Several years ago (June 2006) I wrote an article advancing a new theory of why the dollar is the world’s dominant currency and why it is likely to remain so. The article was published in the midst of the last boom and sank like a stone. But now debate about the cause of the dollar’s hegemony has been revived in an interesting paper by Fields and Vernengo titled “Hegemonic currencies during the crisis: The dollar versus the euro in a Cartelist perspective” (also here). Their paper provides an opportunity to revive discussion, so I am posting the article again. Here it is (subject to a couple of word edits)Thomas Palley
A Keynesian Theory of Hegemonic Currencies – Or Why the World Pays Dollar Tribute
Thomas I. Palley
24 comments:
I'm afraid I don't understand the buyer of last resort theory. People are willing to give their industrial output away for dollars just because they can't find anything else to trade it for domestically?
Isn't it rather the case that when people get dollars for their output, they receive in return both purchasing power equivalent in value to the goods they gave away, and a fairly secure saving vehicle.
Why is this "tribute"? Many people also seek to acquire gold for reasons similar to the reasons they acquire dollars. Is this tribute to the gold gods?
It's an interesting question how the dollar acquired the globally pervasive exchange value it possesses, and how it maintains that value. But given that it has that value, there isn't that much mystery about why people seek to obtain dollars. You can buy a lot of good stuff with them.
Dan, a state must create a demand for its currency to give an otherwise worthless piece of paper value, and this is done as we know by making taxes payable only "in the coin of the realm," i.e., state money.
The US took a step further to create demand for USD internationally by establishing the USD as the medium of exchange for obtaining crude oil. Since oil is the predominant energy source for the world economy, and most countries are oil importers, it follows that they must obtain USD.
Moreover, the US being the largest economy and the American consumer reliable prior to the crisis, exporters had to save in USD in order to continue exporting at the desired volume to the US. This also created a demand for USD unless countries either wish to run balanced trade or acquire US assets.
This demand creates an "extraordinary privilege" for the USD that Henry C. Liu dubbed "dollar hegemony."
Tom, taxation is not the only way a state creates value for its money. A broad collection of laws and institutions work together to preserve the primacy of a single currency in the domestic economy. Also, all countries with a sovereign currency collect taxes in that currency. So the fact that the US does this, and that that is part of the way they create domestic demand for the currency, does nothing to explain why the dollar would be the world's chief reserve currency.
The USD is the medium of exchange for crude oil because the producers of crude oil prefer dollars to other possible media of exchange. That is part of the phenomenon to be explained, not the explanation of the phenomenon.
The dollar has value primarily because the US - despite its trade imbalance - is a huge exporter of goods and services in high global demand, and so people want dollars so they can buy those goods and services. The US also has a track record of avoiding significant inflations, and that is another reason.
The Eurozone is a larger export market than the US, but the Euro is a riskier savings vehicle as we have seen, because the Eurozone has no organized way of restoring its economic vitality in the face of crisis. The Chinese export more too, but their currency policy is mysterious, and tied to the dollar.
Yes, there is dollar hegemony. People always want there to be a stable medium of exchange, and tend to settle rapidly on the one from the largest economy, with the most diverse and expansive collection of things available to buy in that currency. That does give the US advantages that others don't have. But I think this is just the way of the world.
Dan, what I presented was the thinking behind dollar hegemony.
MMT economists disagree with most of it.
Laws, institutions, safety all come into it certainly. You can add the ease with which USD are exchanged, liquidity in asset markets, too. Don't forget another element that locks in USD hegemony - the institutions set up after the war such as IMF, World Bank and so on, use USD, with the result that many countries are forced to borrow them, and also have then historically pegged their currencies.
Being the issuer of the World’s premier currency does confer “extraordinary privileges” as Tom puts it. It’s much like private banks which create and lend out money: that’s a nice little earner as long as it’s done in a competent manner.
But it’s a privilege that the issuer cannot abuse too much. If inflation gets too high in the US relative to elsewhere, the world will then tend to dump dollars. The dollar would decline relative to other currencies. US citizens would then find it much more expensive to import stuff from elsewhere. Plus they’d find themselves working to produce goods for consumption elsewhere, rather than to consume themselves. I.e. the net effect would be to reduce US living standards.
“Buyer of last resort” is mercantilism stated in terms of capital account deficits rather than current account surpluses.
In terms of “last resort”, it’s a passive use of that term that analogizes very roughly to central bank LLR.
The US generates dollar BLR "buying" just like banks that go to the window generate LLR.
The US spends more than it earns; some banks lend more than they fund, ex LLR.
JKH, I understand all of those facts but they don't appear add up to Palley's third theory.
Dan,
Isn’t that third theory just the dark, unsustainable side of mercantilism?
And when he says:
“Put bluntly, the tribute other countries pay the U.S. through their trade surpluses is the result of their failure to generate adequate consumption spending in their own markets, be it due to poor income distribution or bad domestic economic policies.”
