Our deficit hysterians love to raise the specter of China. Supposedly Uncle Sam is at the mercy of the Chinese, who have a stranglehold on the supply of dollars necessary to keep the US government above water. If the Chinese suddenly decided to stop lending those scare dollars, Uncle Sam would be forced to default.
Can anyone, please, explain to me how the sovereign issuer of the US dollar—Uncle Sam—could ever run out of his supply of dollars? Please, give me one coherent explanation of how that could happen.
And please explain to me how China got those dollars in the first place. So far as I know, every single dollar the Chinese have comes from the USA. There are two sources: US lending and US spending. China loves the second: Chinese work hard to produce stuff to sell to America so they can get dollars.
Folks, all the dollars the Chinese have came from the US. There is no net supply of dollars from China.
They get dollars from net exports to the US. These end up at the Bank of China. The Bank of China rationally prefers to earn interest on dollar holdings, so these are converted to US treasuries. This is nothing more than a balance sheet operation on the books of the Fed: Bank of China reserves at the Fed are debited and Bank of China treasuries are credited. There’s no net flow of dollars to the US Treasury.
If the fear mongers are correct, China might decide to reverse that operation: exchange the treasuries for reserves at the Fed. And then, who knows what. Maybe China will choose to buy Greek treasuries?
I doubt it, but so what. There are plenty of holders of Greek treasuries who want to unwind into the safest asset in the world—Uncle Sam. If China wants to play the dupe, there are plenty of others willing to take the other side. (Hint: China ain’t the dupe. Maybe some US hedge funds want to play dupe?)
Worst case scenario? The US dollar might depreciate against some other currency. That’s a long-shot but it could happen. Will that push up US interest rates? Doubtful. The US Fed determines the short rate, and the global search for safe assets plus expectations of future US Fed policy determines the longer rates.
Guess what. As we head into the next GFC, the US continues to look awfully good. Don’t bet against the dollar or US interest rates. Uncle Sam wears the biggest pants in the world.
Krugman continues to inch away from ISLM thinking and toward MMT. Witness his latest post:
But the crucial point, which Mr. Yglesias touches on only briefly at the end, is that whatever China’s motives, the Chinese wouldn’t hurt us if they dumped our bonds – in fact, it would probably be good for the United States.
But, you say, wouldn’t that send interest rates up and depress the American economy? I’ve been writing about this issue a lot in various guises, and have yet to see any coherent explanation of how it’s supposed to work. Think about it: China’s selling American bonds wouldn’t drive up short-term interest rates, which are set by the Federal Reserve.
It’s not clear why it would drive up long-term rates, either, since these mainly reflect expected short-term rates. And even if Chinese sales somehow put a squeeze on longer maturities, the Fed could just engage in more quantitative easing and buy up those bonds. It’s true that such actions could possibly depress the value of the dollar. But that would be good for America!
Right! Again, I doubt any significant dollar appreciation will occur. The US, as a sovereign currency issuer, faces no financial constraint. It cannot be forced into default. It controls its policy interest rate.
The rest of the world are users of the dollar, not issuers. They can never hold us hostage.
I don’t see why the Chinese “dumping” their Treasuries would not drive up interest rates for the maturities they sell, other than short-term ones whose price is controlled by the Fed.
$Billions of Treasuries are traded daily around the world, and the price and yield varies daily. The 2-year and 10-year rates are widely reported as indicators of what’s going on in the bond markets. If the Chinese were to become large sellers of 2-year or 10-year notes, how could that not drive the price lower (and the yield higher) than it otherwise would have been? Maybe not much, since the market is so large, but it must have an effect.
Yes, the Fed could buy in the same quantity that the Chinese sell, but why would they? They have allowed the 2-year and 10-year rates to float freely so far, between about 1.4% and 2.9% for the 10-year in the past 18 months or so. Why change now?
Agreed, the US can never default on dollar denominated debt unless it makes the policy choice to do so.
But if the USD loses its status as exclusive reserve currency due to some combination of US incompetence and global economic insurrection, if that magical wave function collapses, then USD will behave similarly to most other hard currencies on the global market, US buyers will only be able to import as much as US sellers export.
Having to pay our full freight in global trade would have as much impact on the US economy as choosing the option to default on debt.
