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...
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...
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.
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.
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1/14
This article by Tim Harford is useful because it shows some of the partial thinking that often distorts discussions about trade. One area of confusion is when he discusses how comparative advantage works.
2/14
As he discusses the arithmetic of comparative advantage, he fails to emphasize that it is able to maximize total production only because each side exports the goods and services in which it has a comparative production advantage in order to import those in which it doesn't.
3/14
Comparative advantage, in other words, can only be expressed in the exchange of goods and services, which means that for the world to benefit from comparative advantage, countries should maximize exports in order to pay for imports, not to externalize weak domestic demand.
1/8 Good Keith Bradsher article on the extent of automation in the car industry: "China’s secret weapon in the trade war is an army of factory robots, powered by artificial intelligence, that have revolutionized manufacturing."
2/8 "As a result," he continues, "China’s factories will be able to keep the price of many of its exports lower, giving it an advantage in fighting the trade war."
But it is more complicated than that. Automation increases the productivity of workers.
3/8 That's a good thing if wages keep pace with rising productivity. If not, it must result in an even greater imbalance between what Chinese workers can produce in the aggregate and what they can consume, which in turn will require a greater trade surplus to resolve.
1/4 Caixin: "China reported better-than-expected year-on-year GDP growth of 5.4% in the first quarter, in stark contrast to the country’s fiscal performance — tax revenue fell 3.5% in the period, continuing a downward trend that began at the end of 2023."
2/4 According to the MoF, the main reason for the decline in tax revenues was tax rebates for businesses that spent on equipment, logistics and R&D expenses.
This helps show why it is so hard to boost the domestic role of consumption.
3/4 On the one hand, the sustainable way to boost consumption and rebalance the economy requires higher direct or indirect wages for Chinese households, but businesses cannot tolerate this because they are already losing money.
1/8 This Caixin article summarizes various proposals by Chinese academics on how to respond to Trump's tariffs. Most of these proposals focus on boosting domestic demand, but some involve expanding "free-trade" relationships with other countries, which... caixinglobal.com/2025-04-18/in-…
2/8 basically means that if the US stops absorbing China's growing trade surplus, China should ensure that other countries (mainly Europe) do so instead.
But this misses the point. Dozens of countries have already raised tariffs on Chinese goods, and this is likely to worsen.
3/8 Of course if other countries refuse to replace the US as the consumer of last resort of China's manufacturing expansion, the resulting contraction in China's trade surplus requires either that domestic production decline or that domestic demand rise.
1/5 Reuters: "Policymakers have to walk a tight rope as the yuan has come under pressure after U.S. President Donald Trump's tariff onslaught, while shrinking interest margins at lenders has continued to limit the scope for monetary easing." reuters.com/markets/rates-…
2/5 Reuters adds that "A reduction to the banks' deposit rates could alleviate net interest margin pressure at lenders and allow them to lower lending rates," but this also shows why rebalancing is so difficult.
3/5 While lowering the deposit rate would indeed allow banks to lower lending rates without squeezing their margins further, it represents a further transfer of income from net lenders in the system (households) to net borrowers (businesses and governments).
1/5 WSJ: "In the two weeks since President Trump’s “Liberation Day,” many U.S. trade partners have a clear plan to convince Washington against reimposing stiff tariffs on their exports to the U.S.: buy more American stuff."
2/5 Getting foreigners to "buy more American stuff" may seem like an obvious way to resolve US trade imbalances, but it isn't. Trade clears systemically, and without changing the domestic policies that drive savings imbalances, trade imbalances won't change.
3/5 If foreigners agree to buy more specific goods from the US, this simply shifts US imbalances between countries and sectors, without changing them in the aggregate. That's because as long as they produce more than they can invest or consume domestically, they must...