Are we starting to see why its really the exorbitant “burden”

This may be excessively optimistic on my part, but there seems to be a slow change in the way the world thinks about reserve currencies. For a long time it was widely accepted that reserve currency status granted the provider of the currency substantial economic benefits. For much of my career I pretty much accepted the consensus, but as I started to think more seriously about the components of the balance of payments, I realized that when Keynes at Bretton Woods argued for a hybrid currency (which he called “bancor”) to serve as the global reserve currency, and not the US dollar, he wasn’t only expressing his dismay about the transfer of international status from Britain to the US. Keynes recognized that once the reserve currency was no longer constrained by gold convertibility, the world needed an alternative way to prevent destabilizing imbalances from developing.

This should have become obvious to me much earlier except that, like most people, I never really worked through the fairly basic arithmetic that shows why these imbalances must develop. For most of my career I worked on Wall Street – at different times running fixed income trading, capital markets and liability management teams at various investment banks, usually focusing on Latin America – and taught classes at Columbia’s business school on debt trading and arbitrage, emerging markets finance and financial history. Both my banking work and my academic work converged nicely on the related topics of global capital flows, financial crises and the structure of balance sheets. My 2001 book, The Volatility Machine, was my attempt to construct a balance sheet analysis of capital-flow volatility and financial crises.

When I moved to China in 2002, its huge savings and investment imbalances forced me to extend my “balance sheet” approach to consider the structure of the overall balance of payments rather than just the capital flows component. Like most balance sheet guys, I tend to think more easily in terms of “systems” than of components of a system, and by forcing me to focus on the way policies and institutional constraints affect the relationship between savings and investment within China and globally, thinking abut China opened up for me a whole new way of thinking about the role of the US dollar as the dominant reserve currency.

Until then, like most people, and because of its role in Latin America, I had pretty much taken the role of the dollar as a given, and assumed vaguely that its dominance gave the US some ill-defined but important advantage – after all they did call it the “exorbitant privilege”. But after a few years in China (I moved to Beijing in 2002) I became increasingly suspicious of the value of this exorbitant privilege.

Frankly it shouldn’t have taken so long. After all it didn’t take much to see evidence of countries that did all they could to avoid receiving any part of this privilege. Capital controls have historically been as much about preventing foreigners from buying local government bonds as it has been about preventing destabilizing bouts of flight capital, and living in China, where an aggressive demand for the privileges of reserve currency status coincide with equally aggressive policies that prevent the RMB from achieving reserve currency status (and that transfer ever more of the “benefits” to the US) made clear the huge gap in rhetoric and practice. After all the US demand that China revalue the RMB is also a demand that the PBoC stop increasing US dollar reserves.

In fact trade disputes are almost always couched in terms of trade, but the balance of payments identities make it clear that they can be equally expressed in terms of capital flows. If a country takes steps to expand its trade surplus, it is also taking steps to expand its net export of savings – these are one and the same thing. The constant trade disputes between the US and Japan in the 1980s over the undervaluation of the yen can be recast as disputes about Japan’s insistence on its right to give the US more of the exorbitant privilege and the US refusal to accept Japan’s seeming generosity. Trade disputes between China and the US in the 2000s were more of the same.

The creation of the euro provided another illuminating variation on the impact of reserve currency status. When German institutions – government, businesses and labor unions – negotiated among themselves at the turn of the century a sharp reduction in wage growth for its workers, they were obviously attempting to reduce German’s high domestic unemployment by gaining trade competitiveness. Because these polices forced up the savings rate, and perhaps also explain why the investment rate dropped, they resulted in huge current account surplus (or which is the same thing, excesses of savings over investment) that were counterbalanced within Europe. These policies “worked”, and they worked probably far better than anyone expected. The sick man of Europe, with its high unemployment and large current account deficits, turned the corner almost immediately.

Global imbalances emerge

It turns out that it wasn’t just good luck or brilliant economic policy-making that accounted for the speed of the turnaround. Without anyone’s realizing it, the simultaneous imposition of a single currency on a group of countries that clearly did not belong in a currency union had reduced or even eliminated the monetary adjustment mechanisms in those countries, mechanisms that would have automatically counterbalanced the resulting increase in German capital exports. Instead of multiple currencies slowing the impact of German wage policies, the creation of the euro gave these policies far more traction than they would have otherwise had.

Once China and Europe forced me to think more systematically about the balance of payments and its components, I realized how poorly economists understood trade and capital flow mechanisms. It was as simple as recognizing that an excess of savings over investment in one part of an economic system requires an excess of investment over savings in another. When country A exports net savings to Country B, if Country B suffers from underinvestment because it is constrained by insufficient access to domestic and foreign savings, Country A’s net export of savings would cause an increase in wealth in Country B. Otherwise it would cause either an increase in debt or an increase in unemployment or, what is more often the case, an increase in debt followed by an increase in unemployment. This process is pretty automatic.