The US isn’t really an “exclusive” reserve currency. The above links indicate the US makes up 24% of global bonds and 45% of world stocks. That’s 27.5% of global capital markets. It also makes up 19.6% of global GDP. Figures for other countries are more difficult to find but it’s hard to believe the US is the only country that “punches above its GDP” given that nearly 3/4 of global markets are unaccounted for in those numbers.
Right, Euro and Yen are also used as reserves, and gold. They are very liquid and widely accepted outside the boundaries of their native countries (The US is unusually provincial about accepting foreign currencies.)
“USD will behave similarly to most other hard currencies on the global market, US buyers will only be able to import as much as US sellers export.”
My impression is that virtually all countries have either chronic trade deficits or chronic trade surpluses, not balance. Why would the US be different from the others, just because the dollar was no longer the primary world reserve currency?
The reserve currency part may not be the real motivation for holding dollars by many countries. Consider the desire to create jobs locally by having a chronic trade surplus with the US. Then, having a central bank/government willing to exchange those dollars for local currency. Now, the central bank has a choice. They can try to trade those dollars for some other currency via foreign exchange trades in the hope that some other country has a need for dollars. This might result in the dollar depreciating overall and make maintaining the chronic surplus that provides local jobs more difficult. Or, they can hold on to those dollars, but convert them to US treasury securities in order to earn some interest. Taking an MMT view the other country (presuming it is sovereign in its currency) that exchanged the dollars for local currency just created additional local currency. If we think of treasury debt and dollars as essentially equivalent in this case, the foreign country is using the US willingness to create financial assets via deficits to create money in their country. Instead of the foreign government creating jobs via government spending and deficits it is creating jobs by maintaining a favorable exchange rate to maintain a trade surplus, then exchanging the US currency for newly created local currency. Then, the foreign government can make noises about how fiscally irresponsible the US is while claiming they are fiscally virtuous, while giving away their real resources for the benefit of a foreign country.
Exactly. The “noises” are an added bonus, the purpose is the mercantilist strategy, in which the trade surplus enables high employment and accumulates reserves. It had a more valid basis under fixed exchange rates and the gold standard, but it still helps for smaller countries or those who want to maintain a “dirty” float.
MMT is not a description of how the $US works it applies to any Fiat Currency with a floating exchange rate where the government controls the supply of currency (ie printing).
The magical thinking that gives the US special status isn’t necessary. The theory works just as well with $AU or the Pound or most modern currency except the EU which isn’t sovereign.
A trade imbalance will change the relative values of the currencies which could increases prices for US imports. For most goods the increased price lowers demand (or increases supply) and the imbalance decreases.
Republicans from Houston : Ron Paul, Tom Delay, Sarah Davis and Ted Cruz all play dupe and tell everyone that we borrow from China. It’s their way to scream “red coats a comin'” or “wolf in the chicken coop” to their in-the-boonies constituents in the sticks and bayous to rally around the flag of blatant ignorance about macroeconomics. … as well as saying the Department of Education is “unconstitutional” ….
Just to let you know, Ted Cruz family still qualifies for CHiP with the 10% insurance to income rule which is hidden from Texas citizens. If your health insurance costs 10% of your income, your children can qualify for CHiP.
I agree with everything in Wray’s article except for a bit at the end where both Krugman and Wray make a mistake. Krugman says depressing the “value of the dollar” would be “good for America”.
The reality is that depressing the value of the dollar means a standard of living hit for US citizens: exports become more profitable, so citizens spend more time working away to produce stuff which is consumed by the Chinese etc, rather than being consumed by those citizens themselves. Plus imported goodies become more expensive for those citizens to purchase.
Then in the penultimate paragraph, Wray says “I doubt any significant dollar appreciation will occur.” Is that a typo? If China dumps Treasuries and buys the bonds of other countries, then the US dollar would DEPRECIATE not APPRECIATE, wouldn’t it?
Ralph: Yes I meant to say that I’m doubtful that Dollar exchange rate would be affected; most believe it would depreciate, altho some think it would appreciate (as Chinese demand US goods, services, and productive assets).
Hmm, I see a comment along those lines and so I should write a follow-up.
I don’t think Wray agrees with Krugman’s mercantilist comment. MMT says exports are a real cost, imports a real benefit. I think his “right” applied to the ability of the Fed to undo whatever the Chinese would do.
