US 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. The question becomes who 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 where US goods are irresistible, but we aren’t there yet.
And, we are putting out more dollar claims. Witness the trade deficit and the record US 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 US, 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 fees recession, or at least economic slowing. in nations that allow their currencies to rise to restrain inflation.
So, back to my title. Hoarding US dollar reserves brings no advantage after a certain point, particularly when many are doing it. There is nothing scarce about dollar claims. Take the rest of the title: would you play a game with someone who can change the rules against you? Lending to the US in US Dollar terms is exactly that. The US mouths a strong dollar policy while pursuing a weak dollar policy. Who in the US 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 US Dollar, and a lack of willingness for foreigners to accept payment in US Dollars. Or, massive foreign demand to buy US companies, not debt. Or, nations that stop subsidizing their exporters, because the inflation becomes too great, and allow their currencies to appreciate. Maybe we see this in a few years, but certainly by 2020.
Or a move to the Euro as a reserve currency?
As long as China’s economy is growing annually by 9% or so, they don’t want to rock the boat. Recall that Japan’s economy was growing by almost that much until the oil crisis in 1973-74; but after that, never again at that lofty rate. When the current unsustainable situation comes apart, we will find ourselves in a new era when the dust settles, probably with far less public support for trade and globalization and substantially lower rates of growth. The Chinese government’s legitimacy in the eye of its people rests almost entirely in its ability to deliver prosperity; they need the high-growth status quo to continue as long as humanly possible, and maybe just a bit longer.