The cost of America’s free lunch

Editorial, Normal


FOR decades, the world has complained that the dollar’s role as global reserve currency has given the United States, an “exorbitant privilege”.
As long as exchange rates were fixed under the Bretton Woods system, the nature of that privilege was clear – the US was the only country that could freely determine its own monetary policy.
All others had to adapt to the policy dictated by the US.
This changed with the advent of floating exchange rates in the early 1970s, which allowed more stability-conscious countries, such as Germany, to decouple from a US monetary policy that they considered too inflationary.
But, even under floating exchange rates, the US retained an advantage: given that the dollar remained the key global reserve currency, the US could finance large external deficits at very favourable rates.
Today, the US treasury can still borrow unlimited amounts at rock-bottom interest rates. Indeed, the interest rate on inflation-protected bonds has now become -0.5%, even for a five-year maturity!
The US government is, thus, essentially being paid in real terms to take investors’ money – a generous offer that it is accepting on a huge scale, in the hope that channelling these resources to American consumers will boost household spending and thus generate more jobs.
The US seems to have come as close as one can imagine to getting the proverbial “free lunch” – except that, as economists are fond of pointing out, there is no such thing.
That is true here as well – performing the role of reserve currency enables the US to borrow on the cheap, but at the cost of any significant influence over the exchange rate, which is determined by the rest of the world’s demand for dollar assets.
Germany discovered this during the 1960s and 1970s, and resisted the deutschemark’s trend towards becoming an international reserve currency.
The German authorities feared that the country’s export-oriented economy would suffer from the wide exchange-rate swings that are the norm for global reserve currencies. Given the weakness of other European currencies, however, and Germany’s desire to keep markets open, there was very little that its officials could do.
As the deutschemark became a major international reserve currency during the 1980s and 1990s, large gyrations in the dollar exchange rate did, indeed, have at times a dramatic impact on the German economy.
One reason why Germany agreed to merge the deutschemark into the euro was the hope that a monetary union would distribute the burden of the reserve-currency role over a wider area.
The US economy is still rather closed (imports and exports account on average for only about 15% of GDP), and historically exports have never been the main engine of its growth.
This is why the traditional US stance has been: “It is our exchange rate, but your problem.”
So, why is the US now singing a different tune?
The answer is obvious: America’s high unemployment rate, which hovers between 9% and 10%.
This is the price that the US must pay for its lunch: Americans can continue to consume a lot, but the jobs are elsewhere.
Today, China has replaced Germany (and Japan) as the world’s top exporter – but with one difference: it manages its exchange rate tightly, using capital controls and massive intervention in currency markets. – Project Syndicate



*Daniel Gros is director of the Centre for European Policy Studies.