I’m not sure what “tribute” is supposed to mean in its original "pristine" use, but it is effectively neutered and meaningless in its application here, because it’s simply an accounting consequence of mercantilist dynamics.
JKH, you might be right, but I'm not sure I understand the mercantilist element here.
Is Palley arguing that the purchasing power in dollars that people receive from Americans for their exported goods is not equal in value to the value of the goods that are exported? Is he claiming that people in other countries are compelled to export goods at some kind of loss because they cannot sell them domestically?
If the US runs a trade deficit, isn't that mainly because people who acquire dollars abroad through export transactions choose to save a high proportion of them rather than turn them around to make purchases of US goods?
I think his 3rd theory description is pretty consistent with the basic MMT story for the US foreign sector, which is demand for net financial assets in association with foreign current account surpluses. Both are the capital account version of Mercantilism. What may not be consistent with MMT is that he’s implicitly arguing this is not sustainable, even in the case of the US. Others around that time (2006) were very aggressively arguing the same thing – particularly Nouriel Roubini and Brad Setser. They turned out to be dramatically wrong, at least in terms of timing. My understanding of the MMT argument, particularly Mosler’s, is that sustainability in the case of the US is no big deal, due to fiat currency sovereignty etc. But Palley is arguing at least implicitly that it’s unsustainable, when he compares two alternative outcomes for its demise – creation of more foreign domestic demand or collapse in the US consumer’s willingness to continue to net import. And he’s also implicitly arguing that foreign nations need to pursue domestic demand policies in order to “correct” the imbalances.
I thought mercantilism was the doctrine that nations should seek to run positive balance of trade and accumulate the medium of exchange. Palley seems to be criticizing nations for doing just that.
My understanding of the MMT approach is that a trade deficit is sustainable for a monetarily sovereign country so long as other nations are willing to accumulate your currency - not that trade deficits are sustainable without qualification.
Dan: "Why is this "tribute"? Many people also seek to acquire gold for reasons similar to the reasons they acquire dollars. Is this tribute to the gold gods?"
This is interesting...
I have a tendency to agree with Dan and dont think this activity is per se "tribute" as "tribute" per se is like a tax:
Paul here: "6 For therefore you are settling taxes also, for they are God's ministers, perpetuated for this self-same thing.
7 Render to all their dues, to whom tax, tax, to whom tribute, tribute" Romans 13
So these foreign countries DO NOT have a tax or tribute liability to the US. So I dont think "tribute" is perhaps appropriate here...
Nevertheless, these foreign entities are somehow compelled to use and hoard USDs (and Euros btw)... these are two types of what the Greeks and the Romans called "nomisma".
Aristotle here (who was probably there when these systems were designed):
"Nomisma by itself is a mere device which has value only by nomos (law) "
So the USD has VALUE by law...
"we call it nomisma, because its efficacy is due not to nature but to nomos (law)"
And the USD has EFFICACY by law.
So the USD has VALUE and EFFICACY... by LAW, yet these foreign countries are NOT UNDER US LAW.... but nevertheless they zealously seek the USD for it's value and efficacy .... hmmmmm....
Are they "running away" from gold? and running towards nomisma in the current form of the USD?
This would be interesting as many morons actually IN the US govt (Ron Paul, etc) are running away from the USD and trying to run towards gold, yet these foreigners shun gold and instead want the USDs and they dont even have anything to do with the USD by law....
Quite ironic... who is who in all of this???
Rsp,
Matt what foreigners are you talking about?!
Please read the thread above this one (http://mikenormaneconomics.blogspot.com.es/2012/08/kenneth-thomas-us-trade-deficit-largely.html), all of you should do it.
This is just an other case of kleptocracy at work. The whole governing system is designed towards looting of the majority by a minority. USA deficits are off course no different, is just a case of corporate and wealthy looting.
JKH is correct IMHO, and states it every nicely.
In a fiat system where other countries save in the importers "paper," really accounting entries, the tribute is the advantage to the importer in real terms of trade, whereas it use to be gold or silver to the exporter under the previous mercantilism. Now we have "neo-mercantilism."
As WArren has pointed out, other countries are depriving their own people of their resources including labor to accumulate financial claims in a foreign currency (USD) that don't benefit their people correspondingly. For example, China is repressing its consumption sector to benefit its investment sector through exports.
Moreover, as W pointed out when he was president, the trade deficit is offset by both US FDI abroad and its tremendous earning power. See the post I put up about a good % of the trade deficit being intra-firm wrt US multi-nationals.
Lev,
These:
http://www.treasury.gov/resource-center/data-chart-center/tic/Documents/mfh.txt
Rsp,
PS Maybe since the US was the first nation to lead the human out of the last bout of global "metal love", via the two separate actions of metal repudiation by FDR in 1933 and Nixon in 1971, the ROW has come piling in to the USD and away from the metals???
