The dollar’s continued fall will pose a serious threat to the multilateral trading system, and the absence of a globally viable alternative means the United States bears an enormous responsibility to maintain confidence in the currency, a senior U.S. economist warned at a seminar in Tokyo.
A modest depreciation might provide short-term relief to America’s current account deficit, but further erosion of global confidence in the dollar could prompt nations to trade bilaterally without dollars, resulting in discriminatory trade, said Benn Steil, senior fellow and director of international economics at the Council on Foreign Relations.
Speaking Oct. 30 at a seminar organized by Keizai Koho Center, Steil described the issue of global imbalances today as essentially a problem between the U.S. and China, which has surpassed Japan as the largest creditor to the U.S.
And both sides take a different view on who is responsible for taking action, he said.
“China’s position is that the debtor must make the adjustments — that the U.S. must return to tighter monetary and fiscal policy at the earliest opportunity,” he said. “From China’s perspective, the problem of global imbalance lies primarily in the U.S.”
The U.S., on the other hand, holds that it’s the creditor who must adjust and that China must float its exchange rate — a move Washington believes will result in the yuan appreciating against the dollar and reducing the imbalances by boosting U.S. exports and dampening U.S. imports.
However, Steil noted, it’s difficult to determine whether the yuan would rise significantly or actually fall if China were to make its currency completely convertible.
If China permitted convertibility, it would see more capital inflows. But it would also see a massive increase in capital outflows because it would give its population an opportunity to invest assets abroad, putting downward pressure on the yuan, he said.
Steil said that historically, the U.S. position on the currency-exchange regime has been “extremely inconsistent” and that toward China it is consistent only in that the U.S. wants a higher yuan and a lower dollar.
“Many in the U.S. believe that a fall in the value of the dollar is necessary to address imbalances particularly vis-a-vis China, and I think there is a fair argument to be made, at least in the short term, a modest, controlled further depreciation of the dollar might help the U.S. current account deficit,” he said.
“But I would argue that going forward, any sort of extended dollar fall is actually a significant danger to global trade.”
Worried about the glut of dollars in the world economy, “China and other major U.S. creditors are concerned about the future global purchasing power of their huge stock of dollar assets, and are trying to take measures to avoid further accumulation of dollar-based assets,” Steil said.
Some of China’s ideas, including People’s Bank of China Gov. Zhou Xiaochuan’s suggestion that a new global reserve currency be adopted based on International Monetary Fund special drawing rights, may be impractical, he noted.
A Chinese initiative with Brazil and Russia to trade bilaterally without using dollars, on the other hand, “could gain ground among other countries,” he said.
“If this were to become popular around the world, this would mean we would be back in the same situation as we were right after World War II. If there is no international currency, then countries must essentially engage in bilateral barter with other countries, and this means massive trade discrimination,” Steil said. “If confidence in the dollar continues to erode, this could therefore be a threat to the multilateral trading system.”
Today, the only other currency with the breadth of use that would allow it to play the role of a global currency would be the euro, he said.
“But if countries decided to significantly increase their reserves of euro-denominated assets and conduct much more international trade in euro, this would put enormous upward pressure on the euro,” Steil noted. That, he warned, will provoke enormous protectionist pressure within Europe that could also threaten the global trading system.
Given the lack of attractive alternatives to support a multilateral trading system, “the U.S. bears an enormous burden of responsibility to maintain global confidence in the dollar . . . through sound monetary and fiscal policy,” he said.
Naoyuki Yoshino, an economics professor at Keio University who was moderating the event, said the usual pattern of Asian nations buying U.S. debt with dollars earned from exports to the U.S. may start to change.
Asian nations that accumulate dollars by exporting to the U.S. have recycled those funds back into the U.S. by investing in U.S. debt, and efforts to recycle more of those funds into Asia — especially since the 1997 Asian currency crisis — haven’t made much progress, he said.
That’s because the bond market hasn’t developed in Asia, where most countries don’t issue many government bonds, Yoshino said. Lacking a benchmark bond in local markets, Asia turned to U.S. Treasuries, he said.
But that situation may gradually change because many Asian governments have been forced to issue bonds to finance the stimulus measures needed to survive the global crisis, he said.