Reserve Currency Status: exorbitant privilege or burden?

“If a country takes steps to expand its trade surplus, it is also taking steps to expand its net export of savings – these are one and the same thing.”

The fact is that if foreign central banks buy trillions of dollars of US government bonds, except in the very unlikely case that there just happen to be trillions of dollars of productive American investments whose backers were unable to proceed only because American financial markets were unable to provide capital at reasonable prices, then either the US savings rates had to drop because a speculative investment boom unleashed a debt-funded consumption boom (i.e. household consumption rose faster than household income) or the US savings rate had to drop because of a rise in American unemployment. There is no other plausible outcome possible. Americans cannot wholly, and sometimes even partly, determine the American savings rate.

This mistaken belief that American savings are wholly a function of American household preferences arises because most economists – and, it seems, policymakers – can only imagine American households as autonomous economic units, and are seemingly incapable of imaging them as units within a system in which there are certain inflexible constraints. The same is true about households elsewhere. Because flexible exchange rates prevent Europe from running massive surpluses, German capital exports to countries like Spain created the same constraints, meaning that Spanish households too faced the choice only of speculative investment booms, consumption booms, and unemployment.


The fact that both Spain and the US experienced first booms in consumption and speculative investment and then steep rises in unemployment is just a requirement of the arithmetic, and has nothing to do with local cultural vice finally succumbing to the cultural virtue of foreigners. Rather than try to understand how systems constrain choice, economists and bankers, most of them quite wealthy, preferred to lecture and wag their fingers at ineluctably stupid middle- and working-class households.

As US policymakers take steps to extend free trade through various bilateral and multi-lateral agreements, it is important both that the exorbitant burden is addressed before it becomes much more destabilizing but it is also important that the exorbitant burden not become an argument against free trade. To argue in favor of constraining unlimited purchases of US or other government bonds is not the same as arguing that the US or other countries should not engage in international trade, as many commentators have bizarrely clamed.

via Are we starting to see why its really the exorbitant “burden” | Michael Pettis’ CHINA FINANCIAL MARKETS.


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