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Home Publications Blogs Beat the Press If the Dollar Stopped Being the Preeminent Reserve Currency It Would Mean More Jobs and Growth

If the Dollar Stopped Being the Preeminent Reserve Currency It Would Mean More Jobs and Growth

Tuesday, 15 October 2013 13:38

There's a lot of silliness going around about how the dollar may lose its status as the world's reserve currency if we default. The ordinarily astute Floyd Norris contributed to this confusion in a column last week implying that we may no longer be able to borrow internationally in dollars if this happened.

In reality, it is unlikely that we do risk being the world's preeminent currency in any plausible scenario. (This is also Norris' conclusion.) Furthermore, the immediate result of this loss of status would be positive in any case.

A first point is useful just for clarification. Being a reserve currency is not a zero-one proposition. The dollar is the preeminent reserve currency, which means that most of the world's reserves (@70 percent, last time I checked) are held in dollars. However other currencies like the euro, the British pound, the Japanese yen, and even the Swiss franc are also held as reserves.

If there was a loss of confidence in the dollar, we are presumably talking about a drop in the ratio of reserves held as dollars. Maybe it would fall to 40 percent, perhaps 30 percent. It is almost impossible it will fall anywhere near zero as long as the United States is in one piece with a functioning economy.

The effect of this loss of confidence would not be to deny the United States the ability to borrow in its own currency. Many countries borrow in their own currency, including countries like Malaysia and Colombia, which are not ordinarily thought of as titans of the world financial system.

Less stable countries typically pay somewhat of risk premium based on the risk of inflation in that country's currency and the risk of the demise of the country (think Yugoslavia). In several cases this risk premium is negative. For example, the interest rates on Japanese, Swedish, and Danish bonds are all lower than the interest rates on U.S. bonds. These countries do not appear to have suffered from not having the world's preeminent reserve currency. 

There is the second issue of the dollar falling in value relative to the currencies of other countries if the dollar loses its status as the preeminent reserve currency. This possibility should be cause for celebration, not fear. First of all, a lower valued dollar was the ostensible goal of both the Bush and Obama administration when they demanded that China and other countries stop "manipulating" their currency.

In this context, "manipulation" means holding down the value of their currency against the dollar. In other words, it means pushing up the value of the dollar. In spite of it being official policy that we want a lower valued dollar we are now supposed to be terrified that we might get a lower valued dollar. Welcome to economics in Washington.

The reason why we would want a lower valued dollar is that it would make U.S. goods more competitive in the world economy. We would cut back our imports and increase our exports. This is hardly a novel theory, this is econ 101. And, in fact the world follows pretty closely on what the textbooks say should happen. The trade deficit exploded in the late 1990s when the value of the dollar soared following the East Asian financial crisis. (This is when developing countries like China first decided that they needed massive amounts of dollar reserves). The trade deficit then shrank in the last decade, with a lag, after the dollar fell in value. The chart shows the non-oil deficit, since we would not expect the demand for oil to be very responsive to the value of the dollar. (The chart does not include the increase in oil exports, since that data was not immediately available when I put the chart together and BEA's website is now down.)



In short there is every reason to believe that if a loss of confidence in the dollar led to a fall in its value that we would see a decline in the size of the trade deficit. If the trade deficit fell by 2 percentage points of GDP (@ $330 billion), this would directly lead to close to 2.7 million jobs. If we assume a multiplier effect of 1.5, then we would be looking at over 4 million jobs being created by this loss of confidence in the dollar. Are you scared yet?

What is really amazing about how economics reporters discuss this issue is that there is no plausible alternative mechanism for creating anything like this number of jobs at this point in time. Sure we could create jobs through additional government spending. And that is as likely as? (Sorry, this is a family friendly blog.) There are probably not 20 members of Congress, zero in leadership positions, who would get up and argue for a big round of spending to get the economy going again. The whole debate right now is how much we are going to cut.

Where else would the new demand come from? Those who are hoping for a burst of consumption have not been looking at the data. The ratio of consumption to disposable income is actually quite high right now. There is no plausible story as to why we would think consumers get really really optimistic and start spending an even higher share of their income. The only time they spent a higher share than they are now is during the bubble years. And with the bubble wealth gone, there is no reason to think that spending shares will get back to bubble levels.

The same story holds for investment. The investment share of GDP is almost back to its pre-recession level. That is strikingly high given the large amounts of excess capacity in many sectors. In short, the idea that we could see an investment boom any time in the foreseeable future is just silliness. 

This means that if we want to see job growth, we should want to see the dollar fall against other currencies. My preferred way of getting there is not a debt default, but if a default does occur and a drop in the dollar is one outcome: remember, that is a good thing.