And I agree about the typo.
Yes, Ralph Musgave, I caught that too. I agree with you. Krugman says that depressing the “value of the dollar” would be “good for America.”
I don’t see that. Does Krugman mean inflation? Or does he mean the exchange rate for dollars? I don’t think inflation would help the US economy. As for exchange rates, a weakened dollar would make imports more expensive. Almost everything in Wal Mart, for example, would become more expensive. I don’t see how this would help the US economy.
Maybe Krugman means that US exports would be cheaper, and thus, the sales of exports would become stronger. Again, I don’t see how this would help the US economy. Most U.S. manufacturing has already been sent overseas. And cheapr exports would make no dent in the US trade deficit (which itself is not a problem for the USA, since the USA has monetary sovereignty).
On a different note, Krugman says, “The Chinese wouldn’t hurt us if they dumped our bonds – in fact, it would probably be good for the United States.”
I don’t see how this would make any difference good or bad. The amount of T-securities sold has no effect on the US government’s ability to spend. The entire “national debt” thing is a trivial side show restricted to the Fed.
As for Krugman “inching toward MMT,” I’ve seen this many times before. Again and again, Krugman almost seems to admit the truth of MMT, but then he back-slides into the standard b.s. (I see this same phenomenon at the “Naked Capitalism” blog.)
Remember: Krugman consistently calls for more austerity…just not right this minute.
What taxes does China owe the US government that it needs to accumulate US$?
China accumulates dollars in order to depress the value of their currency vs. the dollar, so that they can maintain their trade surplus, and thereby also high employment and rising standard of living. It’s the mercantilist strategy. It also accumulates reserves with which it can “back” its currency, in case it falls lower than they want, or which they can use to buy commodities that are not for sale in yuan (e.g., oil).
The question I posed is equally applicable to every country other than the US that accumulates US$. The only possible explanation from an MMT standpoint would be that the US military ensures their acceptance in some exporters of critical commodities, like oil, forcing importers of such commodities to accumulate US$ to pay for their future imports of these commodities. However given that China has US$ reserves that can pay for their oil imports long into the future and has managed to convice at least some oil exporters to accept the Renmimbi as payment for their oil imports, China has no reason to continue to accumulate US$. Since their current reserves of US$ represent their savings they would be loath to see their savings drop in value. However as commodity prices escalate in value, their savings, meant for future imports of commodities, are seeing a depreciation in value. If they attempt to buy up commodities like gold in a conspicuous manner, they will only push their prices up in US$ terms resulting in an even bigger loss in their savings. They are caught between a rock and a hard place.
However it is entirely possible that they along with some other large economies similarly placed, institute another international monetary regime, which for a short time converts the existing foreign currency reserves of the participating countries into thise new currency at a fixed rate and allows that currency to float against the US$/Euro/Yen/GBP etc. If the volume of this currency is not linked to any local economy and only the global trade and is backed by the currently accepted currencies for international trade as well as precious metals, it could gain world wide acceptance. Even those forced by the US military to accept US$ as payment for their exports, could use this currency for saving. Should that happen, the US$ will get devalued (against this currency) until all the US$ held by those outside have returned to the US in exchange for US exports and US achieves a trade balance via currency exchange rate.
That’s an interesting thought. The way you describe the creation of this currency seems similar to the creation of the Euro. Are you suggesting China join a new suicide pact like the Euro, and give up their monetary sovereignty? I think the ECB no longer holds the Francs and Marks it collected in exchange for the Euros it issued. They’re gone, no? What would this new currency issuer do with the dollars and yen and yuan and whatever it collected in return for the new currency it issued? And how and when and why would it issue more? If it keeps the dollars, or holds Treasuries, say in its Federal Reserve account, it looks to the US exactly like another China, replacing the current China accounts. If it continues to exchange the new currency for dollars, it looks just like any other country hoarding the dollars it earns from a trade surplus with the US. Whatever dollars it buys would help support the dollar, not weaken it. Unless this new currency issuer sells its dollars, and accumulates some other currency (not its own, presumably – there’d be no point in that), I don’t see any effect on the exchange rate. And if they do “dump” it, they’d be between the same rock and hard place as China is.
