Thread by @michaelxpettis

1/19

Apologies in advance for this very long thread, but as regular readers know, I worry greatly about common misunderstandings of the role of reserve currencies. The author seems to assume that what makes a currency a dominant reserve currency is...

ft.com/content/3fe905…

2/19

its low frictional trading costs, which is why, he believes, digital currencies, with China in the lead, will dominate international trade.

But while a low frictional trading cost is a necessary condition, it is not nearly sufficient. A quick glance at the role of the...

3/19

US dollar over the past 100 years, the period during which it achieved dominant status, makes this clear: when the world was short of savings relative to its investment needs, during the first fifty years of that period (a period characterized by the global need to...

4/19

rebuild economically from 2 world wars) the US was a permanent net provider of savings to the world.

In the next five decades, however, when the global economy was substantially rebuilt and needed to export excess savings, the US automatically became a permanent net...

5/19

absorber of foreign savings. Of course during this time the US shifted from permanent trade surpluses, when the world needed the US to supply it with food, capital goods and consumer goods, to permanent trade deficits, when the world urgently some place in which to dump...

6/19

excess production of consumer goods.

This was no mere coincidence. To me it suggests three things. First, that reserve currency status is a function of a lot more than low-cost trading. In fact given that the cost is already so low, and seems to be in permanent decline...

7/19

decline anyway, I suspect it doesn't even matter much any more.

What seems to matter a lot more is the willingness of the reserve-currency country to run large imbalances in response not to its own needs but rather to the needs of the rest of the world. As an excellent...

8/19

CFR resource shows, the US typically absorbs 40-50% of global imbalances, and the Anglophone economies — with similar financial markets all of whom, like the US, punch way above their weights as international reserve currencies — collectively...

cfr.org/report/global-…

9/19

absorb 65-75% of global imbalances.

Given that China's currency (and that of other surplus countries, like Japan) punches so far below it's weight, it is surprising that anyone would argue that there is no relationship between the international status of a currency...

10/19

and its willingness and ability to absorb global imbalances.

Second, the reason these countries are "willing" to accept major reserve-currency status has more to do with ideology than with economic rationality, driven by, and reinforcing, the disproportionate power of...

11/19

the financial sector on domestic decision-making. Like the UK in the 1920s, they are perhaps too willing to sacrifice the needs of the producer side of their economies in order to maintain the overwhelming power of the financial side. The result, as Matthew Klein and I...

12/19

show in our book, is that these reserve-currency countries have constantly to choose between allowing unemployment to rise or allowing debt to rise. They have mostly chosen the latter.

yalebooks.yale.edu/book/978030024…

13/19

And third, while China has been promising for nearly two decades that its currency will achieve dominant reserve status within five years or so, in fact the RMB is probably the least important of the top ten currencies given China's status as the second largest economy...

14/19

and largest trader in the world, and by relevant standards its role has barely improved in the past decade and may even have declined.

Why? Because for all over-excited talk about achieving major international status, Beijing has always refused to take the economic...

15/19

steps needed to increase its role in absorbing global imbalances.

On the contrary, when Covid-19 created a demand shock in a world already suffering from excess savings and insufficient demand, Beijing had an incredible opportunity to boost the role of the RMB by...

16/19

boosting net domestic demand. Instead it implemented a muscular supply-side response that actually worsened its contribution to global demand imbalances.

In the end I do expect the international status of the US dollar eventually to decline, but not because of the...

17/19

rise of the yen (which, we were told in the 1980s and 1990s, was virtually assured) or of the RMB. Either it will decline because the US decides that it is no longer willing to absorb the huge and rising economic cost of dominant reserve-currency status to its producing...

18/19

sectors and its balance sheet in exchange for the declining geopolitical benefits and to maintain the status and dominance of of its financial sector (which may be the same thing), or it will decline when the cost of maintaining the power of the dollar helps...

19/19

sufficiently undermine the US economy, which has always been the real source of American power. The experience of the UK in the 1920s provides an accelerated vision of how that can happen.

1/2
I did a quick back-of-the-envelope calculation of currency-share to GDP-share of the top ten currencies:

NZD 9.4
HKD 8.9
SFR 6.2
GPB 4.2
Aus dollar 4.4
USD 3.6
Yen 2.9
Can. dollar 2.7
Euro 2.2
RMB 0.3

2/2

There are a lot of problems with this table, not least because it reflects a single point in time, and obviously the smaller the economy, the more likely it is to be an outlier, but it is still interesting.