Breaking News 9/16/18
The U.S. Dollar's Global Roles: Where Do Things Stand? from Liberty Street Economics -- this post authored by Linda S. Goldberg and Robert Lerman
The dollar share in official global reserves has gradually declined, falling from as high as 70 percent in 1999 to about 63 percent at the end of 2017, with early gains for the euro and later gains for a broader group of currencies.
The RMB’s status as a reserve currency has risen, but remains low.
The dollar’s share in bank external claims has risen, largely at the expense of the euro,
Volumes through U.S.-based dollar wire transfer and settlement systems have continued to rise.
Since the global financial crisis there has not been a widespread change in the international monetary architecture. The dollar’s remains dominant. Recent trends bear watching as a currency’s dominant status is not immutable.
Crisis Increases Dollar Strength
Still No Challenges
Confronting Chinese currency manipulation?
One of the most widely cited strategies for reducing the likelihood of a
hard landing involves confronting Chinese currency manipulation.
Proponents of this strategy argue that by hastening an appreciation of the
yuan relative to the dollar, U.S. exports will become more competitive,
which will act to reduce the trade deficit, and thereby serve to improve
investor confidence along with the precarious climate of uncertainty. But
as we shall see, this strategy involves significant tradeoffs – for the United
States, Asia, developing countries, and the International Monetary Fund
(IMF) – that are likely to undermine its viability and effectiveness.
While the obvious benefit of such a strategy for the United States is
the potential improvement in its balance of trade, there could also be significant
costs. First, such a strategy may, at least in the short run, end up
having the opposite effect of that which is intended. As we have seen, the
responsiveness of U.S. imports to fluctuations in the exchange rate is far
from instantaneous. In considering the extent to which imports currently
exceed exports, the higher dollar price of imported goods – resulting from
an appreciation of the yuan – would in fact worsen U.S. trade performance,
and contribute to even larger deficits (Chinn and Steil 2006). In the short
run, a significant appreciation of the yuan could also be detrimental to
the United States by cutting off the large amount of capital inflows that
are necessary to finance its deficits. China’s policy of sterilized intervention
– and its resultant success in maintaining a devalued exchange rate
– is contingent upon its ongoing purchase of U.S. Treasury bonds. Thus,
if the yuan were allowed to appreciate, China would no longer have any
need to purchase the vast number of Treasury bonds on which the United
States so heavily depends.
In forcing China to appreciate, the United States also runs the risk of
solidifying its position as a “coercive hegemony.” Already facing much anti-
American sentiment around the world, the United States can ill afford to
increase resentment by coercing China to pursue an economic agenda that
is counter to its own autonomous policy goals. Yet, scholars like Goldstein
reject the notion that confronting China would cause a hardening of its
position, and argue that Chinese currency manipulation should be subject
to the same kinds of criticism that are leveled at its military-build up and
In responding to employment pressures,
China continues to rely considerably upon the performance of its export
sector – which is in turn heavily contingent upon a devalued currency. A
rapid appreciation of the yuan might very well serve to remedy operational
and allocation inefficiencies in the financial sector, but such benefits are
outweighed by considerations of a potentially dramatic slowdown in the
Chinese economy – and the social and political instability that might result.
Indeed, while the mounting costs and the waning benefits (of maintaining
an inflexible exchange rate system) will ultimately force China to reconcile
its employment concerns with those of a moribund financial system (Rajan
2005), allowing China to maintain its own commitment to a gradualist
approach to currency reform is much preferable to a coercive policy that
calls for immediate adjustment.
A policy that begets immediate adjustment is also likely to have adverse
consequences in Japan. In considering that the economic relationship
between China and Japan is more complementary than competitive,
such a policy would conflict with Japan’s status as a net importer of
Chinese manufactured goods, and its own comparative advantage as
an exporter (to China) of raw materials and goods used for processing,
such as steel and machinery. As highlighted above, a rapid appreciation
of the yuan would hurt China’s export performance, and cause a general
slowdown in the Chinese economy. Because processing makes up a significant
proportion of China’s trade, such a slowdown would likely reduce
the demand for Japanese exports in certain key industries (e.g. the steel
and machinery industries). Indeed, for the Japanese economy, which has
become increasingly reliant upon exports to China, a policy that induces
an immediate appreciation of the yuan would almost certainly have a net
negative effect (Kwan 2003).
