Michael Pettis: Is it time for the US to disengage the world from the dollar?

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By Michael Pettis, a Senior Associate at the Carnegie Endowment for International Peace and a finance professor at Peking University’s Guanghua School of Management. Cross posted from China Financial Markets

The week before last on Thursday the Financial Times published an OpEd piece I wrote arguing that Washington should take the lead in getting the world to abandon the dollar as the dominant reserve currency. My basic argument is that every twenty to thirty years – whenever, it seems, that American current account deficits surge – we hear dire warnings in the US and abroad about the end of the dollar’s dominance as the world’s reserve currency. Needless to say in the last few years these warnings have intensified to an almost feverish pitch. In fact I discuss one such warning, by Barry Eichengreen, in an entry two months ago.

But these predictions are likely to be as wrong now as they have been in the past. Reserve currency status is a global public good that comes with a cost, and people often forget that cost.

Just as importantly as a public good it requires a number of characteristics. At a minimum these include ample liquidity, central bank credibility, flexible domestic financial markets, minimal government or political intervention, and very deep and open domestic bond markets. With the exception perhaps of the euro, which may or may not emerge in the next decade on a more rational basis than it currently exists (albeit with more than one defection), no other currency has the necessary characteristics that will allow it plausibly to serve the needs of the global economy.

And no other country, not even Europe, will be willing to pay the cost. If there is any chance that the dollar’s status declines in the future, it will require that Washington itself take the lead in forcing the world gradually to disengage from the dollar.

Ironically, this is exactly what Washington should be doing. Conspiracy theory notwithstanding, claims that the reserve status of the dollar unfairly benefits the US are no longer true if they ever were. On the contrary, the global use of the dollar has become bad for the US economy, and because of the global imbalances it permits, bad for the world.

During the first few decades of the post-War period, the cost of maintaining the dollar’s status could be justified by the incremental benefits to the US of a stable and growing world economy within Cold War constraints. The trading benefits that accrued from a widely available global currency benefitted US allies and the relative size of the US economy ensured that the costs were limited. But beginning in the 1980s, trade policies in a number of countries abroad have sharply raised the cost to the US, while the end of the Cold War has limited the benefits.

This cost comes as a choice between rising unemployment and rising debt. The mechanism is fairly straightforward. Countries that seek to supercharge domestic growth by acquiring a larger share of global demand can do so by gaming the global system and actively stockpiling foreign currency, mainly in the form of, but not limited to, central bank reserves. This allows them to forcibly accumulate domestic savings while relying on foreign demand to compensate for their own limited domestic demand.

Always dollars

In practice, dollar liquidity, limited Washington intervention, and the size and flexibility of US financial markets ensure that these countries always stockpiled dollars. There is no real alternative to the dollar, and most other governments would anyway actively discourage massive purchases of their own currencies because of the adverse trade impacts. If foreigners accumulate euros or yen at anywhere near the rate they accumulate dollars, they would force Europe and Japan into massive current account deficits, and neither Europe nor Japan has any interest in seeing this happen.

So foreign acquisition of dollars automatically forces the US into running a corresponding current account deficit as foreign polices that constrain consumption at home require higher consumption abroad. Active trade intervention in countries that engineer large trade surpluses, in other words, have to be accommodated by rising trade deficits in the US.

This importing of US demand by other countries forces the US economy to respond in one of two ways. Either American unemployment must rise as demand is diverted abroad and the tradable goods sector in the US shrinks, or Americans must counteract the employment impact by increasing domestic consumption or investment.

Without government intervention, there is no reason for domestic investment to rise in response to policies abroad. On the contrary, with the diversion of domestic demand private investment may even decline.

So in order to limit the employment impact, capital flows into the US have to finance additional US consumption. Americans, in other words, are forced to choose between higher unemployment and higher debt, and in the past the Federal Reserve has chosen to encourage higher debt.

But what about the benefits to the US of reserve currency status? A lot of analysts argue that the predominance of the dollar gives the US two important advantages. It reduces the cost of imports to American consumers and it lowers US government borrowing costs.

But both arguments are seriously flawed, I think. Americans already over-consume, and so it is hard to argue that they benefit in the aggregate from lower consumption costs, especially when it comes at the expense of employment. And anyway if cheaper consumption is such a gift, it is hard to explain why attempts by the US to return the gift to countries whose consumption costs are artificially high – demanding for example that these countries revalue their currencies and so reduce costs for their own consumers – are always so indignantly rejected.

As for borrowing cheaply, what matters to a government’s borrowing cost, as countries like Switzerland clearly demonstrate, is not major reserve currency status but rather creditworthiness. Because reserve currency status actually increases US borrowing, it is more likely to undermine the ability of the US Treasury to finance itself cheaply than the loss of reserve status would.