Few economists, however, let alone to the general public, had realized how ambiguous are the benefits of reserve currency status, which I called in a 2011 article in Foreign Policy and in a chapter of my 2013 book, The Great Rebalancing, the “exorbitant burden”. A statement that is true by definition, that an excess of savings over investment in one part of an economic system requires an excess of investment over savings in another, was usually treated as politics, and anyone who thought that by pointing this out he was merely pointing out something as simple and obvious as 2 + 3 = 5 instead found himself being attacked from the right as a Keynesian who thinks infinite deficits are good and savings are evil, and from the left as a hard money guy who blames his problems on the poor.

The one thing both sides agreed on, however, was that the US enjoyed an advantage because of the reserve currency status of the US dollar, with some people even assuming that the US was somehow repressing the ability of Europe, China and Japan to gain the advantage for themselves. No matter how many times the US engaged in policies that tried to shift the benefits to those countries, or these countries engaged in policies that prevented them from receiving the benefits, it was somehow clear to both sides that reserve currency status is a wonderful thing that everyone wants but only the US is allowed to have.

And yet it is actually quite easy to list the conditions under which reserve currency status encourages growth and the conditions under which it forces a rise either in debt or in unemployment. In advanced countries with deep and flexible financial markets, except in the case in which capital has become severely constrained by the need for money to be backed by gold, or real interest rates have been forced up to extremely high levels in order to break inflation (as was the case in the late 1970s and early 1980s), the net inflows associated automatically with reserve currency status will not result in an increase in productive investment. They only result in an increase either in debt or in unemployment.

This is not an argument in favor of returning to gold, by the way. It is completely neutral on the issue. This argument simply restates the Keynesian insight that eliminating the discipline imposed by the gold standard is likely to become destabilizing unless there is another way to impose discipline. Robert Triffin proved this quite clearly in the 1960s, and yet for some reason, perhaps because at the time the potentially destabilizing effect was pretty distant, his insight was never developed in ways that modified the current regime of global trade and capital flows.

Conditions have changed however, and the potentially destabilizing effect is no longer so distant. In a recent essay I tried to show that if we have not already reached the point at which the dominant reserve currency status of the US dollar is harmful to the US and potentially destabilizing to the world, logically we will inevitably reach that point, and probably soon.

At the start of this essay I said that I am optimistic that we are seeing a change in the way the world thinks about the role of the US dollar, and I think this is because the 2007-08 crisis in Europe and the US, the start of Abenomics, and the extremely difficult adjustment that China faces have all focused attention on the nature and structure of savings imbalances and their effect on the global balance of payments. It is becoming increasingly obvious, I think, that Keynes was right. Several years ago, I received an email from Kenneth Austin, a Treasury Department economist who had read one of my articles. He himself was working on the same set of ideas and over the years we have had a running conversation about this topic.

The political spectrum

Austin recently published what I think is a very important paper in the latest issue of The Journal of Post Keynesian Economics (“Systemic equilibrium in a Bretton Woods II-type international monetary system”) which explains why currency war is really a battle over where to assign excess savings, and must lead to unemployment in the country whose assets are most assiduously collected by central banks. You need to subscribe to read the full article, but the abstract tells you what Austin set out to prove:

This article develops a model, based on balance-of-payment identities, of the new international monetary system (Bretton Woods II or BWII). It shows that if some countries engineer current account surpluses by exchange-rate manipulation and foreign-reserve accumulation, the burden of the corresponding current account deficits falls first on the reserve-issuing countries, unless those savings inflows are diverted elsewhere. The imbalances of the BWII period result from official, policy-driven reserve flows, rather than market-determined, private savings flows. The struggle to divert these unwanted financing flows is at the root of the “currency wars” within the system. 

While recognition of the exorbitant burden had been growing in recent years, Austin’s article focused a lot of new attention on this topic, and it seems that finally Keynes’s insight is attracting the kind of acceptance that might eventually modify future policy. In August in a much-commented-upon article in the New York Times, Jared Bernstein explained one of the corollaries of Austin’s model, pointing out that

Americans alone do not determine their rates of savings and consumption. Think of an open, global economy as having one huge, aggregated amount of income that must all be consumed, saved or invested. That means individual countries must adjust to one another. If trade-surplus countries suppress their own consumption and use their excess savings to accumulate dollars, trade-deficit countries must absorb those excess savings to finance their excess consumption or investment.

Note that as long as the dollar is the reserve currency, America’s trade deficit can worsen even when we’re not directly in on the trade. Suppose South Korea runs a surplus with Brazil. By storing its surplus export revenues in Treasury bonds, South Korea nudges up the relative value of the dollar against our competitors’ currencies, and our trade deficit increases, even though the original transaction had nothing to do with the United States.

