Paul K’s agrees with me on the core aspects of my post yesterday regarding our persistent trade deficits as a barrier to full employment, but disagrees the dollars status as a reserve currency has much to do with it.
Certainly the key part of all this is recognizing the damage done by trade deficits to growth and jobs (particularly among manufacturers), as well as the role these imbalances play in investment and asset bubbles. I’m continuously thrown by analyses which talk about the factors holding back growth and ignore the fact that since 2000, the US trade deficit has averaged 4% of GDP. To be clear, that’s far from the only problem, and it’s certainly possible to offset the growth drag that trade deficits of that magnitude create, but doing so often creates its own problems, as in the bubbles just noted.
But as Paul suggests, one certainly does not need to invoke the reserve currency issue to make the case that we need to do something about this problem, as I did in this earlier piece with Dean Baker.
A few points, however. First, as noted, my thinking on this is influenced by recent work by Ken Austin and earlier work by Michael Pettis (links to all this stuff are in my original post). Austin constructs what I read as a pretty airtight model wherein under conditions like those that prevail today, exchange rate manipulators accumulate currency from reserve issuers ensuring surpluses in the former and deficits in the latter.
No less than Ben Bernanke has made this point as well:
Another factor [driving trade deficits] is the special international status of the U.S. dollar. Because the dollar is the leading international reserve currency, and because some emerging-market countries use the dollar as a reference point when managing the values of their own currencies, the saving flowing out of the developing world has been directed relatively more into dollar-denominated assets, such as U.S. Treasury securities. The effects of the saving outflow may thus have been felt disproportionately on U.S. interest rates and the dollar. For example, the dollar probably strengthened more in the latter 1990s than it would have if it had not been the principal reserve currency, enhancing the effect on the U.S. current account.
As Paul notes, and others have correctly made this point, the dollar is not the only reserve currency. But it is by far the most preeminent one and we therefore face a relatively large adjustment burden, which is a nice way of saying that this setup leads to the exporting of a lot of good jobs.
[Another colleague correctly reminded me—and this is in Austin’s model as well—that the excess savings reserve accumulators export to us don’t automatically have to show up as our trade deficits. The capital inflows could be used by investors to buy foreign assets instead of consumers buying imports. However, given the magnitude of trade deficits in recent years, the empirical record suggests that the Pettis/Austin dynamics apply.]
Do I think we’d run balanced trade if the dollar didn’t hold its reserve status? Of course not: I’ve always stressed other factors are in play. But I’d be very interested in Paul’s take on Austin’s work in particular. I suspect it might nudge him a bit towards me on this.
End of the day, however, not much point in arguing about this reverse point. The main thing is to lower the trade deficit. Dollar, schmollar, as long as he calls his mother. And if reserve currency arguments don’t help in that regard, then they should be put aside.
Here too, however, I wonder if there’s something advantageous to my position that PK is overlooking. To lower our trade deficit, you don’t have to just be willing to allow the dollar to be more competitive in foreign markets (Ezra Klein pointed out to me long ago that “competitive” sounds better than “weaker”), you have to be willing to take action against those managing their currencies to gain a price advantage. And this necessity could be thwarted by arguments about how such actions threaten the sovereignty of King Dollar.
Our policy makers are all a muddle about this. In the morning, our Treasury secretaries pledge their undying allegiance to the strong dollar. In the afternoon they call for China to allow their currency to appreciate against the dollar, i.e., they call for a weaker—oops…”more competitive”—dollar. Perhaps the arguments I and others are putting forth can help clear the way for clearer thinking on this critical issue.
So, let’s hear more from Paul–who knows a little something about international trade–on the substantive case I’ve been highlighting (where are Austin, Pettis, Bernanke getting it wrong?), but let’s not lose sight of the fundamental goals here, as he correctly stresses.