US Dollar: “I’m Not Dead Yet!”

Analyzing currencies is weird, and most people don’t get it.  Sometimes, I think I don’t get it.  There is nothing fixed in our economic world, no fixed measure of value.  Everything trades against everything else.  Currencies exist to make the trading easier.  Imagine a matrix that is millions by millions, with trillions of exchange rates for one good or asset against another.  With currencies, it simplifies.  Each nation prices out goods and assets in their own currency, and then currencies trade against each other, subject to arbitrage with commodities, and commodity-like assets.

Anyone who has read me for a while knows that I am not a bull on the US Dollar.  But where I part ways with the grizzly bears (call me a teddy bear :) ), is that the fundamental accounting identities must be maintained.  Whatever country of our world has the status of reserve currency must issue debt, and a lot of it, that other countries can invest in to park their idle cash balances.

It does not matter what currency crude oil trading, or any other trading, is denominated in; it does matter in what currency the proceeds from the sale of crude oil is invested in.  So long as the US runs current account deficits, foreigners must acquire US assets in order to fill in the gap.  In the past that has mainly been bonds — agency, mortgage, corporate, but increasingly Treasury notes.

It is not that easy to abandon the US Dollar.  Where do you go?  The yen will suffer for years as Japan heads into demographic decline and large structural budget deficits. The Euro is still an experiment; there are many pressures on it; its survival is mot assured. Nothing else is large enough or stable enough, or mature enough to run the deficits necessary to have the debt markets, to be the global reserve currency.  As an example, China does not want to run deficits, nor is its financial system strong enough to bear the wear and tear of global use of its currency.

So, when reporters write pieces indicating the imminent demise of the US Dollar, I don’t buy their arguments:

Other parties disagree with the worry:

If the money is not invested in US Dollar investments, where will they invest? That is the question.

Now, there are other issues. China  could queer global trade by asserting that entities in China could default on obligations from derivative contracts and not worry about it.  Why is this big?  If a major country does not respect contract law, that country will not be respected in global trade.  Granted, China is a creditor, not a debtor on net, but the ability to transfer capital is paramount in the global economy, and if China will not honor contracts, that will bite them.

Away from that, I was fascinated by Australia’s interest rate hike.  It makes me bullish on the Australian Dollar, even after its significant rise.  That said, don’t move too aggressively, because eventually US Dollar rates will rise.

My view is that the US is in a Japan-like funk, which it will not rise out of for years.  I don’t think the Fed will move aggressively — they will be timid.  It is easier to argue to Congress that they did their best but conditions were severe, than to argue that they headed off inflation, but many people were unemployed.

Unless Europe moves to a full political union, or China frees its economy, there is no real competitor to the US Dollar.  Yes, the dollar will likely decline over the next decade, but it will not be likely to lose its reserve status, unless a commodity standard currency comes into being.


  • I agree entirely with this. Whenever I interview fund managers and investment advisers who are down on the dollar (usually over disagreements with U.S. government and Federal Reserve policies) they find it almost impossible to explain what should go up and why in its stead. The Euro? You think we have debts and obligations! Duh…

    Well said, David.

  • But What do I Know? says:

    To paraphrase Winston Churchill, the dollar is the worst currency except for all the others.

  • David Pearson says:

    Most people who argue “the world will always hold dollars” make one or both of these points: 1) they will as long as we run a C.A. deficit; and 2) there are no alternatives. Both points make an implicit assumption that foreign demand for goods is static. There is no support for such an assumption.

    The Chinese, for instance, can at any moment decide to exchange their dollars for U.S. goods. The argument is made, sometimes, that they cannot for “structural” reasons: lack of consumer credit, retail infrastructure, etc. Nonsense. I can point to countless examples of emerging economies that ran large trade deficits on the back of consumer spending booms. The reason China doesn’t is primarily a function of state-directed credit (a policy that could change) and the under-valued Yuan. Please trust me when I say that countries, like Brazil, have easily run up large trade deficits on the back of over-valued exchange rates and money-printing.

    So, you are basically saying, the U.S. will continue to run large C.A. deficits because foreigners will continue to prefer dollars over goods. Yet the very essence of inflationary expectations is that actors should prefer goods over dollars. So, you are basically making a prediction about the Fed’s willingness to accept deflation. You may be right, but it is my no means the kind of certainty that you propose in your post.

  • João Carlos says:

    “[…] unless a commodity standard currency comes into being.”

    Yes, it is. That is your answer. It is being made. Slowly, trying to not be noisy, but it is being made. USA governement don’t like it, but it can do nothing about it.

