Friday, March 26, 2010

Dollar's reserve status is what keeps it weak, not strong!

Most economists have this totally wrong. They believe that if the dollar loses its role as the reserve currency, then it will collapse. In fact, it's exactly the opposite.

The dollar's reserve currency status is part of what keeps it weak. It MUST supply the currency to those around the world who wish to hold it or use it for transactional purposes. Therefore the U.S. runs trade deficits--not by its own design--but as a consequence of other nations exporting to America to acquire dollars. (They need dollars to pay for oil, for example.) On balance the U.S. imports more than it exports because there is a desire by the rest of the world to "net save" in dollars. Were that not the case the dollar would be scarce and, therfore, fetch a higher exchange rate.


Ralph said...

I respect people who advocate novel ideas. But don’t agree with the above one.

Say US exports equal imports. Then country X starts to hoard dollars at $Y a year. The dollar would strengthen to some level above the original level and stay there as long as the “hoard” is expanding at $Y a year. When demand for anything rises, its price nearly always rises, doesn’t it?

If hoarding stopped, the dollar (all other things being equal) would revert to its original level. And if country X dumped dollars, then the latter’s value on forex markets would decline to below its original level. Extra supply causes prices to drop, normally. And a few years after the dumping stopped, the dollar would revert to its original level (still assuming other things being equal).

Now where have I gone wrong?

googleheim said...

This is awesome info.

Take an aside perspective :

IF the dollar is the mechanism by which the world's banks ( and economies ) transact ( carry trade or reserve currency ) for energy and therefore "net save" in dollars, then the creative destructionists are wrong again.

They fail to see that if they wish to balance the budget by various measures including the wish to stop the aweful reality that China "buys are debt" ( in fact we know that China opens up treasury accounts and gets the dollars without exchanging for renmibi yuan whatever it is .. ) , THEN
they will make the dollar scarce by what Mike shows here as well as what Mike and Mosler show as pulling money out of the real economy and back into the fed/tsy area ( like the dot com recession when Clinton balanced the budget )

and result of a strong dollar will impede exports which is what these creative destructionistas want since they think exporting is the key to a higher living standard.

All in All, this is contradictory once again.

The Mike Norman Theory of Capacity can start from the invariants - such as "i = = s" in which investment is a function of spending. Elliminating the spending and pulling the money from the markets will dry things up and not necessarily make the dollar stronger.

Mike Norman said...


Nation X can only hoard if nation Y runs a trade deficit. Think about it using the analogy of subway tokens. Riders can only hoard tokens if the transportation authority sells more tokens than the actual rides given. A "trade balance" would mean that the riders used every token for a ride and that was all that was sold. If the transportation authority sold less tokens than rides demanded (ran a trade "suplus"), then tokens would be scarce and their price on a black market would go up. In the end the transportation authority MUST sell as many tokens as riders demand, with some of that demand going towards hoarding.

Matt Franko said...

An example I sometimes look at in this case is Iceland.

They ran into major trouble in their banking system a couple of years ago, by lending in a currency other than their own to very high leverage ratios. I think it was eight times their GDP mostly in Euros.

Well they went bust and had to have the IMF go in just to get trade credit. So you would think that Iceland would have to devalue their Kroners (it did go down a bit) to the USD to be able to attract USD to be able to buy things from the US like Pharma, perhaps software, petroleum products, etc..

But in comes the IMF with a $7k per capita loan to Iceland and USD are now available and prices in Iceland still took high to me.

Here is link to a small restaurants site in the Rekjavik area and you can see the prices in Iceland for native foods in USD.

(Goog, they really are Whale Eaters!)

The Whale steak dinner with a frozen dessert is 7,190 (No booze incl!) Kroner or over $56 according to OANDA. That seems expensive to me.

I would submit that if the IMF didnt go in, Iceland would have had to significantly devalue further to attract USD for their products to be able to acquire forex necessary to buy critical products from the US. Perhaps even taking an adventure vacation there would become a value for US travelers, and you would see that in their prices there.

So I have to agree with Mike here that when you flood the rest of the world with USD whether by trade or loans (remember the Fed's unlimited swaplines), it depresses the USD IMO.

Mike Norman said...

Yes, Matt's right. And we do this (run deficits in trade) for a very simple reason: we are (were) the world's richest nation. Many other countries GROW THEIR GDP by selling to us. Rich people (nations) run deficits in trade. It's no big deal. The exchange value of their currency is pretty much arbitary and irrelevant. Latvia has a very strong currency, but it's poor as hell.

googleheim said...

What difference does the Japaneses' high personal savings rates ( and corporate ) and the American lack of personal savings have this discussion with respect to being a rich country and currency position ? Japan has the stronger currency runs a deficit, imports a lot, exports a lot, etc

Matt : So the world bailed out and subsidized a bunch of Whale eaters ? How about a freeze on whale eating as part of austerity measures for these blubbery viking descendants or decadents ?

bernardchan1 said...

this is an interesting perspective. i also regard the dollar losing its reserve currency status as a positive development for the US.