My god, am I inundated by articles surrounding the dollar and its global role these days.
In the last 24 hours, the algos (correctly) think I want to read The Economist ("How a Dollar Crisis Would Unfold") and the FT ("The US would be better off without the global dollar") on the topic
Today, it's Economic Forces day, and Josh delivers... a piece on dollar dominance. My lord:
tl;dr
at low levels of [gov] debt, what we call exorbitant privilege is obviously a net positive. However, once debt becomes sufficiently high, the nature of this exorbitant privilege becomes somewhat tenuous as higher levels of debt increase the risk that the system will break down.
Alright, let's go.
the claims made about the costs of the [global dollar] system pose important questions that one should attempt to answer. Economics is fundamentally about tradeoffs. This implies that most institutional arrangements will have both costs and benefits I see this as especially important because the arguments being made about the costs of the system are not particularly new.
Josh walks us through a basic int-trade textbook model where flexible FX adjusts the balance of trade over time. In reality, some countries don't behave that way:
the U.S. runs persistent trade deficits that do not self-correct. In fact, many times, the dollar appreciates while the U.S. is running trade deficits. How can we explain this phenomenon?
"The reason that the U.S. is different is that the dollar is the primary currency used in global trade."
So the feedback loop gets short-circuited since foreigners are happy to absord the money balance of dollars and/or American assets. ("since the dollar never sufficiently weakens, re-shoring rarely occurs.")
One benefit of the system is that the U.S. never has to worry about its balance of payments. Since trade is invoiced in dollars, the U.S. doesn’t ever have to worry about having a shortage of dollars. This isn’t true of other countries. The dollar’s global status gives the U.S. the ability to supply the rest of the world with cheap pieces of paper in exchange for valuable goods and services. When framed in that way, it certainly seems like the U.S. is getting a great deal.
Epic use of memes:
Costs:
The rest of the world has a flow demand for dollars. The U.S. supplies that flow demand by running trade deficits with the rest of the world. Imagine that U.S. trade deficits are not large enough to meet global demand. What would happen? The simple answer is that the world price of the dollar would rise to meet global demand. Or, in other words, the dollar would appreciate relative to all other currencies.
Awesome... Muricans get more foreign stuff for less hassle
...but, foreign labor gets cheaper, and so production gradually shifts away from the US.
the position of the administration seems to be that trade should reflect genuine differences in comparative advantage. However, the shifts in the pattern of production I’ve just described have little to do with comparative advantage or natural cost advantages and much more to do with fluctuations in the relative strength of the dollar.
NATIONAL DEBT
...and here Josh goes into his long chapter on the Treasury Standard in The Satoshi Papers (#945026).
the U.S. Treasury security is the global reserve asset. In other words, as those dollars flow abroad, foreign banks and financial institutions don’t simply sit on a pile of dollars. They store these dollar balances over time by purchasing U.S. Treasury securities Since these holders of dollars need to hold dollars and since they would prefer to earn a rate of return, they become passive (i.e., price-insensitive) buyers.
Now that I've quoted so much from Josh, I guess you might as well have gone and read it yourself. No need for purple monkeys as middlemen
Then a lengthy convo about a paper by Emmanuel Farhi and Matteo Maggiori on what's essentially the global monetary hegemon and exorbitant privilege ("the model suggests that at a sufficiently high level of debt, this state of affairs becomes unstable and susceptible to self-fulfilling prophecies of collapse."):
Farhi and Maggiori derive three different ranges of debt based on its magnitude. If debt is sufficiently low, the rest of the world will never expect the hegemon to devalue. Furthermore, if debt is sufficiently high, the rest of the world expects the hegemon to devalue with absolute certainty. Finally, there is an intermediate “instability" range of debt in which, under some conditions the hegemon has an incentive to devalue and other times does not. No one knows for certain. Thus, in this intermediate range, the rest of the world must simply assign some probability to its beliefs about devaluation.
"The model is one of strategic interaction. The hegemon chooses its amount of debt based on its expectations of the beliefs that the rest of the world will form."
The trade-off that the hegemon faces is that issuing more debt increases its benefit from serving as the bank to the rest of the world (its exorbitant privilege). However, the more debt that it issues, the more likely the hegemon faces discontinuous increases in the rest of the world’s subjective probability that it will devalue.
Implications
Whatever you think of the Trump administration’s actions over the last several weeks, it seems clear from their rhetoric that they are concerned about the stability of the system given both the magnitude and the trajectory of U.S. government debt.
"The lesson of this post is that they could be wrong in their assessment, but that their argument is not obviously ridiculous."
So yea... that's it. Dollar dominance ending?