The supposed advantages of reserve currency status are simply the obverse of the cost. As countries accumulate dollars, they force trade deficits onto the US, which the US can only manage by increasing borrowing. This borrowing is financed by the foreign accumulation of dollars.

So will it happen?

The massive imbalances that this system has permitted are destabilizing for the world because they permit large and unstable debt buildups both in countries that over-produce, like China and Japan, and those that over-consume, like the US. If the world were forced to give up the dollar, there is no doubt that there would be a cost – it would reduce global trade somewhat and it would probably spell the end of the Asian growth model – but it would also lower long-term economic costs for the US and reduce dangerous global imbalances.

The US, I would argue, should take the lead in shifting the world to multi-currency reserves in which the dollar is simply first among equals. The cost of maintaining sole reserve currency status has simply become too high in the past three decades and is leading inexorably to rising American debt and worrying global imbalances.

My Financial Times article got a lot more response than I would have expected. Some of it was in other news sources, as in this CNN report, but there were also a lot of private responses, suggesting that a larger number of people out there than I had expected were thinking along the same lines. The most interesting of the responses was an email by Kenneth Austin accompanied with an article he had recently published in World Economics. Austin is an International Economist with the US Treasury Department, and a professor at the University of Maryland.

His article was a fascinating re-reading of John Hobson’s theories on under consumption (which I remembered from my graduate school days primarily because he had so profoundly influenced Lenin’s ideas on imperialism). Hobson was a leading British economist of the late 19th and early 20th centuries, and he was one of the major figures in the “underconsumptionist” school. Here is Austin on the topic:

The basic idea is that oversaving causes insufficient demand for economic output. In turn, that leads to recession and resource misallocation, including excessive investment in marketing and distribution. This was a direct challenge to a core thesis of the classical economists: ‘Savings are always beneficial because they allow greater accumulation of capital.’

Keynes, almost 50 years after The Physiology of Industry, found there the essential ideas of the General Theory (first published 1936): the determinants of aggregate demand and the significance of savings– investment imbalances. In Chapter 23 of the General Theory, ‘Notes on Mercantilism etc.’, he lauded Hobson and Mummery for bringing the issue of excess saving to the fore. But Keynes disagreed with Hobson’s theory that excess saving leads to unnecessary investment. Instead, Keynes believed that ‘a relatively weak propensity to consume helps to cause unemployment by requiring and not receiving the accompaniment of a compensating volume of new investment’ (Keynes 1964, p. 370). Keynes attributed Hobson’s error to the lack of an independent theory of the rate of interest. Hobson (Mummery had died many years earlier) considered Keynes’ work the completion and vindication of his efforts.

Hobson took his excess savings theory in another direction in Imperialism: A Study, first published in 1902. In a closed economy, excess savings cause recessions, but an open economy has another alternative: domestic savers can invest abroad. Hobson attributed the renewed enthusiasm for colonial conquest among the industrial powers of the day to a need to find new foreign markets and investment opportunities. He called this need to vent the excess savings abroad ‘The Economic Taproot of Imperialism’.

However, increasing foreign investment requires earning the necessary foreign exchange to invest abroad. This requires an increase in net exports. So foreign investment solves two problems at once. It reduces the excess supply of goods and drains the pool of excess saving. The two objectives are simultaneously fulfilled because they are, in fact and theory, logically equivalent.*

Since industrialised countries tended to develop the same problem of excesses of savings over time, they could not solve the problem cooperatively among themselves. They needed to capture less developed economies to absorb the surplus savings and goods.

Sorry for quoting such a large chunk of Austin’s piece, but I found it a fascinating read and very relevant to understanding China. We may seem to be straying from the topic of the role of the dollar, but basically Austin argues that under-consuming countries today are able to use the dollar today for the same reason that European countries used colonialism in the past – as a way of allowing them to export capital and import foreign demand.

Post script on Black swans

On a totally different subject (and sorry for sounding grumpy), I wonder if I could propose a moratorium on the phrase “black swan.” Although it once had a very limited but useful meaning, it has gradually become one of the most popular and meaningless phrases in financial markets. Last night I watched a Niall Ferguson documentary where he kept warning about black-swan financial crises in places like Latin America. Today I got a report that begins:

The financial markets have endured a flock of geopolitical “black swans” including the devastating earthquake and nuclear crisis in Japan, widespread revolution and violence in the Middle East and North Africa, and escalation of the European sovereign debt crisis. Incredibly domestic markets shrugged aside fear from each transformational event as stocks registered their best first quarter in over a decade led by a recovery in corporate earnings and job growth.