This beginnings of the huge US CAD and external deficits could probably be traced back to Nixon's action in 1971 and continues to present... if Ron Paul gets his way wrt bringing back gold, kiss this current situation goodbye...
there would be no reason for an external entity that was "anti-gold" to remain in the USD as the USD would then be based on gold...
Rsp
Lev,
Ive read the article above. Excerpt:
"Why does Apple have $64 billion in cash abroad?"
Apple can claim these profits for GAAP financial reporting but then NOT claim them for tax pruposes because I do not believe they are actually IN USDs but rather that is the USD exchange value of Apple's foreign profits in the foreign currencies.
iow if the morons at Apple US were to call Apple Europe and say: "hey, send the $64B dollars over here to HQ here in the US we need them here now", the guy at Apple Europe would say: "what USDs are you talking about? we dont have any!".
The author says "Apple has $64B in CASH": wtf does that mean???? What is "cash"????
JKH can explain this better, I believe JKH has described it as "apple is going to have to find someone outside the US to trade their forex holdings for USD liabilities before they can "repatriate the dollars"....
Also, that article you refer to is written from the context of "govt NEEDS the money" and hence is misleading...
Rsp,
Matt,
As of their last quartly earnings report Apple is said to have $117 Billion in "cash". When you look at their balance sheet it shows most of it is in "marketable securities" of assorted maturities.
Don't know exactly how the financial press comes to these conclusions but the trajectory of Apple's "cash" has been reported fairly consistently over the past 15 years or so.
In other words, wrt the framing of financial reporting what constitutes "cash"?
Paul it is probably short term securities in US, Europe, Japan, Brasil, etc... The value of these securities are marked to market based on the average quarterly forex rates and they report it in their GAAP in USD....
There is a good paper from the BEA here:
http://www.bea.gov/international/concepts_estimation_methods.htm
Ive talked to folks at BEA a while back and they said that if a US Corp had a foreign subsidiary, any profits they earned abroad does not reflect in the ITAs... the foreign subsidiary is treated as a completely foreign entity for BEA purposes.... Rsp,
Matt, I think most of these securities are notated as 'cash' are UST with short maturity indeed.
Most of the currency hoarding (USD or EUR) is done by the same people living in our own countries, they hold the assets in the original currencies (indeed, you can't hold UST w/o USD or Bunds w/o EUR). These trade deficits, while a big part go to the wealthy fortunes being created abroad, other go to the fortunes and corporate balance sheets held by westerns.
A recent study estimated tax heavens accumulation of savings to be beyond 25-30 Trillion (american) USD, these estimates were conservative and ONLY for developing nations (if I recall right). This is ridicule, all these deficits are being hoarded by the 'job creators' not some evil foreigner.
Lev,
Did not mean to imply that these foreign entities are "evil", the working class in these foreign jurisdictions look like they are at some level being taken advantage of and being treated unfairly by their own leadership... but nevertheless, the corrupt leadership DOES prefer USD balances (state currency) to metals, or else they would demand to be paid in gold or silver or whatever... so in my view this is at least a positive thing...
And yes there is probably $100s of millions of fraud by insiders in and around the transfers of these balances thru the dealers I have no doubt...
I'm approaching this from the theory that all of these people in leadership involved in this chaos are STUPID (ie morons) though please remember.
This all has to be caused by fraud OR stupidity.
Many out there take the side of fraud/conspiracy... I like to look into it from the side of stupidity.
Then the question becomes: What is the CAUSE of this stupidity?
rsp,
Many themes itnerconnected here. If we are talking about USD balances hoarding, mostly is private parties doing them. Why would they hold USD? It's very clear to me why they would prefer USD to gold.
Only in a goldbug mental case it's not clear why. Wealthy and corporations LOVE USD, just like anybody. With fiat money even if you are trying to defraud taxation you cna still buy assets, gold does not buy nothing at the market place, you must exchange gold at market prices first to buy products & services traded is these fiat currencies.
If we are talking about policy makers, politicians & morons in power, it's all about ideology. Distrust of government and in humanity is why you prefer commodity money (however as history and practice shows commodity money tends to be extremely short-lived, there is always a process of leveraging of these form of monetary tokens and expansion of 'money-things' in the economy, at some point the commodity just acts as a price anchor, goldbugs and/or some austrians don't really get 'money' concept).
In fact distrust in humanity is a strong motivator for commodity money, as commodity money has always dominated in periods of warfare. I could see a return to mainstream gold-buggery as prelude of a new world war. God save us.
Leverage: I could see a return to mainstream gold-buggery as prelude of a new world war. God save us.
Definitely a possibility. Not very likely at this point but events move fast and the future is uncertain.
There are a lot of dark scenarios that could unfold if things take a wrong turn. That the problem with having leaders that are both stupid and greedy. Thinking themselves smart and in charge, they will push the system to limit for an extra nickel. The problem is twofold, knowing where the limit actually is, and surprise — shocks do come unexpectedly.
Right Tom and they are so stupid they will not know what to do... this scares me...
rsp,
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