Chinese and European Dollar Comments are Not Without Merit

It would be absurd to think of the US as a developing nation or third world economy. However, recent comments by Chinese and European officials regarding the dollar sound more like those the United States may have made in the past about the Asian Tigers or former Soviet Bloc countries than something valued trade partners would say about each other. Despite this, and despite the root of the comments from both east and west lying in different concerns, these claims of far too casual treatment of the dollar are not without merit.

The US dollar is unique among the world's currencies in that it is the lead global currency of exchange. This is due to the many global business transactions that occur in dollar terms, and many commodities transactions are settled using cash. The US is also the world's largest debtor, meaning that dollar-denominated securities are held throughout the world. Among a few other factors, the US is also the world's largest economy. All of these factors impact the dollar, as it impacts them. During the best of times, no one is very concerned about this looping relationship, as the benefit of convenience and precedent combine to keep the dollar on its throne.

But it is hardly the best of times for the US economy or the dollar's position as the global currency of choice. Commodities prices, particularly oil, have fluctuated wildly over the past decade. The US Treasury is printing money to fund war and stimulus debts at an unprecedented rate. The pound and the euro are both substantially stronger than the dollar. And China's global economic relevance has never been higher. In addition to the more recent comments, this has lead to a wide range of reactions from many quarters, including threats from the middle east of dropping the dollar as the currency of the oil markets. This would be more believable if the parties of OPEC could stick to a cartel agreement, nevermind develop a currency regime, but it is still cause for concern.

These factors and many more are leading to the recent complaints by both Europe and China. In the former's case, there are fears that the a disproportionate burden of the future global trade imbalance correction will fall upon Old World shoulders; in the latter, that a currency pegged to a dollar wearing concrete boots will impact its own rise to global prominance. There are actions that could be taken by everyone involved to ease the collective burden of dollar distress. However, some of the recent comments do make sense and should case concern for the Fed, the Treasury and anyone else who cares about the dollar or the US economy.



Essentially the world funds the spending of the US government. This is through the huge debt offerings that come in the form of Treasuries, which have historically been bought in large degree by China and oil producing countries, such as Saudi Arabia. This was not the focus of recent comments, which were more related to the current carry trade in the dollar, but they are linked. If demand for the dollar dries up further, and with interest rates so low, Treasury holders may at some point decide that enough is enough, and stop buying, or in a worse case, start selling, their holdings. This has already happened to some extent, but an increase in the rate of this could play a part in a more disastrous domino game where selling begets selling, interest rates are no longer controllable, the dollar loses even more value than it recently has, and no one is left standing in the global economy as trade imbalances could wildly shift and investment completely dries up. It may sound like a scene out of Revelations, but a painfully short walk down memory lane will take one past a financial meltdown of biblical proportions. Why should currency markets be any different?

However, there is a solution. It may seem painful with over 10% unemployment and in the throes of economic despair, but I believe the Fed should start to tighten up monetary policy. Gradually, and with plenty of signalling to the market for sure, but rates should be raised. This will keep demand for dollar assets at its long-term, i.e. market, equilibrium, will decrease demand for the dollar as a participant in the carry trade, and hopefully help to shake out the global trade imbalances which will be a huge factor in future global trade disputes. Since all of these things exacerbate each other, the reduction of risk from any of them has a large impact. Other factors would help, such as China continuing its long-term currency re-weighting and a reduction of savings rates in Asia and to a lesser extent, Europe. However, the US only controls its own destiny, and part of that needs to be more responsibility and less short sighted action vis-a-vis the dollar.