What’s Up with the Dollar?

[Image from Cagle Cartoons]

So the value of the dollar has been depreciating. Lots of speculation, in the media, the markets . . . Policy-makers don’t really know what to do about it because they haven’t encountered the problem before. Concerns have been raised, both at home and abroad. As we all know, the dollar–stable, strong (not to mention, as some people like to emphasize, “backed by the world’s sole superpower”)–has for quite some time now been the unofficial currency of international trade, the preferred reserve holdings of the world’s central banks, the medium of exchange that facilitates the transactions of the global economy (by which it runs?). Now that its value is depreciating, there arise (perhaps well-founded) concerns: Americans are less able to purchase international goods, the dollar holdings of East Asian states (such as China and Japan) give them much of the dollar’s purchasing power, and the appreciation of the euro seems to pose itself as its ready replacement.

Is this a problem? For America, (as this article by Thomas Palley from Foreign Policy suggests–that is, in the beginning, if only in order to rebut it) yes. As Palley (preceded by a well-noted hypothetical, i.e. the big IF! If this were really happening. If the experts are right that the dollar’s position in the world is really sliding. If . . .) says, “an exit from the dollar would lead to its further depreciation, causing increased import prices that might trigger higher inflation.” That means even less purchasing power (for international goods, e.g. travel in Europe) for Americans, and, what more, (since most of the goods we purchase are already “made in China,” i.e. the raw materials already come from abroad) higher prices at home! Moreover, when the dollar is no longer as highly priced in international trade, there would be less demand for it because less international investors would want it. This would lead, as Palley continues, to “a [corresponding] decline in demand for dollar assets [which] would cause a fall in [US] asset prices and raise interest rates, which could cause a recession and permanently slow U.S. economic growth.” The less attractive the dollar is, the less attractive it is to own U.S. assets, ergo less activity (less positives in the balance sheet!) for the US economy. Because of the decline in the demand for local assets, local interest rates would rise, making it more expensive to consume by credit (more expensive to borrow–the true engine of the American economy!), which would lead to even less economic activity.

So this seems to be really really bad news. Sucks! But no, this can’t possibly be true. This can’t possibly be happening. This is the dollar. THE DOLLAR! The strongest currency the world has ever seen. (Just like America) It will bounce back. You’ll see. It’s simply not possible. America has always been rich. Still is. We are the biggest economy in the world. We are the world’s biggest (most obese?) consumers. The dollar will withstand any challenge that comes its way. It will beat this one too. You’ll see. At the end of the day, the dollar will withstand. It will remain standing, stronger than ever. The dollar–still–can buy anything!

This seems to me to be the kind of wishful thinking that many people–pundits especially (that is, when they’re not using fear)–indulge in when discussing the issue. The Foreign Policy article makes a better presentation, but its proofs are buttressed, I think, by the same well-wishing prejudiced assumption. This leads it to its optimistic assessment of the situation–clothed in the statement, “Though the dollar is undergoing a correction, it is a healthy one and the dollar is likely to stay on top for years to come”–leads it, in fact, to entitle the article, “Don’t Bet Against the Dollar!”

The economic support that Palley cites to deliver this statement is the fact that “with an annual GDP of more than $13 trillion and with efficient, liquid capital markets, the U.S. economy operates on a scale and with a vitality that is unmatched. (It also helps that the dollar is backed by the world’s sole superpower.)” This snapshot, however, does not take into account of the fact that another conservative (well, free-market liberal capitalist) magazine, The Economist, cites here, the fact that, “according to Goldman Sachs, China will overtake America around 2027 and become by far the world’s biggest economy by 2050.” (The accompanying chart is especially insightful.) If the fact of America’s GDP being the highest in the world is the support for the dollar retaining its privileged position, what happens when that is no longer true?

If the dollar is to remain the international medium of exchange–if its dominance is to last, if it is to prove its longevity–it is not (only) because of the strength of the American economy, which, as The Economist points out, may not last–at least not (to allude to another article) as number 1. And even if the dollar does remain the international currency, this does not automatically translate into something good for regular working Americans.