Finally, one is inclined to inquire after the effect that such a policy might
have on developing countries. It is certainly true that, like China, much of
the developing world relies on export-driven growth to fuel their economies.
Many developing countries may therefore welcome an appreciation
of the yuan, at least insofar as it makes their own exports more competitive
relative to Chinese goods. A policy that results in an appreciation of
the yuan may also reduce the flood of cheap Chinese imports that have
often overwhelmed the nascent markets of developing countries, such as
in Mexico or many African nations, for example. These positive outcomes
are certainly deserving of consideration. But as we have seen, there is
ultimately no guarantee that the kind of solution offered by scholars like
Goldstein will produce the desired effects. Quite to the contrary, a rapid
human rights abuses (Goldstein 2006). In dismissing the argument that
citing China as a currency manipulator would provide the U.S. Congress
with the justification it needs to enact protectionist legislation, Goldstein
insists that the United States adopt a “tell-it-like-it-is” policy (Goldstein
2006, 13). But again, such a policy does not bode well for fostering
diplomatic solutions or improving American sentiment. And it fails to
provide China with a reasonable avenue for promoting its own agenda
of ensuring political stability and promoting employment for its citizens.
Indeed, Chinese currency manipulation is a crucial part of this agenda,
and should not be considered akin to its military ambitions or alleged
human rights abuses.
To his credit, Goldstein acknowledges that trade retaliation is not the
smartest lever to deal with currency manipulation, and that unilateral action
by the U.S. may provoke just such a response (Goldstein 2006). His
solution, therefore, is to “multilateralize” the issue by pushing the IMF to
fulfill its original mandate to “exercise firm surveillance over the exchange
rate policies” of its member countries, particularly China (Goldstein 2006,
14). Yet, it is doubtful that such a solution would actually address the problems
at hand. From the perspective of many countries around the world,
the IMF is simply a puppet or manifestation of coercive U.S. hegemony.
Pressuring the IMF to recall its original mandate at a time that best suits
U.S. interests is unlikely to improve the status of either actor.
I have already alluded to some of the tradeoffs for China in allowing
their currency to appreciate. There is no question that the process by
which China abides in maintaining an artificially devalued exchange rate
comes at significant cost. Indeed, China’s sterilized intervention may lead
to inefficiencies in the financial sector and significant problems of resource
allocation (Mohanty and Turner 2006). Many scholars emphasize, in
particular, the substantial opportunity costs that arise from China’s large
accumulation of dollar reserves. For example, Zheng and Yi point to
increased risks for the Chinese financial system, mounting inflationary
pressure, and large losses of wealth incurred by a weakening dollar – all a
result of China’s heavy foreign exchange accumulation and a consequent
rise in speculative capital inflows (Zheng and Yi 2007, 23).
The policy proposals that Zheng and Yi offer to mitigate these risks,
however, run counter to one that simply labels China as a currency manipulator.
Their analysis, in encouraging only “gradual liberalization” and
“small-scale diversification” (out of the US dollar), judiciously recognizes
the tradeoffs that China faces in terms of having to ensure political stability
and address “huge employment pressures” amid a “fragile financial system”
appreciation of the yuan could induce severe instability in China that
could have potential spillover effects among both industrial nations and
developing countries throughout the region. And in the event that China
was to harden its stance against liberalization, the possible protectionist
leanings that might result in the U.S. from labeling China as a currency
manipulator would only serve to foster anti-American sentiment among
In conclusion, a strategy that aims to unilaterally confront Chinese
currency manipulation is likely to be ineffective, and yield undesirable
outcomes overall. And as Kirshner’s analysis suggests, true multilateral
solutions (i.e., those that do not involve using the IMF as a tool for one’s
own agenda) that involve cooperative action on exchange rates are probably
beyond reach (Kirshner 2004). Nevertheless, the risk involved in a hard
landing for the U.S. dollar requires planned action. The scale of global
economic problems today may create an incentive for cooperation in the
future, and so efforts to establish coordinated action on exchange rates
should by no means be ignored. But the magnitude of the risk is such that
the United States would do well to start with targeting solutions that fall
directly within its immediate realm of control. Ultimately, in seeking to avert
the possibility of a hard landing, a much more appropriate means would
utilize “the chief policy tool that we can deploy with some confidence” –
reducing the federal budget deficit (Bergsten and Truman 2007).