Comments (25)Add Comment
Even though congress critters may not vote to increase spending, Low-rated comment [Show]
written by Paul, October 15, 2013 3:59
I get your point about the value of the dollar and trade deficit as an issue on its own. I am not sure I get how the government being shut down and the default causing a failure to make payments are leading to anything but trouble. Your analysis seems to assume a short term, rapid resolution of impasse, but what if the impasse isn't rapidly resolved. What if we are sitting here in Jan with a nice big double recession, the government still shut down and still under default, the stock market down, money lending down... I agree such a scenario doesn't make much sense, but does any of this make much sense?
Interest rate effects
written by An Economist, October 15, 2013 4:26
While it's true that a drop in demand for the USD would lead to a comparative devaluation and lower relative prices of US exports, your analysis completely neglects the contraction effect that a decline in demand for Treasuries would have on US borrowing rates, which are in turn so low precisely because of the USD role as the preeminent global reserve currency.
might work....
written by pete, October 15, 2013 4:33
A fall in the dollar (ultimately inflation) will raise the dollar price of oil and lower real wages. This might be beneficial for US output, according to the Keynesian models. This is precisely the Akerloff Yellen model elaborated in the NY Times this past week in their bio on her. For output to increase when nominal wages are sticky downward, inflation is necessary to drive real wages down. Seems like this logic is what originally drove unions away from Keynesianism. Somehow the strangebedfellows have now united with Keynesianism. Keynes is not a socialist dogma, it is very very pro capital. Look at the last 50 years of deficit spending and doubling of the inflation rate....entirely pro capital, not labor.
Pete, any evidence at all for your claim that inflation has doubled?
written by Auburn Parks, October 15, 2013 4:46
Inflation has been steady since the end of the OPEC oil crisis in the mid to late 70's.


The only thing that's been growing the economy since the end of the gold standard has been private debt growth (private debt = money).

As a % of GDP:

And in nominal dollar numbers:

An Economist:
The Fed controls the interest rates. Thats monetary policy. They do this by setting the supply of reserves, and since they are the monopoly supplier of reserves, they can always set the interest rates. Did you miss QE?
Why isn't there an exchange rate race-to-the-bottom currency war?
written by David, October 15, 2013 4:47
I understand pretty much what Dean is saying, but the one thing I don't quite get is this. If the dollar fell, what's to prevent China from working ever harder to devalue their currency further?
written by AlanInAZ, October 15, 2013 5:17
I am a bit skeptical about the employment benefit from a lower dollar. I would think it depends on how much exports increase compared to imports decrease. Lower dollar means higher prices and fewer imported big screen TV purchases requiring fewer Best Buy employees. More exports may not increase employment significantly given that we tend to export less labor intensive stuff. I think more data is needed to prove the case.
written by skeptonomist, October 15, 2013 5:31
Dean now has a four-year lag in his story about the effects of exchange rate on trade balance, so if the dollar falls now it will be four years before the beneficial effects kick in, and meantime we will have all the ill effects of default, which would probably include increased interest rates as well as higher prices of all foreign goods.

Since the dollar actually began to fall in 2002, we have not seen much either of the predictable bad or good effects - no increase in interest rates or inflation, but no increases in employment or wages either. All we have seen is a turnaround after 2006 in the balance of payments, mostly in non-oil things. I suspect other factors may be responsible for this turnaround, and while Dean is right to insist that a lower dollar would probably be good in the long term (not so much in the short term), it would not be as much of a cure-all as he seems to think. Economists put too much reliance on theoretical "textbook" effects of monetary adjustments - their knowledge of all the factors in the real world is insufficient to predict what will happen in most cases.
I wish Dean would address the 'interest rates effects' questions
written by yesdogs, October 15, 2013 5:33
All the economists on news shows are freaking out about higher borrowing costs. Last night on the Rachel Maddow Show they made the claim that the 1979 near-default cost the U.S. economy 12 billion dollars. I'm sure Dean has considered these type of effects in his analysis of the current situation, but I wish he would explain it to us.

Will the benefits of a corrected trade deficit outweigh the negative effects of higher borrowing costs? Who are the winners and losers in this scenario?
The interest rate effect of the 1979 default is garbage
written by Dean, October 15, 2013 9:10
You can't find in the data. No economist has used it in their analysis of interest rates in the 1980s. this is just partisan hype. I'm an economist, not a Democratic hack.
written by watermelonpunch, October 16, 2013 12:48
This is a great! (I mean the post.)

I think the people who are terrified of a lower valued dollar are worried that it will make them personally poorer in some immediate way.
Most people (including myself in the past), have mostly thought of economics in a very localized sense.
It's a vague misunderstanding of a sensation of concern over the thing in the wood shed.

