Responses to MMP Blog #25: Isn’t the Dollar so Special?

By L. Randall Wray

Thanks, Marty for the vote of confidence. Yes, the accounting is essential; it used to provide the foundation for both macro theory and also for “money and banking” but unfortunately it has nearly disappeared. Today’s macro texts begin with representative agents and silly little growth models. Almost all modern macro violates accounting identities—as Wynne Godley lamented.

On to the Q&A:

Q1: Maybe you could say something about Ireland. It appears to me that, were Ireland not in the Eurozone, it would be in a prime position to have its currency accepted abroad. It has a good export base; it has strong FDI and we’re particularly adept at collecting taxes. So, perhaps the best way for developing countries to have their currency accepted abroad (yes, Ireland was basically a developing country up until the 80s) is to focus policy on these variables. We in Ireland did it through education. We ensured that we had a very well educated workforce that attracted FDI.

 A: Yes, there’s got to be a reason. Typically it is because foreigners want to buy products, visit as tourists, or buy financial assets. The demand for the Oz Dollar expanded when global pension funds and other managed money decided to allocate a portion of their portfolios to Oz Dollars. Of course, the commodities boom also helped—the ROW wanted Oz’s commodities. I want to be realistic, however. Many countries in the world do not now produce goods and services the ROW wants, and their assets are deemed too risky even if interest rates were to be kept high. Unfortunately many nations then view the way to increase interest in their goods and assets is to “dollarize” (typically, pegging an exchange rate, or better yet adopting a currency board). But that won’t help. At best it adds default risk in place of currency risk (the country might not be able to keep the promise to convert to dollars, so even though the exchange rate is fixed, the country’s assets are risky). There is no easy answer to this. I would suggest that it is far better to look inward: develop one’s own capacity to produce (yes, education) and to consume its own products.

Q2: So developing countries that are using US Dollars – say Timor Leste (East Timor) – the current low, near zero interest rate (fed funds) would be a benefit for them since East Timor interest rate would be “market determined”. Is that correct?

A: Of course this is related to my previous answer. Default risk. If you look at the experience of Argentina (adopted a currency board), its interest rate remained about the same as its neighbor Brazil’s rate (did not dollarize), and that was much higher than the US Dollar interest rate. Why? Eliminating exchange rate risk was completely offset by adding on default risk as markets worried Argentina could not hold the peg. (I won’t go into it in detail, but the interest rate parity theorem holds reasonably well so that a nation’s interest rate must compensate for expected exchange rate movements. So to the base interest rate we add the risk premium and also expected exchange rate movements.)

Q3: Wray said: “Thus, it is almost always a mistake for government to issue foreign currency bonds. ” Q: This goes against the original sin hypothesis. Don’t you believe that hypothesis?

A: I believe in original sin: from birth you owe taxes. I do not know what “free trade” is, nor what a “complete financial market” would be. These are just religious terms that bear no relation to the real world. I repeat: it is almost always a mistake for a government to issue foreign currency debt. Let the private sector indebt itself if it wants, and then let it fail in the normal way if it cannot get foreign currency to service its debts. You do not want to be an Iceland or Ireland, bailing-out banks. Recommendation: read more MMT, less orthodox theoclassical nonsense.

Q4: If a country wants to peg their currency to the $US, then it is true they could use an accumulation of $US to buy their own currency in the FX market, propping up its value. But they don’t need a unilateral trade surplus with the US to do that. They could have their trade surplus overall with any other countries, and use any foreign currency to buy their own currency in the FX market. They wouldn’t necessarily have to sell anything in the US, and could have a trade deficit with the US, as long as they had a surplus overall. If they needed to depress their currency in the FX markets, they can simply create some and sell it on the FX market, and hold whatever other currency they want. It does not have to be $US. Secondly, how does accumulating dollar claims help them with insufficient domestic demand? A trade surplus helps with that, but it must, again, be a surplus overall and not any particular bilateral surplus.

A: Of course, it is correct to say that a country could peg its exchange rate, and accumulate euros to do so; thus it can run a trade surplus against Germany rather than the US. Good luck with that! The problem is that Germany is a modern mercantilist state that won’t run a trade deficit so it is hard to get claims on Germany; the EMU as a whole runs essentially balanced trade. Much easier to get dollars. And yes of course a nation can run trade surpluses even if it does not trade at all with the US. My answer here is much like my answer about taxes: you do not need to impose a US Dollar tax on every one of the 6 billion people in the world to ensure a global demand for dollars. The Chinese will export to anyone, and willingly accumulates Dollars even though few Chinese need to pay Dollar taxes. And increasingly there will be net exporters who do almost all their trade with China—accumulating foreign currency reserves. Why run net exports? Because domestic demand is too low to absorb the output. Of course there are additional reasons to export—including “learning by doing”.Q: Since oil is essential for the running of a modern economy, how does this petrodollar system effect the fiscal equation for the various governments? What does MMT show us about this relationship, or is it irrelevant?

A: Certainly it is relevant—oil exporters typically have current account surpluses thus accumulate financial assets denominated in foreign currencies. Much of that is in Dollars. That leads to the incorrect belief that OPEC “finances” US borrowing (budget deficit and trade deficit). Better to look at this as US “financing” OPEC asset accumulation.

Q: What was the cause of Argentina to default? Was it debt in foreign currency that caused inflation?

A: See above: adopted a currency board, that actually reduced inflation (strong dollar). The problem was solvency: yes, essentially the debt was in a foreign currency. Go to to see papers that Pavlina Tcherneva and I wrote on the crisis.

Q: MMT and post-keynesians in general say always that banks buy treasuries to have an interest, instead of leave reserves earning nothing (without consider interest on reserves paid by the BC).but, why there are primary dealers? I know that they buy the majority of treasuries issued. this affect reserves because primary dealers have the account in depository institutions. But they buy on behalf of banks or investors, or they buy and after they sell? And so, banks buy treasuries because of the following deficit spending (so this is the deficit that is a non earning stock of reserves) or they use excess reserves (eventually having an automatic overdraft if they haven’t excess reserves)?Thanks.

A: Yes the Fed and Treasury in the US adopted procedures requiring Treasury to sell bonds to private banks before it spends; so special banks buy them, credit Treasury’s deposit account, and then Treasury moves deposits to Fed to cut a check. If these special banks are short reserves, they can always borrow them. Once Treasury spends, banks have reserve credits they then use to buy the Treasuries from the special banks—or from the Fed if necessary.

Q: So if government wants lower rates on its debt, it can always use domestic monetary policy to achieve that goal. Unfortunately, this is not widely understoodI don’t think that is true. As far as I know that’s well understood but so are the potential effects of a lower interest rate on the exchange rate.A: Well, I’ve run across lots of people including policy makers who think markets set rates!

Q: It seems to me that the current system is set up so that net exporting nations always ‘win’ the international trade game and they do that by sucking liquidity out of the target nation – depressing the domestic economy because the domestic government is too scared to replace the liquidity with new liabilities.

A: They “win” the accounting game and “lose” the real game. Exports are a cost! This is a matter of not understanding what an economy is for. But I agree with you.

Q: why do “developing countries” have less demand for their currencies from foreigners? i feel like that is the central question that’s being avoided. what determines the demand for a currency? is it because expected (risk adjusted) profits are lower there then elsewhere? what could increase expected profits? what effect do local cost structures (of the sort Michael Hudson discusses here:… have on foreigner’s currency demand?

A: There are lots of risks, most of them probably are not economic. Obviously, political risk matters. In some cases, corruption. But I want to be clear: there is more corruption on Wall Street and in Washington than in the entire developing world taken together!

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