This is a key and much misunderstood point. The inexorable balance of payments accounting mechanisms make Bernstein’s claim – that “Americans alone do not determine their rates of savings“ – both necessarily true and joltingly shocking to most economists. How many times, for example, have you heard economists insist that the US trade deficit was “caused” by the fact that Americans refuse to save, or, even more foolishly, that “no one held a gun to the American consumer’s head and forced him to buy that flat-screen TV”?

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

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

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

Is it time?

And its not just traditionally “liberal” economists who understand that trade imbalances are not caused by lazy workers. Analysts who retain sympathy for the gold standard, like self-confessed “gold bug” John Mauldin, have always understood that the main argument in favor of gold is that it imposes an unbreakable trade and capital flow discipline – indeed that is also the main argument against gold – but many of them have tended to de-emphasize reserve currency economics mainly, I think, because this particular problem is to them subsumed under their more general concerns about money. I don’t know if Ralph Benko is one of them, but he has written on this subject before and very recently wrote two articles (here and here) in Forbes, which has traditionally been sympathetic to the gold cause, in which he too cites Austin’s paper and adds to the chorus:

The mechanics of the reserve currency system preempt these funds’ ready availability for “the maintenance of industry.” The mechanics of the dollar as a reserve asset, therefore, finance bigger government while insidiously preempting productivity, jobs, and equitable prosperity.

This columnist agrees wholeheartedly with Bernstein on what seem his three most important points. The reserve currency status of the dollar causes American workers, and the world, big problems. The exorbitant privilege deserves and demands far more attention than it receives. Moving the dollar away from being the world’s reserve currency would be a great deal easier than many now assume.

It is hard to construct a economics “tradition” that combines Austin, Bernstein, Mauldin and Benko, and so the fact that they are all in agreement suggests that the discussion about the role of the US dollar as a reserve currency may be emerging from the broader monetary discussion that pits two very opposing economics traditions virulently against each other. Maybe it is just a coincidence that in the last year more and more economists have been questioning conventional wisdom about the benefits of dominant reserve currency status, but once this happens, the logic against the automatic assumption of exorbitant privilege is so powerful that it will be hard ever to believe again. Perhaps we have reached that tipping point.

For readers who are interested, I suggest that you might want to read the various articles, papers and blog entries I have cited above, along with my 2011 article in Foreign Policy and chapters 7 and 8 of my 2013 book, The Great Rebalancing, which Jared Berstein on his blog was kind enough to say presented “an awfully strong argument”. My insistence the Keynes was right, and Robert Triffin was right, but both of them were perhaps right far too early, is quite straightforward and involves only the most basic arithmetic, although it does require you to think in terms of systems and the constraints they impose rather than about autonomous economic entities whose aggregate behavior is simply the sum of unconstrained individual decisions.

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

Like most people who think about these things I largely accept the conventional views on the advantages of free trade, although unlike some free traders I do not believe that comparative advantage is static, and I would argue, instead, that there is a lot of historical evidence that countries can successfully intervene to transform their comparative advantage in ways that generate higher productivity growth, one of the outstanding cases being Alexander Hamilton’s USA. I think it is pretty well substantiated that global output increases as more countries join the global trade and currency regime and I list the reasons why in my September 28 blog entry. But I think there are two important points that must be part of any discussion of the benefits of free trade.

First, significant trade and capital flow imbalances are the consequences of institutional or policy distortions and can in some cases destabilize the overall system (they were the causes, for example, of the 2007-08 crisis). In a well-functioning system there will always be temporary imbalances, and even some very long-running but healthy imbalances, like the current account deficits that the US ran for most of the 19th century. As a general rule, however, many years of excessively high or excessively low savings rates are almost always the consequence either of institutional distortions in one country or of their automatic obverse in another. A well functioning trading system must have a mechanism that constrains the destabilizing distortions. Once the world went off gold, it cannot be a surprise that it lost the discipline imposed by gold. Keynes tried but failed to create an alternative form of discipline, but one way or the other it must be re-established.

Second, the frequently-made argument that any intervention in trade automatically reduces global output is nonsense and completely illogical. If we were at an optimal equilibrium, for example, and this equilibrium were disturbed when one entity introduced a distortion that moved the system away from equilibrium, and if this were followed by a retaliatory intervention that moved it back to equilibrium, either the first intervention or the second intervention must have increased total output. To put it in meat and potato terms, if the Brazilian central bank intervened to force down the level of the Brazilian real against the Mexican peso by 20%, and Mexico intervened successfully by threatening sanctions unless the Brazilian central bank allowed the real to rise back to its original level, one or the other intervention must have caused output to rise. Beggar-thy-neighbor interventions, in other words, can reduce the benefits of global trade. Counter-interventions might reduce them further or might restore them to their original value. It depends on the kind of intervention.