    Remember, money is an illusion. We call money everything we want to call money. If we call bull “money’, then we will have the “bull-money”. And so the latim word “pecus” will be the origin of the word “pecuniary”. And “peculate”, Madof’s style.

    The only real thing is the goods you can make. China can make everything. USA can make only derivatives. And mcmansions. But macmansionas aren’t goods you can ship to other countries.

    It is not a capitalism’s crisis, it is a hegemony’s crisis.

  • David, I appreciate your thoughts. My main point here is not that the US Dollar will not eventually be replaced as the global reserve currency — it will be replaced eventually, but there will be a lot of “sturm und drang” in the process.

    I have two pieces on international economics coming up in the next week which will make this clearer, but until major nations give up neomercantilism, keeping their currencies artificially weak, they will have to keep absorbing US Dollar claims. It’s a lousy way to run the global economy, but they are the active parties in this mess. The US is in some ways the most flexible economy in the world, taking the other side of the trade on imbalances actively foisted on the world by the neomercantilists.

    João — I would like to see a commodity currency. It would be a good thing for all in the long run. In the short run, it would likely lead to economic contraction, as monetary debasement would be more difficult, and asset reflation would slow.

    Yes, it is hegemony’s crisis. The US Dollar is a symbol of a greater reality. But just as it is tough to replace the Dollar, what nation could replace the US in world affairs? (I write as one that has not favored our foreign policy over the last eight years.)

    Who could replace the US? Who does the world trust? Who has the strength? Who has the ability to act when needed? The US is the best of a bunch of bad options — both as a currency, and as a Hegemon (leader).

  • Three other notes:

    1) BWDIK — yeah, my conclusion too, and Caroline Baum’s as well (last I saw).

    2) The price of the tradeoff for goods for US debts will continue to erode. I am a US Dollar bear over the long run. That doesn’t mean there can’t be occasional sharp rallies if Fed policy tightens. With dollar lending funding more carry trades, the situation becomes more volatile, with all of the hot money.

    3) This makes the shortening of maturities of US Treasury debt more worrisome. The amount to roll over will grow dramatically in the next five years.

  • David,

    I’m not sure if you saw me as one of the pundits predicting an imminent demise for the dollar. But, in case it wasn’t clear from my post, i am pretty much in agreement with your sentiments:

    “the US Dollar will not eventually be replaced as the global reserve currency — it will be replaced eventually, but there will be a lot of “sturm und drang” in the process.”

    And I really don’t buy the story that the Chinese are ready to dump the dollar here and now. Then they replace it with what? As George Soros has said, “the dollar is a very weak currency except all the others.”

    • Edward, no I didn’t. I like your work. If I did a rewrite, I would have mentioned your piece below, and not grouped it with the first piece, of which I was critical. My apologies.

  • Josh Stern says:

    Seems like there is some huge money being made accommodating investors desire for liquid commodity investments:

    Who are the main players making that profit?

  • RichL says:

    I know that purchasing power parity is less important than interest rates for the carry trade in affecting currency rates, but it is REALLY expensive to live in Europe vs. the US. And the last time I checked, Harvard and MIT accept dollars for tuition.

    Some less restrictive policies by the US govt. to make it easier to visit the US would help the current account deficit. Tax policies that tax consumption rather than income would go a long way toward making the US more attractive as a place to employ, rather than fire, people.

  • Frank says:

    David – one would like to think that not honouring contracts will bite them, but it depends on market power, which the Chinese are developing more and more. A similar situation developed in the early nineties with the California PUC ordered utilities there to break long term natural gas purchase contracts to take advantage of the much lower spot price. California has its problems, but I don’t think they ever suffered ill effects from that decision.

  • spyros says:

    why should we have only one safe haven currency? with reference to euro drawbacks, it is my belief that the lack of a strong debt market is an advantage as there is no room for supply shocks.

  • “Whatever country of our world has the status of reserve currency must issue debt, and a lot of it, that other countries can invest in to park their idle cash balances.”

    I made this point in more detail elsewhere today, but instead of having surplus countries buy up U.S. debt to satiate their demand for dollar-based assets, why doesn’t the U.S. government offer them an equity-like investment instead? Specifically, why not offer shares in a sort of massive master limited partnership that would invest its assets in nuclear power plants and other infrastructure, and pay dividends out of the revenues generated from those infrastructure assets?

    Unlike the proceeds from the sale of Treasuries, which can go to fund transfer payments and health care for retirees, or extended military expeditions, proceeds from the sale of shares in this master limited partnership would go toward increasing productive capacity, which would fuel future economic growth in the U.S.