Black swans rarely fly in flocks, and not a single one of these are black swans. They are just shocks. A black swan is an event that disproves a widely-held hypothesis – in the original case, the widely-believed hypothesis was that all swans are white. The discovery of black swans in Australia disproved that hypothesis once and for all.

The Japanese earthquake, then, was not a black swan. To have been a black swan would have required that until last month all of us believed that for whatever reason Japan was wholly immune to earthquakes. In that case the devastating earthquake last month would have resoundingly overturned all of our deepest geological convictions and so it would have qualified as a black swan. Since we know Japan is on a major fault, and everyone has been waiting for decades for the “big one” to hit Japan, the terrible earthquake that hit last month cannot possibly have overturned any hypotheses about Japan and earthquakes and so cannot have been a black swan. The fact that it may have unleashed a nuclear disaster is also not a black swan, unless most of us truly believed that nuclear disasters are in principle and in practice impossible.

Financial crises are not black swans. Revolutions in Egypt are not black swans. If Portugal defaults that will not be a black swan, and the fact that its government-bond spreads are widening is not even close to being a black swan. If Portugal suddenly negotiated an agreement with Australia to become an Australian state, however, that might qualify as a black swan because it would create a reality that none of us had previously thought possible and it would have dramatically changed most of our ideas about possible resolutions to the debt crisis. Widening credit spreads do not qualify.

Black swans almost never occur while shocks occur all the time, and there is no point confusing the two. And by the way while we are on the subject we should probably also call a moratorium on the phrase “tipping point”. I can’t say how many times I have been asked to predict tipping points. The whole point of the “tipping point” concept is that it is totally unpredictable. It means that small incremental inputs will have no discernable effect on output until, suddenly and unexpectedly, a single additional tiny input causes a massive change in output. The straw that broke the camel’s back is an example of a tipping point, and of course it is impossible to predict which straw will do that.

This is an abbreviated version of the newsletter that went out last week. Academics, journalists, and government and NGO officials who want to subscribe to the newsletter should write to me at chinfinpettis@yahoo.com, stating your affiliation, please. Investors who are clients of Shenyin Wanguo Securities will already receive the newsletter. Investors who are not clients but who want to buy a subscription should write to me. also at that address.

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  1. NOTaREALmerican

    Well… That “black swan” article was sure a “tipping point” for me; I never expected THAT.

  2. ToivoS

    Tipping point remains a useful term even if widely misused. A few decades back the term was ‘cusp’ and I recall that this was misused. Then there was chaos theory, another effort to describe the same unpredictability.

    But I think you are right about black swan. These are events that are so rare, that each time one happens, it deserves its own term. I am puzzled about one thing: what actually happened in the fall of 2008 that earned that event such a special term?

    1. fajensen

      what actually happened in the fall of 2008 that earned that event such a special term?

      People finally discovered that leverage (and the enormous amount of money in circulation) increases the system gain to the point where even minor disturbances slams it into the rails. We have reached the point where the gain is so large that mere rumored weasel words from a central banker moves trillions of USD via exchange rates.

      One must expect instability to grow into stability, but in the form of permanent limit-locked markets.

  3. F. Beard

    This entire article is predicated on a single government enforced monopoly money supply for all debts, public and private just as it says on Federal Reserve Notes.

    But what if the US had genuine private money alternatives? Then instead of a single current accounts balance there would be dozens or perhaps hundreds of current account balances between US corporations and the rest of the world. Of course the world could continue to buy US dollars if it wished (but not directly from the US Government since the US government should recognize no currency but its own fiat) but that should not affect US suppliers other than those who supplied government and its dependents which is admittedly a large market.

    The private sector would have to compete with foreigners to buy government fiat (to pay taxes and fees) but that is no problem since the government could create sufficient debt-free fiat at will to meet both foreign and domestic demand. And if foreigners ever repatriated that fiat, again there would be no problem since the private sector would be immune to government fiat price inflation and as for government workers and other dependents they could receive pay raises to compensate for the price inflation.

    So yes, the US can have its cake and eat it too. It can provide the world with a reserve currency without destroying its own private sector manufacturing capability. Furthermore, for providing that reserve currency, the US could finance its government with foreign currency given in exchange for it (much as it does now).

    Jesus gave us the money solution almost 2000 years ago in Matthew 22:16-22 – separate government and private money supplies. Is it any wonder that it has miraculous properties?

    1. frances snoot

      Jesus supported slavery. The new system is a system where human capital steps into the black hole vacated by the dollar-value-index.

      And then shall the end come: when the gospel of anglo-mercantilism is predicated under one auspice.