Because I have written about this topic so many times before, I won’t make the full argument, but it might be useful to remind readers why reserve currency status is an exorbitant burden:

1. Because for a variety of reasons dollars are the preferred form of foreign currency reserve, or of any “risk-off” kind of trade, in order to combat uncertainty or to increase domestic employment, foreign countries are most likely to accumulate reserves by buying US government bonds or other liquid, low-risk US dollar assets. This reserve accumulation might be formally classified as reserves, and accumulated by the central bank, or other institutions, some of which are referred to as sovereign wealth funds, might accumulate these reserves.

2. When it is the private sector that accumulates dollars, there are likely to be too many potential reasons and consequences to try to summarize them. But when governments systematically accumulate huge amounts of dollars, the reason has almost always to do with creating or expanding the trade or current account surplus, which is just the obverse of expanding the export of net domestic savings. The mechanism involves suppressing domestic consumption by taxing households (usually indirectly in the form of currency undervaluation, financial repression, anti-labor legislation, etc) and subsidizing exports. These mechanisms force up the savings rate while making exports more competitive on the international markets, the net effect of which is to reduce domestic unemployment.

3. If these savings are exported to the US, for example if the central bank buys US government bonds, the US must run the corresponding trade deficit. This has nothing to do with whether the exports go to the US or to some other country. It is astonishing how few economists understand this, but if Country A is a net exporter of savings to Country B, the former must run a surplus and the latter a deficit, even if the two do not trade together at all.

4. Does the US benefit from importing foreign savings and foreign investment? The local state or country that receives the investment may benefit, but any country only benefits from importing foreign capital under one or more of three conditions:

  • When a country has high levels of potentially productive investment but domestic savings are insufficient to satisfy domestic demand, the country benefits from importing foreign capital to fund these productive investments. As long as the total economic return on these investments, including all externalities, exceeds the cost of the foreign borrowing, or is funded by foreign equity investment, foreign capital inflows are wealth creating for the recipient.
  • When during a crisis major borrowers, including the government, face severe short-term liquidity constraints and domestic capital is, for whatever reason, unwilling or unable to fund maturing debt, foreign capital inflows can help bridge the gap. In this case foreign investors fulfill the classic role of a central bank, lending to creditworthy borrowers or against acceptable assets in order to prevent a liquidity crisis from forcing the borrower into insolvency.
  • For countries that lack technology, that have weak business and management institutions, or that suffer from low levels of social capital, foreign investment can bring with it the technology and management skills that allow the economy

In the days of the gold standard it was possible for an advanced economy like the US to suffer from the first condition. Today it suffers from none of the three conditions.

5. Let me explain why it does not suffer from the first. If the US is a net recipient of capital inflows, it is simply taking the other side of the accounting identity I listed earlier: an excess of savings over investment in one part of an economic system requires an excess of investment over savings in another part. If Japan, with its undervalued currency and repressed interest rates, forced its savings rate up above its already high investment rate in the 1980s, and used the excess to by US government bonds, the US had to see its investment rate exceed its savings rate. There are only three ways in which the US can increase investment relative to savings, or reduce savings relative to investment:

  1. It can increase productive investment.
  2. It can increase nonproductive investment, especially in real estate, as foreign inflows unleash a stock and real estate market bubble, or it can increase consumption, as these bubbles unleash a wealth effect which causes ordinary Americans to increase their consumption relative to their income (i.e. reduce their savings). In either case US debt rises faster than US debt-servicing capacity.
  3. Unemployment can rise as the expansion in imports relative to exports causes American factories to cut back on production and fire workers. Of course fired workers no longer produce but they still must consume, so the savings rate drops.

These are the only three possible outcomes. If productive investment in the US has been constrained by the lack of American access to capital – domestic or foreign – as was the case in the 19th Century, it is possible that reserve currency status increases American employment and wealth creation. But in advanced economies productive investment is never constrained by lack of capital. It is almost always the case, in other words, that an increase in net foreign investment to the US (and to most advanced countries by the way) must result in some combination of a speculative investment boom, a consumption boom or a rise in unemployment. What typically happens is that in the beginning we get the first two, until debt levels become too high, after which we get the third.

6. Bryan Riley and William Wilson, two economists from the Heritage Foundation, in their response to Jared Bernstein’s article, provided their reasons in a blog entry last month for arguing that in principle the benefits of use of the dollar as the dominant reserve currency exceed the cost to the US of this higher debt or higher unemployment. Their piece was fairly short, and so I don’t want to suggest that I am representing the full scope of their disagreement, but they suggest that the benefits are:

Seignorage. The largest benefit has been “seignorage,” which means that foreigners must sell real goods and services or ownership of the real capital stock to add to their dollar reserve holdings.

Low Interest Rates. The U.S. has been able to run up huge debts denominated in its own currency at low interest rates. The dollar’s role as the world’s reserve currency reduces U.S. interest rates because foreign investors like to invest in the relatively safe U.S. economy.