I used to be worried when people nattered on with grave warnings about the value of the dollar. Because I didn't even know what that meant.
This was in the mid 1990s. (So it's been going on awhile now. lol)

Then I learned that the only people talking about this were... well one guy his parents had a stockpile of supplies in their basement, and another warned me about "3 days of darkness", and was going on a road trip to see the virgin mary appear on a wall somewhere.

So I've come to the conclusion that worrying about inflation, worrying about the value of the dollar, maybe even worrying about the deficit... I think either the people are like I was, and just don't know what the hell it means or what the concern meant, or they actually want disaster to strike, because they see it as a chance to rise above.
Sad that in our nation, there isn't a chance to rise above, so people hope for disaster to give them some kind of "opportunity". :o(

I really hope lots of people get with the program, and find out what being a reserve currency means to them personally - nothing really.
written by watermelonpunch, October 16, 2013 12:58

Oh, and I wanted to say also that it's very hard to get out of that knee jerk idea to fear a lower value dollar.
I have no idea why. But I think it's related to wages not keeping up with inflation. And the ideas get conflated, and people already feel like the money in their pockets isn't worth enough.

I would compare it to bees & hornets...
I'm allergic to hornet stings - particularly yellow jackets. They're black & yellow and well, bee like.
But they're not bees like bumble bees & honey bees.
I know I've never been stung by a bumble bee or honey bee, and they're just not aggressive.
But I'm still a tad on the defensive around them.
written by keenan, October 16, 2013 3:34
Baker's following sentence seems in need of editing:

"In reality, it is unlikely that we do risk being the world's preeminent currency in any plausible scenario."

Shouldn't this be something like: "In reality, it is unlikely we risk losing our status as the world's preeminent currency in any plausible scenario."
lower valued dollar raises wages of ordinary workers
written by Dean, October 16, 2013 4:56
the point is it increases demand off manufacturing workers -- say relative to doctors and bankers. Also full employment pushes up wages. Suppose your pay goes up 20 percent but you pay another 5 percent for your shirts? I think most folks would accept that deal.
written by dax, October 16, 2013 6:49
But Dean why are you sure that wages go up 20% and shirt prices 5% and not vice versa?

Also, I (again) think you are too sanguine about the effects of a default. China is sending consumable goods to the US in exchange for bits of papers. If it doesn't do that, the US will overall feel a lot poorer. Maybe as you say it will be the investment bankers feeling poorer and everyone else will be okay, but that seems a big maybe. My guess is the result will be as it almost always is: the poor will be the ones who lose out most (inflation but without jobs or increases in salary).
written by watermelonpunch, October 16, 2013 8:05
lower valued dollar raises wages of ordinary workers
written by Dean, October 16, 2013 4:56

This can't be stated enough.
Maybe if more people repeated it this truth, it would become more accepted as a fact.

But know, that it is not accepted as fact and not understood by many ordinary people.

I know that now, and I've known it for some time.
But to understand why, I've kind of had to do more reading about the economics of international trade than I think most average working Americans have time to do.
I try to tell others why, but it's kind of hard to explain quickly & succinctly. It's a struggle.

RE: "but the default is bad anyway"
Well yeah, the point is not to miss the fact that there are individual trees in the forest.

The Black Death was A Bad Thing. Clearly.
Doesn't change the fact that the reduced population served to make life easier for the poor who were left, by making land more affordable and giving workers more bargaining power because of a labor shortage.

Saying but the default is bad... and it would lower the value of the dollar. So that must be bad too.
Is kind of like saying the plague was bad... so the increased bargaining power of the peasants must've been a bad thing too.

And I don't know why people buy into this idea that big companies & the financial sector MUST make huge profits skimming off the workers one way or another.
(ie: you either get paid next to nothing, or you'll be charged excessively for goods & services!)
Another possible reason why capitalists want a strong dollar
written by David M, October 16, 2013 10:30
The rich take vacations and go on shopping sprees overseas; most workers stay within the US. Doesn't seem like much, but getting less cash at the currency exchange booth a very tangible result of a weaker dollar.

Of course, it also hurts remittances, which does impact a lot of workers' families, but politicians don't tend to care about people in line at the bodega or check cashing place.
wages rise 20% with an effective 20% unemployment rate???
written by pete, October 16, 2013 12:10
This is real voodoo economics. Clearly inflation benefits capital not labor. Labor works more, that is the AkerloffYellen goal for sure, but only because they assume they are making more money, when in fact they are making less.
written by AlanInAZ, October 16, 2013 2:25
If the trade deficit fell by 2 percentage points of GDP (@ $330 billion), this would directly lead to close to 2.7 million jobs. If we assume a multiplier effect of 1.5, then we would be looking at over 4 million jobs being created

The CBO estimated that the $814 billion stimulus created 3.3 million jobs. If we accept Dean's assumption of $330 billion increase in GDP then using the same job creating effect as the stimulus gives us about 1.3 million new jobs. I fail to see where the data supports an estimate of 4 million new jobs.


