OPINION:
The United States prints the world’s gold, and that bestows a huge privilege.
The U.S. share of global exports is only 9%. Yet 54% of global trade is dollar-invoiced, and 59% of foreign central bank reserves are held in U.S. currency and securities.
The dollar is the vehicle currency for 88% of foreign exchange transactions. When a Chilean business buys Vietnamese apparel, it trades pesos for dollars and converts them into Vietnamese dong.
The Treasury sells bonds to foreign investors to provide liquidity for an expanding global economy. This permits Americans to consume more than they produce annually, resulting in a trade deficit equal to 3% of gross domestic product.
This is enabled by trust in U.S. fiscal and monetary policies, which aim to keep the purchasing power of the dollar reasonably stable relative to other currencies by avoiding excessive inflation.
While the recent U.S. macroeconomic performance has been first-in-class among advanced economies, the International Monetary Fund has warned that U.S. budget deficits are “out of line with fiscal sustainability” and adding to inflation.
The Federal Reserve was slow to respond to the 2021 surge in inflation and gave too much weight to the self-correcting potential for COVID-period supply constraints.
From the global financial crisis of 2007-2009 to COVID-19, the Fed maintained historically low interest rates as globalization protected it from inflationary pressures.
The 10-year Treasury rate averaged 2.3%, and the inflation-adjusted real rate was only 0.5%. That’s well below the assumed 2% sustainable growth rate, which provides a reasonable gauge for the social cost of capital.
Excessively low interest rates encourage the governments of both the U.S. and developing countries, often borrowing in dollars, to overspend and rack up debt.
When inflation arrives — as it generally does in the wake of easy money — politicians are reluctant to trim spending and place too much burden on the Fed and foreign central banks to rein in prices.
This results in recessions that discomfort politicians and test the political independence of central bankers.
One can only speculate how much influence President Biden’s hesitancy in reappointing Chairman Jerome Powell inspired the Fed to cling to the notion that the 2021 surge in inflation was merely transitory.
Virtually free money in real terms encouraged investors to pour into junk bonds, leveraged loans, private equity, etc. That misallocated capital, which is the most critical resource in the efficient allocation of labor, research and development, and entrepreneurial energy, to businesses that should have failed or never have been so generously funded.
The notion that easy money promotes growth is an illusion.
An IMF study of about 100 bouts with inflation across 56 countries found that central banks that deal with inflation forcefully and with some finality enjoy better longer-term growth.
Washington could face a fiscal crisis next year because the IMF projects that the deficit will soar to 7.1% of GDP. International investors could balk at absorbing so many new bonds, turning the dollar’s recent ascent into a rout.
Americans must either pay higher taxes or cut entitlements, which account for 63% of federal spending, or recklessly put international confidence in the dollar at risk.
Last year, after the debt-ceiling standoff in Congress, the Treasury temporarily but substantially boosted its borrowing to rebuild its cash balances. That instigated a full percentage-point jump in the 10-year Treasury rate to nearly 5% in mid-October as domestic and international investors demonstrated limits to their appetite for ever-increasing U.S. debt.
Permanently elevated borrowing requirements would make federal finances and inflation difficult to control as debt service would grow faster than nominal GDP. That would inspire foreign central banks to seek alternatives to the dollar.
The Fed needs to reevaluate its long-term objectives for interest rates.
The 10-year Treasury rate is the most critical price for allocating capital among competing uses, not the federal funds rate the Fed controls through open market operations and the rate it pays on bank reserves.
The Fed holds $4.5 trillion in Treasury securities, and through sales and purchases, it could manage the 10-year rate to an inflation-adjusted 2%.
In parallel, the United States uses the dollar as a rather blunt instrument of foreign policy. The cooperation of Western allies can curb access to the SWIFT system. A consortium of major banks mostly domiciled in the United States and its NATO and Pacific allies, SWIFT provides a messaging system that enables seamless currency trades.
Sanctions against Russia and Iran have inspired Persian Gulf oil exporters and the BRICS nations — Brazil, Russia, India, China and South Africa — to seek ways around the dollar in their commerce. But except for Russian-Chinese bilateral trade, these efforts have not gained much traction.
The dollar’s dominance and foreign policy leverage could evaporate if large federal deficits and lax monetary policies beget persistently elevated inflation and excessive reliance on financial markets to absorb U.S. debt.
• Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.
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