Lower Transaction Costs. U.S. traders, borrowers, and lenders face lower transaction costs and foreign exchange risk when they can deal in their own currency. It’s easier to do business with people who take dollars.

Power and Prestige. The dollar’s dominant reserve status gives the United States political power and prestige. Britain’s loss of reserve-currency status in the 20th century coincided with its loss of political and military preeminence.

7. I think this is a pretty fair summary of the arguments generally used in favor of supporting “king dollar”, and I think they are worth addressing specifically. To address seniorage, the benefits of seniorage are really what the whole debate is about. If the US believes that it is important for the global trading system that the US produce enough reserves for a growing global economy, and if the global trading system benefits the US, it should do so. As long as the growth in global reserves is less than the growth in the US economy, the associated rise in debt is sustainable.

But, and this is the Triffin Dilemma, if reserves and other government accumulation of US assets grow faster than US GDP, seniorage results in an unsustainable increase in US debt (or unemployment). In my previous blog entry I argued that the former may have been the case in the 1950s, but as global GDP growth exceeds US GDP growth, as more countries and regions join in the global trading system, and as there is convergence between advanced and backward economies, the growth in US debt needed to capture these benefits either becomes unsustainable or, to restrain the growth in debt, requires a rise in US unemployment.

8. To address lower interest rates, I showed in my book why foreign purchases of US government bonds do not lower US interest rates. At best they simply distort the US yield curve and in the long term even raise them. I will not repeat the full explanation here, especially as there is a bit of circularity in the argument and counterargument: If the exorbitant burden causes unemployment to rise, as Austin and Bernstein argue, fiscal revenues must drop and fiscal expenses must rise, causing total government debt to rise by the same, or more (because most of us would agree that demand created by government spending is less efficient than demand created by trade) than the capital inflows available to fund government debt. So the additional supply of funding is only equal to or less than the additional demand for funding. But if you think unemployment doesn’t rise, as Riley and Wilson might argue (I am not sure if they do or don’t), then total debt doesn’t rise, or it doesn’t rise much, and the additional funding should cause interest rates to decline. In order to keep this short I would suggest simply that we consider the following.

The larger a country’s foreign current account deficit, by definition the greater the inflow of foreign money to purchase its assets, mainly government bonds in the case of the US and many other countries. The higher a country’s current account surplus, by definition the greater the outflow of money to purchase foreign assets, and the less domestic money available to purchase domestic assets. Is it reasonable, then, to assume that the larger a country’s current account deficit, the lower its interest rates, while the larger a country’s current account surplus, the higher its interest rates? This is what the low-interest-rate argument implies.

9. To address transaction costs, while it is true that trading in US dollars reduces transaction costs for American businesses, it is hard to believe that these transaction costs are not priced into the imports and exports of their foreign counterparts. More importantly, it is not clear that reducing central bank purchases of US government bonds will cause transaction costs to rise. The vast bulk of trading volume does not consist of central bank purchases of US government bonds. It is trade and investment related. If foreign central banks were limited in their ability to stockpile US dollar reserves, foreign exchange transaction costs would barely budge.

10. To address power and prestige, while it may be true that Britain’s loss of reserve-currency status in the 20th century coincided roughly with its loss of political and military preeminence, I think it is incorrect to imply that Britain lost power and prestige after the Great War mainly or even partly because sterling lost its status as the dominant reserve currency (which in fact really occurred some time in the 1930s and 1940s). It was the destruction, during the first two years of the Great War, of London’s role in trade finance (which formed the vast bulk of international lending at the time, with nearly the entire trade finance market moving to neutral Amsterdam and New York), followed by its aerial pounding in WW2, that caused London to lose its financial pre-eminence.

Even today it is hard to associate London’s current role as either the first or second most important financial center in the world, depending on how you measure it, with the status of sterling as a reserve currency. What is more, the US dollar only became the pre-eminent reserve currency in the 1930s and 1940s, but the US was the leading economic power – nominally, per capita, and technologically – by the 1870s. I would argue that US power and prestige probably has more to do with the size and dynamism of its economy, with the creativity of Hollywood and New York in entertainment and fashion, with technological innovation in San Francisco, Boston, New York, Austin, and elsewhere, with its composers and artists in New York, San Francisco, and elsewhere, with its overwhelming military superiority, with its universally-valued ideal of ethnic inclusiveness and individualism, with its Ivy League and elite universities, with its think tanks, with its astonishing scientists, and with a host of other factors more important than the currency denomination of central bank reserves.



 Add your comment
  1. It may not be possible to have single reserve currency, which can balance the exorbitant privileges and exorbitant burdens, as they are dynamic in nature. It also may not be possible to construct a composite currency such as SDR, as the composition will continue to fluctuate.

    It probably makes sense to think in terms of an international institution (similar to IMF), which can absorb and release excess savings from participating countries, based on some accepted guidelines. This will be conceptually similar to the role of a typical central bank, which is meant to absorb and release federal debt based on economic conditions within the country.