      1. F. Beard

        Jesus supported slavery. frances snoot

        The Spirit of the Lord GOD is upon me,
        Because the LORD has anointed me
        to bring good news to the afflicted;
        He has sent me to bind up the brokenhearted,
        to proclaim liberty to captives
        and freedom to prisoners
        to proclaim the favorable year of the LORD
        Isaiah 61:1-3 [bold added]

        1. frances snoot

          Check your holy writ again. The intolerant system was supported by Jesus; or was that Paul?

          1. F. Beard

            Jesus quotes Isaiah 61:1-2 in Luke 4:18-19.

            As for Paul:

            Were you called while a slave? Do not worry about it; but if you are able also to become free, rather do that. 1 Corinthians 7:21

            Do your own homework Snoot. Read the entire Bible before you go off 1/2 cocked.

            Here I am trying to reform the money system using the Bible as a guide and folks who should be allies would rather attack the Bible!

            We are all sinners. I don’t know what your particular hangup with the Bible is but everyone has at least one. Get over it, I suggest.

            Or continue to let the usury and counterfeiting class eat your lunch. T’would be poetic justice though it might not rhyme.

          2. frances snoot


            To think the bible is not written in human blood! I have no trouble with what you believe, Frankie, as long as you don’t make a religion of it.

  4. obang

    it is massive wage differential (eg china vs the us)and the subsequent off shoring of manufacturing which is to blame. the dollar has been an international reserve currency for decades. but job displacement is a recent phenomenon.

  5. Jimbo

    Obang, I’d say that (i) Broadband, (ii) Tariff Reduction via the WTO, and (iii) illegal Chinese expropriation of US technology, written off as a cost of doing business by US firms, have resulted in material job displacement,

  6. Martin

    Completely agree on black swans, but disagree on what you say on tipping points. While it is impossible to say which straw will break the camels back, you know very well, that
    a) putting up enough straw will eventually break the back of the camel, and
    b) you can calculate the ballpark number for when this is happening.
    So when somebody puts straw on a camels back, you are very well prepared to give an adequate warning in time.

    There are even tipping points, that can be completely accurately, e.g. if two different processes can produce something, and they have completely different dependencies on something. As an example, I think it is completely accurate to call 17 * 10^6 degrees Kelvin a tipping point for the type of fusion happening in stars, as the CNO cycle has a temperature dependence of ~T^15 while the standard pp fusion type has a much lower temperature dependency, which dominates at lower temperatures.

  7. Hugh

    The author looks steadfastly into the face of kleptocracy and sees nothing. It goes down hill from there. If it sounds that Pettis is advocating for some kind of new stand-in for a gold standard, that’s because he is. He doesn’t spend any real time describing how such a new standard would work. He just sort of throws it out there and moves on. But think about it. Who would control the volume of the new reserve currency? A new super central bank? Who would control that? It’s rather an important question because he who controls the new currency would also control economic policy for the world. Loosen monetary policy and country A can have an expansion. Tighten it and it experiences a recession. So who decides?

    I don’t identify as an MMTer but geez louise could someone send Pettis a primer on it? Unemployment and debt are not the only two options for the Fed. Here I must admit I saw a kind of conflation of government and private sector debt. Debt is merely the way the Fed and the US government have gone because let’s face it, neither has ever really let go of the gold standard in its thinking.

    Nor is monetary policy the only way to deal with trade imbalances. There is also prudent management of trade. Here we really slip over into kleptocracy because it has been the policy of our elites to strip the middle class of its assets and endebt it, then take the proceeds and send them to places like China. It wasn’t we the people but they the kleptocrats (and the Chinese) who benefited most from an overly cheap renminbi. The failure to manage trade, encourage investment here, and spread the profits to the middle class through better wages didn’t just happen. It has been the policy of our kleptocratic elites for 35 years.

    Not a fan of Taleb but I have no problem with black swan. The idea as I take it is that there is a mismatch between the frequency of an event and its expected frequency.

    My impression is that a lot of economic modeling only looks at the results of the recent past and projects on the basis of these into the future. So there can be events out there that have occurred but aren’t taken into account in the models because they occurred outside the time horizon of the model’s assumptions. When they occur again, they are unexpected in terms of the models.

    Additionally, the models can simply get the frequency wrong, saying that the probability of something happening is less than what it actually is.

    Finally, we have to distinguish between the clustering that occurs in a truly random series of events and the presence of an unrecognized driver. The Japanese earthquake would fall into the first category but the instability in the US, Europe, China, and Japan isn’t random but the result of kleptocracy playing out in each.