Stimulus was over multiple years
written by Dean, October 16, 2013 3:13

the stimulus was spent out mostly over two years, but some dragged on into 2011 and and later years. If you want to take the increase in net exports over say, 2.5 years it would be about $800 billion. Also, much of the stimulus was tax cuts, which creates fewer jobs than direct spending. And roughly $70 billion was the fix to the alternative minimum tax, which really created no jobs since this is down every year and no one expected to pay it.


as far as "This is real voodoo economics. Clearly inflation benefits capital not labor. "

Not sure where you got this or what you're talking about. First the impact on inflation will likely be minor. (How much inflation did we have in the years 2003-2007 following the drop in the dollar?) And periods of low unemployment like the late 1990s and the late 1960s are often associated with higher rates of inflation. They also tend to be associated with more rapid rates of real wage growth. You're welcome to assert the opposite, but it would be useful to present some evidence.

Re-slicing the pie would also boost demand and employment
written by Sustainable Gains, October 16, 2013 3:34
"Where else would the new demand come from? Those who are hoping for a burst of consumption have not been looking at the data."

It seems to me that there IS one other way for the U.S. to generate new demand that would stimulate a return to full employment. That would be by implementing policies that would re-slice the GDP pie in favor of labor over corporate profits. Sending the fruits of labor back to labor would put cash where the marginal propensity to spend is much higher, boosting monetary velocity and creating a virtuous cycle. The 1% who harvest the corporate profits would be put out temporarily, but oddly enough, since the virtuous cycle would regenerate GDP growth, over the long term probably EVERYONE would come out better.

It's too bad that no one seems to be capable of thinking about the long run much anymore. Or thinking about how getting everyone working productively would help us all.
service sector trade balance
written by Jim, October 16, 2013 4:19
if i read the data correct we actually run a 200 billion surplus in service trade. so wouldnt a weaker dollar cause this to increase further, and unless our policies regarding importing doctors or other professionals suddenly change, have less of an impact on creating demand? then wouldn't this further increase the demand for these professionals and increase their wages? i guess transportation and construction/engineering/architectural services are also included but bea is down so can't see what sectors we run surpluses in...
since 1972 inflation averaged 4% v 2% in the prior 25 yrs
written by pete, October 16, 2013 5:24
up to 1968, income inequality was diminishing, after that, zoom zoom...seems like this latter period has been a period when capital has zoomed, market returns fantastic even after a few blips. meanwhile real wages have stagnated, basically nominal wages barely keeping up with inflations. And of course this is exactly the Akerloff Yelen prediction for Keynesian policies...drive real wages down by inflating, i.e., output prices rise faster than wages. Standard model, not sure why nobody (other than the new fed chairman) understands it or think there is something else going on.
Infaltion and wages
written by Dean, October 16, 2013 9:59

real wages continued to rise rapidly to 1973. They stagnated in the 1970s years of high inflation and then the 1980s and early 1990s, years of low inflation. Then they rose in the late 1990s, when inflation was little changed from the early 1990s. They stagnated in the last decade, years of low inflation. You will have to beat up the data pretty badly to get a story of inflation being associated with lower real wages.

There is some truth to this story in that when oil prices jump that will lower real wages and raise inflation. But that is because oil prices jump. Not much the Fed can do about that one.


the service sector surplus would improve with a lower dollar. But the absolute amount of service sector trade is swamped (@ 8 to 1) by goods trade, so the impact of the change in the service sector surplus would be swamped by manufacturing. btw, the area with the largest surplus in the service sector is tourism. So that will mean more jobs for housekeepers, restaurant workers and custodians.
if governmnets and/or consumers borrow less, doesn't that tend to pull DOWN interest rates
written by Joe Emersberger, October 17, 2013 8:26
As Dean has noted before, the law of indentity, God of Algebra or whatever you want to call it, tells us that a lowering the trade deficit MUST push down the government's budget defict and/ or increase private savings.

(X-M) = (S-I) + (T-G)

X-M is exports minus imports, or the trade surplus,
S-I is private saving minus private investment,
T-G is taxes minus government spending, or the budget surplus

If (X-M) is negative (a trade deficit exists) then (T-G) must be negative (a budget deficit exists) OR (S-I) is negative (the savings rate is very low) OR both.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.