I agree the strength of the US military is a key factor in worldwide acceptance of the dollar, but not like you say. It makes no economic difference if they sell to us for dollars and exchange the dollars for their own currency, or some other that they wish to hold as reserves, vs selling to us in their own currency, which we would first acquire by exchanging our dollars for it. The US military does not force countries to hoard dollars. They do that for their own purposes, taking into account the safety of the dollar, which is enhanced by the strength of the US military.
The euro is the domestic currency for the region. What I am describing is a currency meant exclusively for external trade, that will not be the currency for internal trade for any of the participating countries. So unlike the EMU countries, no participating country would have lost the monetary sovereignty over its domestic currency, can peg or float its domestic currency against the external trading currency. In other words the only change would be that they would have delinked their external holdings from the domestic economy of any country/region. For example China would continue to issue Renmimbi and tax in Renmimbi, but external trade would be conducted in the new currency instead of the USD, EUR, GBP or JPY.
The new currency issuer would pay from its USD, EUR, GBP and JPY holdings for the member countries’ imports from non-member countries. The fundamental difference between the member countries doing it themselves and under this scheme would that they would be insulated from any potential devaluation of these currencies against internationally traded goods and services. If oil prices double in USD terms, but USD slides to half its value against the new currency, for the member countries, the import price of oil remains unchanged. The currency issuer would issue new currency if there is an increase in the volume of trade using the currency. Only the Central Banks of the member countries can hold accounts with the currency issuer.
Should that happen, the demand for USD, EUR, GBP and JPY outside the issuing countries/region is likely to plummet and you can expect them to be devalued against this new currency. That can set off a chain reaction with more countries joining the new currency regime for external trade and further drop in the exchange rates of these currencies. As the member countries’ trade with non-member countries comes down because of the expansion in the number of members, the new currency issuer will have decreasing need to hold any currency reserves and the different currencies it holds will devalue until all the reserves are exhausted.
Of course, none of that will have any direct bearing on US bond prices. Be it the People’s Bank of China or this new entity, it will be forced to hold the US$ reserves either as currency or bonds or trade them for some other currency. However since this new entity has no reason to protect the value of its reserves, it can easily allow the dollar to lose its value against internationally traded commodities, by allowing the dollar to depreciate against the newly created currency. That is something the People’s Bank of China cannot do without losing the value of its savings.
You are right, the US military cannot force any country to accumulate dollars unless it is under direct US occupation. The very reason why if a genuine challenger to any Western currency emerges, those having trade surpluses are likely to hold their surpluses in that currency rather than a Western currency. China has a great opportnity to bring about such a currency. Not sure if they are aware of the opportunity or willing to exploit it.
“The currency issuer would issue new currency if there is an increase in the volume of trade using the currency.”
How does that work? Do they drop it from helicopters? What if the volume of trade decreases? Do they have the authority to tax it away from the member countries?
“Krugman continues to inch away from ISLM thinking and toward MMT. ”
But once we’re out of this pesky liquidity trap … LOL
This post paints a very static picture of the world’s economy. It’s a valid point that if everything else remains same the result of China dumping their bonds is probably no big deal. Nothing is static though. Competing interests, increased demands, etc.. shape our world and our interactions with one another. Can anyone truly make sense of the actions that led to WWI?
I don’t think you can rule out China’s ability to harm us with their dollars? Drive up the price of natural resources, perhaps? It doesn’t matter if we can create as many dollars as we wish if our leadership is incapable of understanding this, or worse, our allies are unable to keep up with the rising cost of oil, etc… Every nation suffered during WWII when transport was disrupted worldwide; at that point it became apparent how dependent other nations were on each other.
It’s best to just acknowledge that the Chinese-held dollars give a tactical advantage to them, just as our war-machine gives a tactical advantage to us.
I really appreciate the work that the MMT community is doing and their perserverence in spreading the message, so please don’t count me as a deficit-hysterian. I think my criticism against MMT is not the theory, but the assumption that it is not already accepted. It’s not accepted by the mainstream media and some fools in government, but it’s been clearly understand, and utilized, for the past 40 years (at least). Nixon cottoned-on pretty quick. It’s MMT for the rich and warmongering, gold-standard-economics for the middle-class and the poor.
yes, well perceived!