    1. F. Beard

      It wasn’t we the people but they the kleptocrats (and the Chinese) who benefited most from an overly cheap renminbi. Hugh

      Why should another country’s monetary policy affect the US? What difference would it make how cheap the renminbi was if the Fed was not creating the dollars to buy them and thus Chinese exports?

      The problem is thus the Fed and not China.

      Furthermore, the problem is the government subsidized debt-money system that makes the economy dependent on interest rates.

      1. Hugh

        financial matters, just below gives the reason that it is both China and the Fed. It’s important to understand there are at least two actors to every transaction. China needs to cycle its dollars back to us keep its export sector going. Its savings aren’t virtuous, just as our spending isn’t profligate. They are merely two sides of the same coin. The kicker is the degree to which this is happening and the kleptocratic motor behind it. It is that which makes the current arrangement unsustainable. The Chinese kleptocrats and the investment by the US rich and corporations (our kleptocrats) is causing China to run too hot and for us to run too cold. This will work to the detriment of both ordinary Americans and Chinese.

    2. john c. halasz

      Nah. Look up Keynes’ Bancor proposal. Only some such “artificial” international institutional arrangement would rectify the problems with a “spontaneous” floating FX and trade system, (which the MMTers take for granted). That does mean that there are severe problems of international coordination and agreement in instituting a new system, (which would be something virgorously opposed Wall St. and the MNCs, with their international arbitrage strategies, involving currencies first of all, before wages, taxes, regs., etc.) But if such a new system would be arrived at it would likely involve crawling pegs to a basket of major international currencies, (like IMF SDRs currently).

      1. financial matters

        Keynes understood the dangers of unrestricted cross country capital flows..

        “”Dismantling capital controls is one thing. But we have taken a full step again beyond that, to a world where capital is not only free to flow across borders but is actively and artificially encouraged to flow, lured by the offshore attractions of secrecy, evasion of prudential banking regulations, tax evasion and avoidance and more. Once again, Keynes would have been horrified”” (Treasure Islands by Nicholas Shaxson)

        I liked the way Pettis put it in another article which he mentions.. ‘. In fact I discuss one such warning, by Barry Eichengreen, in an entry, http://www.roubini.com/emergingmarkets-monitor/260642/the_dollar__the_rmb_and_the_euro?utm_source=contactology&utm_medium=email&utm_campaign=RGE_360_10_15_110 , The Dollar, the RMB and the Euro , two months ago’

        “”If countries that have accumulated massive reserves, like Japan, Germany and China, chose to diversify their holdings, or were forced to, away from the dollar, this would be tantamount to saying that the US current account deficit would have to contract and other countries would be forced into absorbing those surpluses. The US would also borrow less because a lower trade deficit would require less fiscal or household borrowing to maintain any given level of growth and employment.

        But very few other countries can absorb the US trade deficit. In that case countries that rely on large current account surpluses to absorb their excess capacity would be forced into reducing their surpluses and reducing their capacity. Their growth, in other words, would be lower.
        The US, on the other hand, would be “forced” into either higher growth or lower debt levels. This does not seem either like a good thing for surplus countries or a bad thing for the US.””

  8. Three Wickets

    “Is it time for the US to disengage the world from the dollar?”

    No, that would mean disengaging from direct trade, and who wants that. Though it is true that the yuan was devalued from 1.5 yuan/dollar in 1980 to 8.3 yuan/dollar by 1994 where it was pegged until 2005. That was helpful for Chinese manufacturing. Today we are at 6.5 yuan/dollar.

  9. RebelEconomist

    “So foreign acquisition of dollars automatically forces the US into running a corresponding current account deficit as foreign polices that constrain consumption at home require higher consumption abroad.”

    As I have been writing at least since the days of Brad Setser’s blog, this view is wrong on two counts. First, as Michael himself admits later in his post, and as was discussed in yesterday’s post on China, the US could tolerate the current account deficit and increase its public investment – constrained consumption overseas need not force higher consumption in the US. The potentially high return on increased public expenditure of some kinds in the US was also exemplified yesterday by the link about the cost of low teacher salaries (admittedly, expenditure on teacher salaries would probably be recorded as government consumption rather than investment). Second, the US could increase its own foreign exchange reserves and share the current account deficit, not to mention the interest in getting China to adjust, with other countries. US foreign currency reserves have not increased for more than a decade despite growing financial and trade flows, and are woefully inadequate on any of the standard yardsticks.

    1. john c. halasz

      Pettis himself has semi-seriously (or semi-jokingly) proposed just such a Chinese financing of a new U.S. New Deal.

        1. TomWang

          Actually Pettis is always pretty honest about taking ideas from others, and in fact his proposal is in a very different spirit from yours. Given the way he thinks and the things on which he focuses I think it is pretty obvious he didn’t credit you because he didn’t get the idea from you. It’s a good idea for expressing the problem, though. Credit to both of you.

