An exorbitant burden
IN AMERICA, the Democratic leadership in Congress is once again pushing forward a measure to "get tough" with China over its currency policy. The measure makes for great politics but dubious economics. Don't get me wrong, China continues to intervene in markets to hold down the value of the yuan. That doesn't imply that America will reap big benefits from pressuring China, for a few reasons. First, there could be negative side effects, including a political or trade row with China or a sharp weakening in the Chinese economy. Second, there has been quite a lot of real appreciation in China already; while movement in the exchange rate has been slower than some would prefer, wage growth has been scorching, rapidly eroding China's cost advantages in a number of tradable sectors. And finally, China does not compete with America in the production of many tradable goods, and additional appreciation might simply shift China's position within supply chains. The composition of America's trade deficit is likely to change, but it's not clear that there would be a big shift in its size. In my view, the benefits of a confrontation are unlikely to outweigh the costs.Ezra Klein pivots from the Chinese case, however, to make a broader, and sensible, point:I just had an interesting conversation with economist Carmen Reinhart (of “Reinhart-Rogoff” fame) that speaks to this question a bit.“Bernanke has said the reason we expect more recovery than in past crises is we’ve done more monetary stimulus. And de jure, we have done more on the monetary side. Much more. But de facto matters a lot. In some of those countries, when the crisis hit, there was a big depreciation in the value of the currency, and that’s a very big stimulus factor. We didn’t get that. We had a dollar appreciation, and that goes the wrong way for the recovery.”To put this a bit more plainly, most countries that suffer big financial crises see the value of their currency fall. That makes their exports cheaper, and helps them recover. For reasons related to the safety of Treasury bonds and trade strategies by countries like China, our currency gained value during the crisis.This is a manifestation of what Michael Pettis calls America's "exorbitant burden". Dollars are the world's primary reserve currency, and Treasuries are the world's preferred "risk-free" asset. At any time, foreign governments and investors find it attractive to hold lots of both. When panic reigns, investors pour into dollars and dollar securities. In 2008, while financial collapse was gutting the American economy, the dollar soared in value. As panic subsided, the dollar resumed a slow slide, but with every new flare-up of the European crisis the greenback jumps in value.This is not so much an issue of exchange-rate manipulation as of the economic role America occupies in the world. It clearly has some downsides, however. In recent weeks, European panic has led a number of financial institutions to pull money from emerging markets in Asia—risk-on financial bets—which has in turn led to swoons in the value of emerging-market currencies. This is just peachy so far as many emerging markets are concerned; at just the time that the world economy looks shaky, their export industries get a competitiveness boost. In America, by contrast, a shaky world economy leads to a rising dollar and a harder road for American exporters.Another way to look at this dynamic is to say that in times of trouble, the global economy becomes more dependent on American domestic demand. By pouring money into American securities, they're bidding up American purchasing power and, by happenstance or design, increasing sales of goods from their countries into the American market. So long as the dollar is the world's reserve currency, it's hard to imagine too much decoupling taking place.This dynamic casts monetary easing in an interesting light, however. Sceptics of easy monetary policy often complain that easy money is designed to fuel consumption and put off adjustments: to give the American economy a temporary boost, delaying the inevitable reckoning. When we focus on the current-account picture, however, it's clear that monetary easing does just the opposite. When world markets are fearful and therefore rush for dollars, that impedes the adjustment in America's current-account deficit. When the Fed eases, it creates many more dollars, helping to meet the sudden excess demand for greenbacks and preventing a surge in the dollar's value. That, in turn, eases the pressure on American demand; it fends off the deflationary rise in the dollar while facilitating an internal rebalancing toward domestic demand.That may lead to some nasty words from other countries used to relying on America as consumer-of-last-resort. But the sensible thing for the central bank managing the supply of the world's reserve currency to do when greeted with a massive jump in demand for that currency is to try and meet that demand.