It is here that the other reason that the Foreign Policy article offers, which it calls the “buyer of last resort” theory, makes sense–much more than the first (the touted economic superiority). Economic superiority (measured in terms of GDP, what it produces, which, ideally, in economic theory–adjusted with imports and exports–equals what it consumes: Inputs = Outputs; Assets = Liabilities + Net Income/Loss) in itself would not be able to secure any denomination a position as world currency. Rather, the other players in the world market (inferior economically, but some of which are not that inferior, e.g. Japan) have a role to play as well.

These other players, especially the ones that are most insecure (i.e. those lagging behind, unable (or for some reason not desiring) to compete directly with the dominant player (enough to dethrone it from its place) (that is, for now!)) (in contrast to someone who’s more like a rival, like the European Union, who outrightly rejects or hinders trade with the dominant power) react to the economic superiority of the superpower–the US. What is paradoxical is that these actions by these other players allow the dominant power to preserve its position, its hegemony.

In other words, America being economically strong in itself does not assure the dollar its privileged status. In fact, if it is too strong–if the dollar’s value is too high–then no one would be able to afford it and it wouldn’t be a very effective vehicle of exchange, of trade. The other (economic) players also have to be doing something (which implies that they benefit from it somehow) (in that way, they are just as interested as America in seeing the dollar retain its position), which lets the dollar retain its place.

Now, how exactly does this happen? What are the other players doing that allow the dominant power to hold its place? Why are they doing it? How do they benefit? As the Foreign Policy article explains, “Countries [i.e. the other players] hold dollar assets because they want trade surpluses with the United States. According to this theory, many countries can’t generate enough domestic consumption to spur growth and full employment, forcing them to rely on exports. As the United States is the world’s largest consumer market [keeping in mind that this mostly relies--for average Americans at least--on the ability to obtain credit], countries therefore have an incentive to make their goods cheaper and more competitive by undervaluing their currencies against the dollar. This obliges them to buy and hold dollars to maintain their undervalued exchange rates. The economic history of the past decade bears this theory out. Since the late 1990s, American consumers have powered a global boom, compensating for weak domestic demand in much of the world.”

What we see here is a power mechanism between, on the one hand, a sole superpower, and, on the other, everyone else. (We will, of course, have to make distinctions between “everyone else.” For now, let’s make the distinction between the other players that are receptive to the interests of the superpower (Japan, China now) and those who see themselves more as independent rivals (Europe, China tomorrow?).) (What would the mechanism look like if there was not only one superpower, but perhaps two major power centers, as in Ancient Greece, with Athens and Sparta? How did the world look like before the fall of the Soviet Union?) In this situation, the superpower (especially as it is the only one) is dominant enough that the other players (except for would-be rivals) cannot (or are perhaps unwilling to) outrightly challenge its (economic) superiority.–But they have to thrive. So, like the tribes on the horizons of Ancient Rome (or the other European States (headed by England and Habsburg Austria) allying against France), these other players have to adapt according to the patterns of behavior of the superpower (the whims of the emperor?).

America is rich. It has money, capital. It can afford to spend. It can consume (the most). The other players, since they cannot equal the amount of capital (again: not yet) that the superpower has, cannot consume and invest as much. Nonetheless, they need to consume. So what they do is keep their currency values low (either by direct devaluation or by buying up US dollar reserves) so that their products are cheap, the superpower buys from them (this is, of course, not a direct cause and effect; economies valued less would have goods with corresponding lower values, which leads to a lower value of the currency, which is then maintained by further devaluation, reinforced by buying dollar reserves . . .), fueling their economy, allowing them to consume. This is the mechanism that explains why “East Asian countries such as China have been especially reliant on exports, a policy that has earned them trade surpluses and a massive storehouse of dollars.” This is how now, “China and Hong Kong have U.S. Treasury bond holdings of $455 billion, while Japan has holdings of $582 billion.”

The world economic system (currently having the dollar as its preferred currency) is therefore maintained not by the superpower alone, but–due to their adaptation, their will to survive–by the other (“lesser,” as opposed to rival) players as well. In the current situation, “because [the other players] want their exports to stay competitive, none of these countries wants its currency to appreciate against either the dollar or the currencies of its trading rivals.” Thus, this thing that we’re seeing happening to the dollar now–the other players do not like it as well!