          On the other hand is it starting to seem as if all the smart writers are lifting Pettis wholesale when it comes to China, and qithou always citing the source? Roubini especially seems recently to be channelling Pettis on China. My friend says they both spoke at a conference in Hangzhou earlier this year and while there had a long tête a tete. Ever since then you can just read Roubini if you want to know what Pettis thinks. And it’s not just Roubini on China. I am seeing the “Pettis” view of the world popping up increasingly in debates about trade, central banking, European debt, and of course, Chinese growth.

  10. craazyman

    Marshall Auerback once wrote a macroeconomics article that made sense. That was a black swan in my book.

    Macroeconomics would make more sense than it does now if people started before money. You make canoes and I make TeePees. If we trade 1 for 1, or 2 for 1 or 1 for 2 or 3 for 5, nobody is unemployed and there’s no imbalances.

    So then a mongrol hoard moves upland from downriver and they make TeePees for half the number of canoes I do. You start trading with them and I have to promise to give you furs at the hunt.

    Maybe I’m lucky or maybe you decide that the Great Nature Spirit is a bigger dude than me, and you forgive my debt, because you know I hunted well, and you want peace in the valley. You also realize that all trade is an exchange of spirit through the creative application of nature, labor and imagination, and you know they are all spirit waves.

    No, money makes debt eternal and fixes things hopelessly in time, and, like all things, it contains itself and its opposite, at the same time. Eros and Thanatos, Love and Hate, Male and Female, Bit and Byte. Sun and Moon. There’s no way to put those in equations without more unknowns than variables. Never. LOL.

    1. F. Beard

      No, money makes debt eternal and fixes things hopelessly in time, craazyman

      How indoctrinated folks are by the usury cartel!

      At least two forms of money can be created debt-free:

      1) Government fiat.
      2) Common stock.

      Both can simply be spent into circulation. One could argue that government fiat represents a tax debt to the government but at least there is no private debt.

      There is no need to fall back to primitive barter. Money can be implemented ethically.

      Men prepare a meal for enjoyment, and wine makes life merry, and money is the answer to everything. Ecclesiastes 10:19

    2. Cedric Regula

      This teepee, canoes and furs stuff confuses me.

      But I’m amazed how no economists have the slightest idea how international macro works. The government cuts taxes resulting in a fiscal deficit and causes the resulting discretionary after tax income for the consumer. The consumer spends it on a relatively non-essential foreign import. The foreign saver uses the surplus to buy a Treasury and finance the consumers’ taxes.

      It’s probably the Pilot Wave that makes that work, and the gnostically inclined get it. But not a macro-economist.

  11. craazyman

    I don’t really get it either. I don’t think anyone can ever get 16 equations with 19 unknowns. I mixed up the canoes and teepees anyway, and I messed up with bit and byte. They’re not opposites. I should have said 1 and zero. And it still has lots of gaps and elisions, as it were. It’s just a mind painting.

    And even though nobody cares, I still did want to say that Marshall really wrote a good macro article and the black swan wasn’t that he wrote it, but that it was a good macro article. It was a black swan that flew with a soft and graceful glide over all macro articles, ever written. Because he observed that corporate investment was being held back by one factor — lack of imagination. Not lack of animal spirits or capital or labor or money supply or anything of those things that are only diluted second-order incarnations of some invisible variable. But the thing that makes it all move, the hidden variable itself. The Imagination mind wave. And so he made a black swan, at least once. And I will always remember it with a smile. :)

    1. Attitude_Check

      Actually, there are ways to solve 19 unknowns from 16 equations, using constraints, and Minimum Squared Error techniques. The whole area of Inverse Problems deals with this issue – among others.

      1. craazyman

        Interesting. Thank you.

        I Googled it and can’t say I followed all the math — it’s been quite a while since I studied Eigenvalues :) — but all the examples seem to be related to natural physical phenomenon, which appear to operate with some considerable degree of regularity, which we can call “laws” of nature.

        And then there was this jewel from Wikipedia: “While inverse problems are often formulated in infinite dimensional spaces, limitations to a finite number of measurements, and the practical consideration of recovering only a finite number of unknown parameters, may lead to the problems being recast in discrete form. In this case the inverse problem will typically be ill-conditioned. In these cases, regularization may be used to introduce mild assumptions on the solution and prevent overfitting. Many instances of regularized inverse problems can be interpreted as special cases of Bayesian inference.”

        So there’s always a guess going on somewhere to fit reality to the model.