The first guy to publicly use (a form of) MMT was John Law at the court of France in 1716
“John Law (baptised 21 April 1671 – 21 March 1729) was a Scottish economist who believed that money was only a means of exchange that did not constitute wealth in itself and that national wealth depended on trade. He was appointed Controller General of Finances of France under King Louis XV.
In 1716 Law established the Banque Générale in France, a private bank, but three-quarters of the capital consisted of government bills and government-accepted notes, effectively making it the first central bank of the nation.”
So yes, the top guys cotton on pretty quick to what is going on.
For the rest 99 percent, not a hope in hell…
Ok, I’m a relatively long term MMT devotee, cross my heart, and the following scenario seems outside of your what ifs. Recently it has been observed that China has also been buying up gold and has been supporting/initiating a new rating agency based out of Hong Kong that is outside of the small pond of western based and complicit rating agencies. These actions seem to represent a different set of tactical priorities. Both seem to be ways for China to at least to diminish the western imperial/post Bretton Woods choke hold on the global economy by establishing an alternative to the US dollar as the leading global reserve currency. It includes China foregoing the interest on US reserves or US treasuries, which under “ordinary” circumstances and trade they would not This could be a feint to set off the hyperventilators, and it could be simply to initiate global financial reform in the clear absence of honorable intentions by the western plutocracies. China does seem to operate by Weiqi/Go strategies in the realm of foreign affairs, rather than poker or the current three card monte model. It also true that in “modern” times China has operated based upon P/K structured institutions in terms of preventing foreign currencies from circulating within China itself. This at least demonstrates that they are invested in MMT without explicit endorsement. One analysis that has been offered is that it wants to lead financial global reform because the western elites are steadfastly sustaining the criminal nature of western banking institutions/culture. Another piece that seems to be relevant is the economic warfare being waged by the US in the fabrication of the TPP. The TPP seems to be attached to a bullying strategy, that is in a best case scenario seems like a bluff or a grossly over-played hand. It would seem that China would seek to use P/K capacities as well to further defend its interests and position, in part because western banking has privatized MMT through QEx. I’d appreciate your assistance in sorting this out.
What is P/K?
China was once the only superpower in its world. It craves to have that status again. Besides what you mention, China and Japan (another country that was once the only superpower in its world) have agreed to hold each others’ currencies as reserves, aiming to dethrone the dollar as the primary world reserve currency.
And you’re right, the stereotype is that the Chinese are much more strategy, long-term focused than last quarters’ GDP number. They are thinking about 20 or 50 or 100 years from now. Some day we will wake up to a different world and be surprised.
Mosler talks about China’s newer economic policy-makers as being the “kids” trained in the West, starting to make the same mistakes we do, following the orthodox schools of economics. So maybe (for the US) all is not lost. They may have implemented some MMT-like policies by pure chance.
Post Keynesianism = P/K It is not a stereotype imo. Do you know as in have played the game of Go, as in more than a stab at it. It requires a wholly different sort of strategic thinking. Henry Liu had a part in advising the PRC toward the walling out of foreign currencies from the Chinese economy. When China was the super-power their way of addressing foreign relations was doing such thing as making diplomatic gifts of cannons to emphasize their interest in trade over the west’s trade by force and enslavement by opium or simply chattel slavery, and what is known as primitive accumulation.
Eventually China will probably realize that holding more dollars is pointless, whether you are earning interest or not. If you never spend them they are just pieces of paper (or magnetic domains on a hard drive). They have more than enough reserves to protect them from any conceivable sort of financial crisis. All they are doing now is lowering the standard of living of their citizens.
If they actually decided to lower their holdings by buying something, I suppose that could cause an increase in inflation. More likely it would just put everyone here back to work and get capacity utilization up to more normal levels.
One issue that MMT adherents never seem to discuss is what would happen if China used its dollars to buy productive assets in the US? Could that cause a (slight) decline in US living standards? Would political considerations prevent that (the Chinese were simply not permitted to buy Unocal)?
“More likely it would just put everyone here back to work and get capacity utilization up to more normal levels.”
Exactly. In the extreme, it could even, at least temporarily, reverse the US trade deficit to a surplus, and potentially also the US budget deficit. There is no need for it to automatically cause inflation, if appropriate tax policy is implemented.
Steve K9 writes: “One issue that MMT adherents never seem to discuss is what would happen if China used its dollars to buy productive assets in the US?”