  2. – the problem with the “exorbitant privilege” is that it benefits the elites whereas the “non-elites” are forced to pay the price (e.g. higher debt) for that “privilege”. But I think the “non-elites” will take revenge by going bankrupt in droves & bankrupting the financial system.
    – The US (CA Deficit) with its “Exorbitant Privilege” & China (CA Surplus) have one thing in common: Over the years the worker’s & household’s share of output/GDP has gone down.
    – I disagree. Having a CA Deficit means a net outflow of money/capital. Nothing more, nothing less. That’s on its own VERY deflationary unless that money is re-cycled back to the country of origin. That’s what we saw in southern Europe (e.g. Spain). That’s also why now in Eurozone with its small CA Surplus rates are as low as or even lower than in the US with its CA Deficit.

    • Having a current account deficit means having a capital account surplus. In other words, running a current account deficit implies that you MUST import capital.

      • No. Take e.g. Brasil in the 1980s. It suffered under “Capital flight”. and that meant that Brazil had a negative Capital Account.

        • Until the 1982 crisis, Willy 2, Brazil ran large capital account surpluses because of the huge amount of foreign lending. These ended after 1982 when, probably mainly because of flight capital, as you point out, Brazil ran capital account deficits every year to the end of the decade (except 1987, if I remember correctly, when a surge of optimism unleashed some net inflows).

          But of course Suvy is right. Brazil’s capital account deficits where necessarily the obverse of current account surpluses, which Brazil ran every year (except 1987 of course). These current account surpluses consisted of huge trade surpluses (I think Brazil had among the largest trade surpluses in the world during much of the 1980s) reduced by net interest payments on its external debt.interest payment outflows.

      • Yes, but your reply doesn’t refute my reasoning. I would argue that if the Capital Account Surplus shrinks (foreign investors unwilling to re-cycle the money back into the country of origin) then with a lag the Current Account Deficit will shrink as well. I use the word “lag” because people have savings and use those saving to keep consumption going for a while. I would argue that movement in the Capital Account leads the movement in the Current Account.

        • There is no lag, Willy2. Both must occur simultaneously. This can seem confusing but it isn’t when you work out the cash flows. If foreign lenders reduced the amount of money they lend to “Brazil”, but the Brazilian current account is unchanged, either we would see simultaneously a drop in “Brazil’s” FX reserves, or Brazilians would sell assets they held abroad, or foreigners would purchase more Brazilian assets, or the Brazilian importer, rather than pay, would run up a payable. All of these things cause an increase in capital inflows the sum of which would exactly matched the change in lending.

          This is often very hard to grasp, which is why so many economists, reporters, policymakers, etc., get it wrong, and it is why in my class we often spend the good part of one session just working through the cashflows until everyone fully understands the reasoning behind it. This is what we mean by “accounting identity”. It s true by definition and true at every point in time.

          • Mr. Pettis,

            Your explanation makes much more sense, especially when using simple words. I am just trying to understand the confusing world we live in today. And your articles & explanation have helped a lot.

          • – But wouldn’t foreigners buying more brazilian assets lead to an increased Capital Account ? But in my assumption that account drops. Or is that part of the Current Account ?

          • Willy2,

            The capital account and current account are, for all effective purposes, additive inverses. So foreigners buying Brazilian assets implies that Brazil would experience a rise in the capital account (capital inflows). That means the current account must fall.

          • @Suvy,

            – No. As Mr. Pettis has explained above, the Capital Account and the Current Account are NOT equal. When the one increases/decreases the other doesn’t have to decrease/increase as well. The difference between the two then shows up in changes in e.g. the FX reserves.

          • @Suvy,

            No, the Capital Account can increase but the Current Account can stay flat at the same time. The difference between the two then shows up in a change in the FX reserves. Read Mr.Pettis reply.

          • I agree if there’s a shift in the central banks reserves. Otherwise, a shift in one requires an inverse move in the other.

          • Willy2 WROTE: “No. As Mr. Pettis has explained above, the Capital Account and the Current Account are NOT equal. When the one increases/decreases the other doesn’t have to decrease/increase as well. The difference between the two then shows up in changes in e.g. the FX reserves…..”

            (1) FX Reserves are a part of the Capital Account. When FX reserves increase, it means that capital is being ‘pushed out’ through the capital account; conversely, when FX reserves decrease, it means that capital is being ‘drawn in’ through the capital account.

            (2) The Capital Account does NOT need to equal the Current Account. It is the Capital Account BALANCE (capital-inflows minus capital-outflows) that MUST be EQUAL to the Current Account BALANCE (imports-exports), once FX-reserves are correctly included in the capital account.