        1. MonkeeRench

          “So there’s always a guess going on somewhere to fit reality to the model.”–craazyman

          …and not just with Reality — with mathematics and logic as well, as Go”del shocked the Idealists with long ago. Unprovable assumption(s) must always be the basis for a (thus incomplete) system/model to make it consistent. If one’s assumptions are elegant/beautiful/simplistic just to make the math easily-solved/linear/convenient, yet totally WRONG/never demonstrated/range-limited (e.g. that financial values follow Gaussian/normal probability) you’ve got a Black Swan waiting to shock Idealists into Reality.

          Incidentally the Black/White Swan terminology problem as usual is the sameol’/sameol’ dispute of simple-mindedness: Reality is not black/white, it’s gradations of gray. Taleb never said Black Swans were impossible, just perceived as highly improbable, thus ignored for convenience. A shock is a perceived discontinuity, of course not a purely Black Swan, but a rather dark grey for most simplistic modelers.

          Just as the Japan disaster was not a matter of IF, but rather WHEN (and most decision-makers conveniently assume ‘not on my watch’), the earthquake/tsunami destruction of Seattle’s Northwest and the massive destruction of much of the Bible Belt by the Yellowstone Caldera/Supervolcano by a similar disaster is also inevitable/indeterminate — hardly the impossible of pure Black.

  12. PeakVT

    This is a good piece by Pettis but it fails to acknowledge that there are winners and losers within the United States at any particular level of the dollar. Right now, the people who have purchased our politicians – bankers and the CEO class – are benefiting from a stronger than necessary dollar, and average workers – especially those in manufacturing – are hurting. Until that changes, there will be no pressure from inside the US to change anything, even if the country as a whole suffers.

  13. ChrisPacific

    I agree that ‘black swan’ is a widely misused term. It’s ironic that it was the GFC that made Taleb famous even though it was really not a black swan event at all (to Taleb’s credit, he has made this point himself).

  14. Attitude_Check

    So we need a replacement for the $ as reserve currency. This is a natural result of Triffin’s dilemma that the author should review. So what should the replacement be?

    1. Not a currency of a country that want’s a healthy economy, and avoid Triffin’s dilemma
    2. Large international liquidity
    3. Internationally accepted

    The idea that a basket of currencies is a solution (aka the SDR) is not viable. WHY would the SDR countries want that? It just spreads the pain over a larger % of the world economy. This is the basis for Zopelick’s idea of “reference point gold”. Gold becomes the ultimate world reserve currency – it meets all the requirements. The problem is that just using Gold isn’t likely to work – we tried that before, with fixed exchange rates to Gold. The answer is to have the SDR float relative to Gold, and the remaining currencies float relative to the SDR. As SDR nations print more money, they devalue against Gold, and vice versa. Actual Gold flow is not required, but Gold be comes the international reference point.

    1. RebelEconomist

      I don’t believe that Triffin’s dilemma ever was real. It is not necessary for a reserve currency country to run a current account deficit for other countries to accumulate its currency in their reserves. The reserve currency country can on-lend the reserve capital inflows to other countries so that its capital account (and therefore current account) remains balanced. In Triffin’s day, during the Bretton Woods era, the US was supposed to back its dollar money supply with gold, so that the capital account offset to reserves inflows should have been an inflow of (monetary) gold. But then, as more recently, the US chose to consume the reserves capital inflows (at that time, in the Vietnam war). It might be more accurate to describe the problem for the reserve issuing country as “Triffin’s irresistible temptation”.

      1. Steve

        Rebel – So would you agree with me that most of Pettis’ article is just a half-assed rehash of the Trffin Dilemma?

        But the even more serious failure of his article is the absence of a serious analysis of the US seignorage benefit, which he strangely seems to imply is now a “cost”, versus the costs imposed on the US by the Triffin Dilemma (in the form of consumption/investment incentive distortions etc.).

        He dances around it, but fails to deliver convincingly. What do you think about this? Anyone else have views?

        1. Anonymous Jones

          My view is that you don’t understand what you think you do, and either your bar for “half-assed” is incredibly aberrant or you are incredibly stupid.

          He did not say that a “benefit” was a “cost.” He identified a “cost” to be juxtaposed with the “benefits.” Do you truly not understand that everything has both “costs” and “benefits,” and using either label is dependent upon each individual’s perspective?

          It seems you are trying to argue that when someone identifies a “cost” with respect to a policy, this means that there can never be any “benefit” associated with that policy. If that’s not what you meant, you are a poor writer and communicator.

          Pettis thinks the costs now outweigh the benefits when viewing the policy from a macro, mostly U.S. (not individual, not non-U.S.) perspective. You have any coherent arguments that this is not the case? If you do, you certainly didn’t make them in your post.