China can only buy American assets that the US government allows China to buy. A collection of federal agencies closely scrutinize all purchase proposals from any foreign agents (Chinese or otherwise) for their national security implications.
On rare occasions a foreign interest will use shell companies to buy US assets, but they are inevitably discovered, and the foreign buyers can be forced to relinquish the asset they bought. Last year, for example, Obama ordered the Ralls Corporation (owned by the Chinese Sany Group) to divest itself of four small wind farm projects located too close to a U.S. Navy weapons systems training facility in Boardman, Oregon.
Sometimes the US President himself tries to sell American assets to foreigners, but is overruled. An example was W. Bush’s attempt in 2006 to sell six U.S. ports to Dubai Ports World (a company owned by the UAE government).
For more info on this topic, see the wikipedia entry on the Committee on Foreign Investment in the United States.
China’s selling American bonds wouldn’t drive up short-term interest rates, which are set by the Federal Reserve.
How is fixing the price of borrowing money any different than fixing the price of gasoline or tortillas or medical procedures? Is price fixing generally a good thing?
It’s true that such actions could possibly depress the value of the dollar. But that would be good for America!
Good for America? If the medium of exchange that I’ve spent time and energy acquiring loses value it’s “good for America”? How is “good for America” measured? Who, or what, is America? Are the interests of each and every resident of the country identical? If depressing the value of the dollar would be “good for America”, what are we waiting for?
“Is price fixing generally a good thing?”
I say no. In cases where the fixed price is close to the market price, the distortions may be minimal, or at least not fatal. In cases where the market is grossly ineffective, or when other considerations override economic considerations, it can even be helpful, if done carefully. Price controls and rationing were helpful in WWII. Sin taxes (a way to impose artificially high prices, and depress demand) can help reduce social and medical costs.
In the case of interest rates, as in any monopoly, the monopolist can and must set either the price of the product or the quantity. It cannot do both, and it cannot do neither. Setting the price works for the way our banking system is set up, with clearing by the Fed using required reserve balances. Setting the quantity and letting the price float wouldn’t work.
The mercantilist strategy of high employment and accumulation of financial assets fueled by a trade surplus (a deficit of real assets) is helped by suppressing the value of the currency. That’s what Krugman meant. He’s got it backward, of course.
The currency depreciation issue has always been a complex one for me.. people like Krugman and Dean Baker generally favor it due to increased demand for our products, while Mosler and others saying there’s nothing wrong with giving people our IOU’s for their hard work on cheap products. It seems to me that it is basically a wash, since the increase in demand for our goods would likely be somewhere in line with the decrease in demand for their goods. The Chinese of course are highly dependant on the export model still, and would not want to see this happen..
Measuring the value of a currency in a way that seems to be “absolute” is misleading. It’s like saying your car is going 60 miles per hour, and ignoring the fact that the road is moving through the cosmos at 80,000 miles per hour. You can only measure the speed of the car in relation to the road, not in an absolute sense. Similarly, when you measure a currency’s value against another currency, you can only see the relative change, not absolute changes. Even with a basket of currencies, or a basket of goods and services, the items in the basket are also moving. You can only hope that the ones going down sort of cancel the ones going up, and so your basket is representative of some fixed value.
Exactly, so the idea that a decrease (or increase) in the value of the USD would be “good” for the US seems to be a nearly useless argument to get into. Our products will be in higher demand from abroad, but we will also have to pay more for the products we want to purchase from them.
Trying to take any kind of meaningful measurement of this process seems impossible -too many moving parts! Although in an “ideal” world I guess Warren’s argument makes sense, better to be the one holding the strong currency than the one slaving away to ship your product to a foreign country.
“we will also have to pay more for the products we want to purchase from them”
that’s why people switch to buying more non-imported goods instead of imported goods.
From Seeking Alpha:
The Chinese yuan has passed the euro to become the second-most used currency in global trade finance, the Society for Worldwide Interbank Financial Telecommunication (Swift) says.
The renminbi took an 8.66% share of letters of credit and collections in October vs 6.64% for the euro.
The yuan’s rise has been rapid, with its share in January 2012 just 1.89%.
The trend indicates that China’s attempts to internationalize the currency, such as loosening forex controls, have been successful. The government intends to take more steps as part of a major economic reform plan.