            (3) You could conceptually-model the situation with the capital account balance as ‘supply’, the current account balance as ‘demand’, the FX reserves as ‘inventory’ and the currency exchange-rate as ‘price’. If you hold inventory constant, then the PRICE ADJUST such that supply EQUALS demand. Similarly, if you hold reserves constant, the capital account balance WILL EQUAL the current-account balance by means of an ADJUSTMENT in the currency exchange-rate.

            Do you disagree? Please let me know your views.

          • @Vinezi Karim:

            Yes, those thoughts make much more sense. If/when the adjustment in the FX reserves is added to the Capital Account (balance) then indeed the Current Account (balance) needs to be equal to the Capital Account (balance). I myself, also figured that out.

  3. “seemingly incapable of imaging them as units within a system in which there are certain inflexible constraints….booms in consumption and speculative investment and then steep rises in unemployment is just a requirement of the arithmetic”

    I would be careful of the phrase “inflexible constraints”, and I do not mean to nitpick. Rather than “inflexible constraint”, rather, a set of forces and relationships, an attribute of the system; one that currently obtains to the system. But inevitably, if your own analysis is correct, is stressed, moving and altering; under principles of open, complex and adaptive systems. Rather than static, and controlled systems, or the systems on, the assumptions of, which economists, policy-makers, conspiratorial theorists, fundamentalists, apologists and post-modern critics normally operate, on, similarly static, assumptions (and chosen, felt, accepted, and believed, values, sets of assumptions from which they view and act).

    So, the constraint, is one that obtains to the current system, but the set of forces, relations, and attributes of systems do change, as these, said same, change. Leading to emerging properties, new and altering, configurations of these inter-relations of forces, and new attributes of the system, that WILL inevitably, lead to another (at a moment in time and space, stasis). Thus while there is an inflexible constraint, it itself is constrained, and at a moment, will cycle the system to a new admixture of relations. This is, why ideologues are so detrimental, those that merely feel it, moreover, and why it can be assumed, rather than failure in the system, success, that now needs a new set of worldview components in the discourse, of which your notions are an important component, to optimize the set of relations that are currently found in this new stage. Assumptions are distress, failure, excess, unsustainability, but the actors and forces, and functions that have inter-acted to create success and advancement, require new light, require greater understanding, a reinvigorated dialogue, a new global compact in a world where many are retreating into parochialism. This, least of all, need occur, in the land too often found as the most likely suspect, and rather more broadly. Not long ago, I watched a Scandinavian academic, International Relations, discuss global governance and the provision of global public goods, and smile, why not believing it was in the interests of the US to provide such a vast array, as it was costly, but smile and say, it might rather be in our benefit that they do, and we might do as well to just let them. While true for many in the global system, such parochialism will eventually find uncomfortable future conditions, economically and politically (with repercussions across all environments, as regards “progress” and sustainability).

    • In other words countries should collaborate, because you never know?

      • The human, perhaps not (completely) willfully anthropogenic, inevitably has had a great influence on its environment. It has been successful in its environment. It has flourished and populated its environment, reducing many predators. Humans duration lengthens. Humans use more things, more of them continuously using more things. Knowledge spreads, humans have more knowledge; useful and otherwise. The ability to see more humans using more things advance; the flow of that trend advances regardless. The ability to communicate how to use things advance. Belief, desire and expectations advance, on a world with more people, living longer, and able (desirous and expectating) to use more things, who have more things, able to be used, as ability to use more things advance.

        So, there have been relations and structures to enable this process advancing. There are flows of trends that see advances along any and every realm of risk and opportunity.

        This, when there are and aren’t abilities of control; some where cooperation is possible (from level of a human to governments) and others where there exists no control [“genie out of bottle” effects (less able to control{create, manipulate, utilize, retard, advance} if able to veer; perhaps)}.

        Very really, people and countries need to quickly get far more cognizant of what is at stake. A great deal of balanced advancement has occurred globally, and despite some very grave dislocations, over the past century of acceleration. The human is and will, evermore, be engaged in his environment; influencing trends (along with any number of singular and complex forces) that might not necessarily eventuate as beneficial as it has in the past.

        What is seeded, or able to grow, very much depends on the will of people and countries to collaborate. Because we do know, that without such we can face terrible effects of trends otherwise. These effects can be very difficult to overcome with collaboration, very much more detrimental without it. The human is very successful in its environment; rather less successful spiritually. Couple the basic human condition to the advancing capability of man, and countries, and many should be rather more concerned to foster an environment that is properly incentivized toward constructively confronting the challenges that stem of the successful human in its environment ( successful insofar as able to influence, which advances greatly). Such is why we need to very dearly interrogate our beliefs, and what they portend, and what is moving in our environment. What we know is not good otherwise; but it can be better.

    • I understand your point, Cstevens, but in this case the constraints I meant, that savings and investment balance, are pretty inflexible. Systems, of course are flexible, and the more complex, usually the more flexible, but accounting identities are inflexible.