What about rival players, like Europe (as opposed to China, whose economy is still just emerging; thus, it still needs–rather than crushing it–the American economy, for mutual growth, mutual flourishing–that is, for now!) with its euro (the potential replacement of the dollar)? If the dollar gets too weak and the euro appreciates too much, that gives European economies the burden of lower demand. Its assets and goods would be too expensive for the rest of the world to buy. Thus, rivals themselves are–with the superpower–interested in maintaining the present situation. Europe itself does not want the dollar to depreciate so much!

The world economic (pertaining not just to goods, but the economics of power itself) system is thus comprised of these mutual interactions of all these different players, and when we have a system in which there is a sole superpower, we see that its hegemonic position–with the other players salvaging what they can from it–tends to be reinforced–even by rivals. It can thus be said that the world system is centered on–although not purely determined by–the sole superpower. If the system, therefore, experiences dramatic change, if, for example, the dollar loses its status as world currency, if it loses too much value, then it is not only America that is affected. That is, I think, what makes this issue a very much pertinent concern (for everyone).

Now, this problem–the depreciation of the dollar–is not necessarily bad for all players. (What gains would the lesser players be able to derive from such a change? What gains would the replacement currency bring its host, although the host does not (because it does not automatically follow) itself replace the superpower?) But, if such a change were to occur, there would certainly follow a time of adjustment, a period of instability that some players, including the lesser ones (and the rivals) (even as they stand to benefit later on) may be adverse to. Hence the tight holding on to the status quo.

For Americans, the question to ask is: Have we spent enough? Have we used our consuming power to such an extent that we’ve actually changed the balance of the different currencies against each other (and with that, the balance of power?) such that we no longer hold the prime position, as it were, or at least can no longer afford to be the world’s greatest consumer? Has the system been altered enough such that the imbalance among the currencies shifted, that the other players actually no longer need to kowtow to the dollar and adjust to the whims of the superpower? Seeing as, as cited by the Foreign Policy article, our “massive spending on goods imported from abroad has [. . .] caused the U.S. trade deficit to balloon to $759 billion dollars in 2006, equal to 5.8 percent of U.S. GDP,” is it, quite simply, time to pay up?

Foreign Policy goes on to cite other facts to argue that the dollar is not likely to be replaced anytime soon. Put simply, Palley argues that there are simply no other alternatives. “Yen investments yield low returns. So do euro investments, and they may now be risky given the euro’s large appreciation in recent years.”

Now, supposed that Foreign Policy is right, supposed that the dollar were to remain the international medium of exchange, what good is that to average Americans when, as The Economist points out is happening now, this other fast-rising new economy, China, “is helping to prop up the weak American dollar by buying large chunks of American debt,” that is to say, when it is the Chinese state (which, it should be pointed out, is not the same as the Chinese people! Rather, the un-democratic one-party state) who owns most of it, who has most of the dollars? What happens when, further, (keeping in mind the hypothetical situation of the Chinese state already owning most of the US dollar reserves), “China [pushes] America aside as the world’s biggest exporter, [hence the US gets even less of its own dollar back] [as we've witnessed happened] last year [when China] produced more cars than the United States”? Add to this the other challenge coming from that other rival, Europe, where, as The Economist cites, “London is vying to replace New York as the most important financial centre, and the euro has displaced the dollar as the main currency of the international bond market,” which could perhaps take away the riskiness associated with this potential replacement currency.

How much of this–the depreciation of the dollar–is symptomatic of the weakening of American power? (The national currency, especially in the capitalist capital of the world, has to be in some way symbolic of the country, no?) What other (aside from the economic) aspects of American life indicate this? What changes/consequences would follow? Is this necessarily bad? Is it even right to look at this from the American perspective (because we want America–the liberal, benevolent power that it is–to remain in (super)power)? Or should we instead take an overall world perspective? After all, perhaps, there are better options than American sole superpower? Are there?

To be sure, American status in the world has changed somewhat (which average Americans already feel: “I can’t buy as much!”). But perhaps there’s also something good in this (We can finally solve our obesity problem!)? After all, no one remains a superpower forever! But: how much has American status changed? How much has American power eroded? And would/can it bounce back? Should it? Is this but a temporary setback in the reign of American power or would it (Rome, after all, did not fall in a day) prove to be the start of a continual decline? And if so, so what?