subramanian boldly contends that, not only is there a transition in economic dominance and reserve currency status, “but that the shift away from the United States toward China is more imminent, more broad-based, and greater in magnitude than is currently anticipated or contemplated.” He projects, for instance, that in 2030 China will account for close to 20 percent of world GDP and 15 percent of world trade. There is no particular reason for the reader to doubt these projections. That said, we are increasingly living in an uncertain world in which it is becoming increasingly difficult to predict what will happen next week, let alone twenty years from now.
In terms of currency dominance, Subramanian is less certain of impending Chinese supremacy. He contends that the three determinants for economic dominance – resources, trade, and external finances – also account for the status of a country’s reserve currency. “Together,” he writes, “they explain nearly 70 percent of the variation in reserve currency holdings.” That said, whether the renminbi will achieve reserve currency status is yet to be determined. Subramanian suggests that a transition to Chinese currency dominance “is far from inexorable. It will be conditional on China undertaking far-reaching reforms of its financial sector and exchange rate policies.” Subramanian is spot on when he writes that China is demonstrating its desire to elevate the renminbi’s status, “not least because internationalization of the renminbi offers China’s policymakers a possible exit from the current mercantilist strategy.” This is particularly salient in light of the European debt crisis and in Beijing’s all but certain role in helping to resolve it, at least in some fashion.
It should be noted that the author, subsequent to the publication of Eclipse, penned an op-ed for the New York Times in which he argues that China should play a considerable role in bailing out Europe. Whether increased Chinese influence in Europe, even if through multilateralism, is in the American national interest, however, is debatable. This is particularly true given the significant cultural and political ties between the United States and the European Union’s member states.
While Eclipse is clearly written and mostly avoids academic jargon, much of the material will be inaccessible to a general readership. Those with an academic background in economics or public policy, on the other hand, would find much to appreciate in Subramanian’s nuanced work. It behooves those who seek to take the Chinese challenge to American dominance seriously to give the author’s views ample and due consideration, particularly given the author’s acknowledgment that “[p]rojections of Chinese economic and currency dominance are of course conditional.” In conclusion, one need not agree with all of the author’s views to acknowledge that Eclipse is a serious book and that the author’s arguments should be taken seriously.
Jon Lewis (c) 2011