If Davidson were Greenspan...?

["John Gelles" <johng@xxxxxxxxxx>]

    If Davidson were Greenspan Would He Want
            To Free the Dollar from Debt?

The other day Ric Holt published the Economist on
its own past recognition of the dollar as a modern
gold substitute and our own Paul Davidson's and
Stanford's Ronald McKinnon's similar views.

[The original email message was difficult for me to
read--I've taken liberties with its paragraphing and
reprinted it below.]

The total piece in the economist, and Paul, take issue
with Secretary O'Neil's thought that America's trade
deficit is "meaningless". They find meaning in the
deficit:  it helps other nation's money to work better
than gold might do if the deficit were a surplus.

It is easy to agree with what is presented as Economist,
Davidson and McKinnon thought. It is also easy to re-
member that Greenspan is not happy with the thought
that America might radically cheapen its currency in
the interest of its real economic power "to leave no one
behind."

President Bush came to power promising "to leave no
one behind".  We have since been treated to the spec-
tacle of how his contributors, friends and family have
not left themselves behind:  they took extreme advantage
of corporate power to create fortunes for people at and
near the top while leaving many workers, customers and
investors behind.

Now not Bush, O'Neil or Greenspan are calling for
management of the dollar to leave no one behind--per-
haps because the system they have inherited appears to
experts to be "as good as it can get on Earth".

We do know that Greenspan is not keen to see America
spend to do right by its poor and the environment. He
does not object to his bank's monopoly over the dollar.
He does not ask for Lincoln's greenbacks to allow the US
to buy the weapons of peace and green growth.

Were he to ask for these debtless dollars to supplement
credit and CB monies, to not only ensure "liquidity for
some" but to ensure "production for as many as possible",
he would need Congress to take notice and act.

In reading the interesting piece in the Economist, I won-
dered if Davidson would like to free the dollar from
debt and have Congress spend it into circulation to
wage peace.  Would he want this as the CB continued
to help other nations use dollars as gold or otherwise
pull up their socks and manage greenbacks of their own?

    John Gelles
=====================================

                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 unsustain-
able 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 Stan-
ford University, take the argument a step further (see
references at end). They argue that the world is on a
defacto 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 dollar; 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 com-
pletely 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 eco-
nomy.

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 dollar 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 per-
iodically under the gold standard.

Hence America's deficit is neither a "meaningless con-
cept" 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 sur-
pluses 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
http://econ.bus.utk.edu/davidsonextra/Davidson.html