The Problem with Hoarding, or, Don’t Play a Game with Someone Who Can Change the Rules

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.