Thread by @michaelxpettis

1/16
While Bloomberg is right to say that "a less hegemonic dollar would [adversely] affect America’s geopolitical prowess," it is wrong to assume that it would also adversely affect the US economy, or that it would raise US interest rates.
bloomberg.com/news/articles/…

2/16
There is no evidence at all that a country's economy must benefit from the wide use of its currency. To the extent the global use of a currency primarily reflects the extent to which other countries want to acquire local assets in exchange, its only obvious economic impact...

3/16
is that countries like the US (and the UK and Canada), whose currencies play a far larger global role than justified by the size of their economies, must run trade deficits large enough to balance net capital inflows, i.e. to accommodate the trade surpluses of other countries.

4/16
As a corollary, it also mean that these countries must allow manufacturing to move to countries that want to expand their share of global manufacturing. This shouldn't surprise as much as it does. Countries that subsidize manufacturing with explicit or implicit...

5/16
household transfers should naturally see the manufacturing share of their economies rise, and they should tend towards running trade surpluses. Their trade partners should naturally run deficits and see production shift from manufacturing to commodities or nontradables.

6/16
The standard explanation for how a country benefits economically from the widespread use of its currency is that net capital inflows automatically reduce domestic interest rates and raise investment. This seems like such a truism that it doesn't need to be discussed.

7/16
Sure enough, Bloomberg makes this argument without any discussion when it assets that "In a world where euro- or yen-denominated assets are more strongly vying for investor attention, borrowing costs for the US government would need to rise."

8/16
This is simply not true. Net capital inflows do change the structure of the recipient economy (any change in a country's external imbalance must be reflected by a change in its internal imbalances) but there are many ways the economy can adjust to absorb net capital inflows.

9/16
These depend on underlying conditions. One way is indeed with lower interest rates and more investment. But a second way is with lower domestic interest rates and higher unemployment. And yet a third way is with no change in interest rates and higher domestic debt.

10/16
If we assume that the first way is the only possible way, then yes, the US is better off with more net capital inflows. But this would only be the case if high US investment needs were constrained by the scarce availability of capital (i.e. if it is a developing economy).

11/16
This hasn't been true for decades, which means that the other two ways, neither of which is good for the US economy (or that of the UK or Canada), are the more likely consequences of net capital inflows.
carnegieendowment.org/china-financia…

12/16
Rather than simply assert that net capital inflows must lower US interest rates, and that this must lead to more investment and faster growth, economists should really consider more carefully the various ways in which a real economy (i.e. not an Econ 101 economy) adjusts to changes in its external imbalances.

13/16
They may still conclude that the US is in fact a saving-constrained developing country, in which US businesses have huge productive investment needs that they are unable to meet because they are struggling to raise the cash needed to build more production in the US.

14/16
But what they are more likely to find is that to the extent that the US has investment needs, these are not constrained by the inability of US businesses to access financing, in which case the dumping of foreign saving into the US economy will have no impact on investment.

15/16
But it must nonetheless have an impact on the structure of the US economy, in which case we (and the British and the Canadians) really should be discussing the various other ways in which an economy can adjust to massive, unwanted net capital inflows.

16/16
It is strange that the Trump administration is screaming that it wants a strong dollar because it is good for the US economy, and Trump's fiercest critics are screaming that Trump's policies will undermine the strong dollar, and that this will hurt the US economy. Confusion is bipartisan.