--- Begin Message ---
Ric:
You may want to put the following article from the current issue of THE
ECONOMIST on the pktnet. Although they do not get my message
absolutely right, they do spell my name correctly -- and that's
important
Economics focus
The dollar and the deficit
Sep 12th 2002
From The Economist print edition
Why the dollar still rules the
world?and why the world should be grateful
THE dollar is looking vulnerable. It is propped up not by the
strength of America's exports, but by vast imports of capital. America, a
country already rich in capital, has to borrow from abroad almost $2
billion net every working day to cover a current-account deficit forecast
to reach almost $500 billion this year.
To most economists, this deficit represents an unsustainable drain on
world savings. If the capital inflows were to dry up, some reckon that
the dollar could lose a quarter of its value. Only Paul O'Neill,
America's treasury secretary, appears unruffled. The current-account
deficit, he declares, is a ?meaningless concept?, which he talks about
only because others insist on doing so.
The dollar is not just a matter for America, because the dollar is not
just America's currency. Over half of all dollar bills in circulation are
held outside America's borders, and almost half of America's Treasury
bonds are held as reserves by foreign central banks. The euro cannot yet
rival this global reach. International financiers borrow and lend in
dollars, and international traders use dollars, even if Americans are at
neither end of the deal. No asset since gold has enjoyed such widespread
acceptance as a medium of exchange and store of value. In fact, some
economists, such as Paul Davidson of the University of Tennessee and
Ronald McKinnon of Stanford University, take the argument a step further
(see references at end). They argue that the world is on a de facto
dollar standard, akin to the 19th-century gold standard.
For roughly a century up to 1914, the world's main currencies were pegged
to gold. You could buy an ounce for about four pounds or twenty dollars.
The contemporary ?dollar standard? is a looser affair. In principle, the
world's currencies float in value against each other, but in reality few
float freely. Countries fear losing competitiveness on world markets if
their currency rises too much against the greenback; they fear inflation
if it falls too far. As long as American prices remain stable, the dollar
therefore provides an anchor for world currencies and prices, ensuring
that they do not become completely unmoored.
In the days of the gold standard, the volume of money and credit in
circulation was tied to the amount of gold in a country's vaults.
Economies laboured under the ?tyranny? of the gold regime, booming when
gold was abundant, deflating when it was scarce. The dollar standard is a
more liberal system. Central banks retain the right to expand the volume
of domestic credit to keep pace with the growth of the home
economy.
Eventually, however, growth in the world's economies translates into a
growing demand for dollar assets. The more money central banks print, the
more dollars they like to hold in reserve to underpin their currency. The
more business is done across borders, the more dollars traders need to
cover their transactions. If the greenback is the new gold, Alan
Greenspan, the Federal Reserve chairman, is the world's alchemist,
responsible for concocting enough liquidity to keep world trade bubbling
along nicely.
But America can play this role only if it is happy to allow foreigners to
build up a
huge mass of claims on its assets?and if foreigners are happy to go
along. Some economists watch with consternation as the rest of the
world's claims on America outstrip America's claims on the rest of the
world. As they point out, even a dollar bill is an American liability, a
promise of ultimate payment by the US Treasury. Can America keep making
these promises to foreigners, without eventually emptying them of value?
According to Mr Davidson, the world cannot risk America stopping.
America's external deficit means an extra $500 billion is going into
circulation in the world economy each year. If America reined in its
current account, international commerce would suffer a liquidity crunch,
as it did periodically under the gold standard. Hence America's deficit
is neither a ?meaningless concept? nor a lamentable drain on world
savings. It is an indispensable fount of liquidity for world trade.
Spigot by nature
But is the deficit sustainable? Many
of America's creditors, Mr McKinnon argues, have a stake in preserving
the dollar standard, whatever the euro's potential charms. In particular,
a large share of America's more liquid assets are held by foreign central
banks, particularly in Asia, which dare not offload them for fear of
undermining the competitiveness of their own currencies. ?Willy nilly,?
Mr McKinnon says, ?foreign governments cannot avoid being important
creditors of the United States.? China, for one, added $60 billion to its
reserves in the year to June by ploughing most of its trade surplus with
America back into American assets.
This is not the first time America's external deficits have raised alarm.
In 1966, as America's post-war trade surpluses began to dwindle, The
Economist ran an article entitled ?The dollar and world liquidity: a
minority view.? According to this view, the build-up of dollar claims by
foreigners was not a ?deficit? in need of ?correction?. Rather, the
American capital market was acting like a global financial intermediary,
providing essential liquidity to foreign governments and enterprises. In
their own ways, Mr Davidson and Mr McKinnon echo this minority view
today. A ?correction? of America's current deficit, they say, would
create more problems than it would solve. Whether the world's holders of
dollars will always agree remains to be seen.
?Financial Markets, Money and the
Real World? by Paul Davidson. Edward Elgar 2002.
?The International Dollar Standard and Sustainability of the U.S. Current
Account Deficit? by Ronald McKinnon 2001. Available on
www.stanford.edu/~
mckinnon/papers.htm
|
|
| Copyright © 2002 The
Economist Newspaper and The Economist Group. All rights
reserved. |
|
|
|
|
Paul Davidson
Editor, JOURNAL OF POST KEYNESIAN ECONOMICS
Economics Department - University of Tennessee
503 SMC
Knoxville, Tennessee 37996-0550
work phone: (865) 974-4221
fax: (865) 974-4601/ (865) 974-1686
home phone and fax (865) 692-0802
--- End Message ---