        2. RebelEconomist

          As seigniorage is normally defined – ie the ability to borrow interest free in the form of base money – there is not much seigniorage benefit from issuing a reserve currency. The more significant benefit is to be able to issue a much larger amount of interest-bearing government debt at lower interest rates. It is, however, difficult to determine the value of the interest subsidy (eg the attempt made by the Warnocks), and you are right that Michael Pettis does not offer any figures here, but it is just a blog post. A couple of points that I would make about what Michael did say are (1) that US creditworthiness would not be strained if the US had built a stock of assets to match its debts and (2) that the Swiss franc may well be a more important reserve currency relative to the size of the issuer’s economy than the US dollar – I actually hold some CHF myself despite receiving zero interest!

          You might also note that Michael Pettis did not discuss how the US might restrict the use of the dollar as a reserve currency. I have some ideas to offer about that here: http://reservedplace.blogspot.com/2008/10/just-say-no.html
          (no doubt someone will refer to similar suggestions made by Daniel Gros two years later!).

          1. Steve

            Thanks for your response. A. Jones was correct in that I should have written a clearer, longer response to Pettis’ article. It’s a complex topic, but Pettis’ article was a bland repetition of the Triffin Dilemma intermingled with a confusing cost/benefit analysis of the US’ present monetary/trade problem.

            Your proposal to “tax” accumulated foreign holdings of US currency seems tantamount to forced upward valuation of foreign currencies. It’s an interesting idea, but it would be hard to implement. What do you think the knock-on effects of your tax might be? Wouldn’t these governments simply accumulate commodities or gold with their dollars? Would you let them by US equities instead?

          2. RebelEconomist

            Good questions, Steve. Hopefully you will see this response.

            Yes, by penalising or even prohibiting the purchase of the traditional reserve asset, the policy is designed to make the intervening countries accept an appreciation of their currencies against the US dollar. You are right though that such countries could shift their purchases to other assets priced in dollars – in fact, I believe that this was the aim of China’s introduction of the CIC. In this case, I think that the effect on the dollar will depend on whether the seller is a natural holder of dollars or not. A purchase of US equities will probably be equally effective at appreciating the dollar, whereas a purchase of a commodity sold by foreigners but priced in dollars like gold may generate an immediate sale of dollars by a foreign seller, or conceivably no dollar purchase at all – like an oil purchase from Iran, settled in yen.

    2. Susan Truxes

      The perfect international medium of exchange is toxic sludge. Forget gold and GDP-based currencies. Forget settlements paid in old fashioned money. Forget interest rates as we know them. Interest will be acknowledged by paying up with more toxic sludge just as interest now is simply more money. I don’t mean carbon credits – getting money-value for not doing something. I mean money-value for actually doing something. Technology is there and we should use it to recover the toxins and “bank” them to our credit. It will take decades to clean up the planet and when it is clean and can be maintained we can then search for a new medium of exchange. Nothing could ever be more valuable. And it will put everyone back to work.

  15. einem Luftschlag

    world’s reserve currency. Needless to say in the last few years these warnings have intensified to an almost feverish pitch

    ~~Michael Pettis~

    Is the World’s Currency now Au? Should our treasury issue gold denominated bonds? Had you bought a gold denominated t-bond from UST in December 1979 but rolled it over in 1999 for another bill note or bond, would you personally have lost dollars on the bond in spite of interest received in gold? Would your loss be USTreasury’s gain? Taxpayer’s gain? Would gold denominated bonds be inflation protected by definition? Ah! Not protected from disinflation. Do we need TIPS? No. We need gold denominated bonds. Solid as Fort Knox.

    Solid as rocks.

    Rock on

    1. F. Beard

      Solid as rocks.

      Rocks are dead and gold, being a non-performing asset, is dead too. Gold as money is worse than useless; it is environmentally destructive to mine mere money tokens.

      1. gegensätzlichen Theorien

        non-performing asset, is dead

        ~~F. Beard~

        non-performing asset for customer is a profit for UST, U. S. Treasury.

        Be all that you can be,


  16. frances snoot

    “There is no need to fall back to primitive barter. Money can be implemented ethically.”

    Yes, just as soon as mankind learns how to turn the other cheek. Until that happy day, in our glorious golden throng around the throne, we derive sustenance feeding off each other.

    1. F. Beard

      Yes, just as soon as mankind learns how to turn the other cheek. frances snoot

      “Thou shalt not steal” is a hecka of a lot easier to obey than turning the other cheek AND more universally accepted besides. What society do you know of that condones stealing from each other?

  17. nano

    At least countries could trade in each other’s currencies when mutually agreeable.

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