Dollar reserve system better for East Asian exporters than US
Should the world give up the dollar?
It is ironic that it is considered pro-American to want the dollar to maintain its role as the world's dominant reserve currency and anti-American to call for a change.
In fact, the present system may mean slower economic growth and higher debt for the United States - and faster growth for countries that take advantage of the reserve system to generate export-led growth.
In a debate on Chinese television two years ago, a Chinese professor from a famous Beijing university assured me American economic dominance was predicated on the status of the dollar as the world's primary reserve currency. Leave aside that the US was the largest economy in the world, with the most advanced technology and the highest per capita income, by the late 19th century, at least six or seven decades before Bretton Woods. This is the sort of claim that can only be made by someone who has a very weak grasp of monetary economics.
The strongest argument in favour of the importance to the US of the dollar's reserve status is that it permits the US government to fund itself cheaply, and in its own currency, with the savings of the rest of the world. But this argument may get it exactly backwards. Any country with credibility and an actively traded currency can fund itself in its own currency. So why do foreigners own such a large share of US government debt? Isn't it because they have to buy US government bonds to hold as reserves, and aren't foreign purchases needed to make up the shortfall in US demand for government bonds?
No. US investors can easily fund US government debt. Foreigners own US dollar assets, of which US government bonds are the safest, because they run current account surpluses. Countries with such surpluses have no choice but to acquire foreign assets, and the country whose assets are thus acquired has no choice but to run the corresponding current account deficit. Countries whose domestic policies require large trade surpluses, in other words, must buy the assets of those countries that are able to run large current account deficits. The US is the only economy large enough, flexible enough and open enough to offset the net current account surpluses accumulated by the rest of the world.
If countries that have accumulated massive reserves, like Japan, Germany and China, chose to diversify their holdings, or were forced to, away from the dollar, the US current account deficit would have to contract and other countries would be forced into absorbing those surpluses. But very few countries can. In that case, countries that rely on large current account surpluses to absorb their excess capacity would be forced into reducing their surpluses and reducing their capacity. Their growth, in other words, would be lower. The US, on the other hand, would be 'forced' into either higher growth or lower debt levels. This does not seem like a good thing for surplus countries or a bad thing for the US.
In the US, more and more economists are arguing for a multi-currency world because of worry debt levels are rising too quickly as the US is forced to absorb excess capacity from the rest of the world. If global trade imbalances decline sharply, these calls will probably be ignored, but if they persist, they will gain force until they result in an overhaul of the global financial system. If that happens, the US will not be able to run large trade deficits, and if no other country can replace it, the days of export-led growth as a developing-country strategy will quickly end. This will be especially difficult for East Asia, the region of the world that has most heavily depended on this strategy.
Americans, in short, should strongly oppose the use of the dollar as the dominant reserve currency. The rest of the world, especially rising Asia, should demand that the current reserve system remain in place for many more decades.
Michael Pettis is a professor of finance at the Guanghua School of Peking University and a senior associate at the Carnegie Endowment