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Wednesday, October 20, 2010

The Dollar, Multiple Reserve Currencies, and Obama at Halftime

Due to travel today, a reception this evening, a talk in the early morning, a class to teach late tomorrow afternoon after returning, and the cold I caught yesterday, I don't know how much I'll be able to do until late tomorrow. So here's a few things from Project Syndicate that might be of interest in the interim (I also haven't been able to get to comments for the last two days, and I apologize for that I'll catch up as soon as I can):

The Future of the Dollar, by Martin Feldstein, Commentary, Project Syndicate: ...The goal of a strong dollar at home has guided the Federal Reserve at least since Paul Volcker crushed inflation in the early 1980’s. ... For decades, US Treasury officials have insisted that “A strong dollar is good for America.” But that slogan has never been a guide to official US action in international markets.
The Treasury does not intervene in currency markets to bolster the dollar, and the Fed does not raise interest rates for that purpose. Instead, the US stresses to foreign governments that an effective global trading system requires not only the removal of formal trade barriers, but also the absence of policies aimed at causing currency values that promote large trade surpluses.
In recent years, countries around the world have accumulated very large volumes of foreign exchange, topped by China with more than $2 trillion... The US dollar is and will remain these countries’ major investment currency...
The major risk to the sustained role of the dollar is the large and growing US national debt. ... Foreign investors might ... fear that future US administrations will be tempted to reduce the real value of that debt by allowing a higher inflation rate. But that is unlikely, given the Fed’s general anti-inflationary consensus...
But foreign investors ... could still have reason to worry that the US might someday try to reduce the value of its debt in a way that adversely affects them but not Americans... This need not mean outright default; a plan to repay principal and interest with low-interest securities rather than cash – or to withhold income tax on interest earned from government bonds, crediting those taxes against the obligations of American taxpayers – would achieve the same result.
While such policies are extremely unlikely, fear of such possibilities could cause foreign investors to shun the dollar. ... The best protection of the dollar’s future role – and of the health of the US economy – will be policies that reduce the growth of the national debt.

Barry Eichengreen continues the discussion on whether the dollar will remain the world's reserve currency:

A World of Multiple Reserve Currencies, by Barry Eichengreen, Commentary, Project Syndicate: The competition for reserve-currency status is conventionally portrayed as a winner-take-all game. There is room, in this view, for just one full-fledged international currency. ...
Market logic, it is argued, dictates this result. For importers and exporters, quoting prices in the same currency ... as other importers and exporters avoids confusing one’s customers. For central banks, holding reserves in the same currency as other central banks means holding the most liquid asset. With everyone else buying, selling, and holding dollars, it pays to do the same...
But this premise is wrong, for three reasons. First... Once upon a time, comparing prices in dollars and euros might have been beyond the capacity of all but the most sophisticated traders and investors. Nowadays, “Currency Converter” is one of the Apple app store’s top ten downloads.
Second, the sheer size of today’s global economy means that there is now room for deep and liquid markets in more than one currency.
Finally, the view that there can be just one international and reserve currency at any point in time is inconsistent with history. Before 1914, there were three international currencies: the British pound, the French franc, and the German mark. ...
The implication is that the dollar, the euro, and the renminbi will share the roles of invoicing currency, settlement currency, and reserve currency in coming years. To be sure, all three currencies have their critics. ... But the very fact that there are questions about all three currencies means that none of them will obviously dominate. ...
Some worry about the stability of this world of multiple international currencies. They shouldn’t: a more decentralized international monetary system is precisely what is needed to prevent a replay of the financial crisis. ... No one country will be able to run current-account deficits and use foreign finance to indulge in financial excesses as freely as the United States did in recent years. This will make the world a safer place financially. ...

Finally, Michael Spence on what the Obama administration could have don differently during its first two years:

Obama at Halftime, by Michael Spence, Commentary, Project Syndicate: In September 2008, the global economy and financial system was hit by an earthquake, whose epicenter was in the United States. ... The presidential election was two months away. The timing, from the point of view of crisis management, could not have been worse. ...
The Obama administration ... assumed responsibility for organizing the government’s efforts to boost recovery, the centerpiece being a large stimulus package... After its enactment in late February 2009, the markets’ downward plunge began to decelerate, and prices stabilized...
The Obama administration was not responsible for poor US economic performance in the immediate post-crisis period; that was inevitable. But it was responsible for allowing flawed expectations of a sharp recovery ... to persist. And that left the administration open to the charge that bad policy was the cause of poor economic performance.
The administration needed to see – and to say – that the debt-fueled pre-crisis economy was on a dangerously unsustainable path, and that the challenge now, having averted a depression, was to make a difficult transition to a new path. Instead, it treated the Great Recession as similar to others in the recent past, albeit deeper. ...
And now, as the administration shifts to a more central focus on restoring growth and employment, it risks getting bogged down as declining economic performance relative to expectations translates into waning political support.
The administration is not entirely to blame... It has had to deal with a widespread and understandable loss of confidence in elites – academics, policy analysts, Wall Street, business leaders, regulators, and politicians – which makes implementing pragmatic, centrist policies more difficult. This phenomenon precedes the crisis, but the crisis has certainly made it worse. Elites, after all, failed to see the crisis coming and to take steps to prevent it, and some of them appear to be the only ones who are recovering: profits are up, but employment is not.
Moreover, many Americans’ anxiety is rooted in deepening income inequality. The economic and political implications of this long-term trend have been widely discussed but left largely unattended, betraying the general lack of concern for distributional issues that shadows elites’ excessive faith in markets to provide beneficial outcomes.
Indeed, a lack of clarity about means and ends spans American politics. Markets, regulatory frameworks, and public-sector investments are means to attain shared goals. The administration, political and policy elites, and private-sector leaders need to state clearly that the main goal of domestic economic policy and strategy is to reestablish a pattern of inclusive growth and employment. ...
Obama needs to take the lead in redirecting a highly polarized political environment engaged in a debate about the appropriate role and size of government toward a more pragmatic, results-oriented agenda.

    Posted by on Wednesday, October 20, 2010 at 02:07 PM in Economics | Permalink  Comments (12)


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