      • I understood you did, but wanted to stress, for the pointed, linear thinkers out there, a bit more of the nature of these things, rather than the choices that those as Sukh contends, or the alternate other, that proceeds from a narrow frame. Inevitably, there may be no choice. Rather than decry absolute preferences not having been met, are we really looking at what might occur, if people and countries to not advocate a more productive perspective on these matters.

  4. simply amazing and educational, I wish I could afford the books-thank you very much

  5. There isn’t that much special about the gold standard as non reserve currencies could and would peg lower values and accumulate gold, though in this they also rely on the tendency of the reserve currency to maintain a peg long past the time it should have been devalued. The attraction of a strong currency and the myth of the free lunch from exchanging currency and debt for goods, know no bounds despite favoring consumption over investment.

    The silver lining of the financial crisis is that the adjustment of imbalances favors the reserve currency reducing our exorbitant burden and is substantially why the US recovery has been stronger.

  6. This is beautiful revisionist history.

    Now that the developed world has gotten as much as it possibly could from being the printers of the world’s reserve currencies (with the U.S. being the biggest winner), now we will focus on how this is such a horrible burden to bear.

    The trade (the deal) was China’s slave-labour and environment degradation and the world’s most valuable resource (oil) for pennies on the dollar (in an attempt to deplete this resource from the countries that were blessed with this wealth as much as possible before the privilege/”burden” was no more) IN EXCHANGE for developing nations eventually “stealing” the intellectual property created in the developed world, thus allowing developing nations, for their immense sacrifice, to leapfrog from a 19th century economy to a 21st century economy.

    And when the system is no longer a win-win for both the developed world and the developing world, when it actually becomes a zero-sum game (and the developing world is strong enough to cut ties with the developed world and create new, win-win ties amongst developing nations, well, that is when globalization comes to an end, and is replaced by bi-lateral trade agreements.

    Remember, OPEC oil could only be sold for U.S. dollars. Nothing else would be tolerated.

    • You are able more easily than me to find the white and hats and the black hats, Sukh Hayre, but I don’t know why you think poor people taking on better paying jobs in China must be “slave labor”. I don’t understand your last sentence: “Remember, OPEC oil could only be sold for U.S. dollars. Nothing else would be tolerated.”

      Tolerated by whom? And why can it only be sold for dollars? In fact it can be sold for any currency on which buyer and seller agree. Oil prices are listed in dollars for quite a few obvious reasons, but listing prices in dollars creates no constraint on anyone’s actions. Could you explain why you think this is important?

      And sorry you comment didn’t post immediately, but I have to “approve” comments before they post, and you probably sent your comments during Beijing’s night, when I was asleep.

  7. One advantage for US of its currency as world reserve currency I heard is that oil is traded in USD, thus oil is cheaper in US than any other non-oil producing countries in the world. You think this is true?

    • You heard incorrectly.
      Oil cost differentials will have to do with dynamics around shipping, refining capacity, taxes and (other) similar government interventions, but all commodities are generally sold in a world market (except in the oil exporters themselves, which highly subsidize, then some other countries with negligible supplies, also have this concept that their culture or group has a gift from God, so the subsidize as well, which creates great burdens on the countries). ut, such is an old story and wrong.

      • Yes, Csteven is right, Meofio. The price of oil is determined by total demand versus total supply, adjusted for changes in inventory. If you prefer to think of oil prices in euro terms, or yen terms, or in baht or Mexican pesos, it is very easy to do so and most smart phones can do the conversion quickly.

        For some reason people ascribe the fact that the world publicly prices commodities in the most liquid and widely traded currency as somehow changing the price dynamics in favor of the US or of some elite, but it doesn’t. If oil were indeed cheaper in dollars than, say, in euros, European buyers would buy it in dollars and then trade dollars for euros. Of course it is true that buying gas for your car in the US is cheaper than buying it in most European countries, but this is because of taxes. In some countries, Venezuela for example, it is much cheaper to buy gas for your car than it is in the US.

        Technically the only impact of pricing oil in dollars (which most but not all producers do, and which any producer can change if he wants) is that while the value of oil in dollars is no more or no less volatile than the value of oil in euros, yen, or any other currency, there is slightly more “gapping” in dollar pricing, by which I mean that instead of continuous price changes, which is what happens when your reference currency is not the dollar, you get small gapping jumps when your reference is the dollar.

        This reduces short-term volatility somewhat for dollar-based traders, but the reduction is tiny. I am not an oil trader so I don’t know the units of change in oil prices (I would guess oil prices jump in $0.125 increments, but does anyone know better?), but I would guess that dollar-based traders might get an extra few seconds, or minutes at most, of stable prices, but I can’t se how this confers any advantage at all.

        The huge advantage conferred on the US, or on certain people, by the convention of pricing oil in dollars is one of those things that everyone seems to know, but no one seems to be able to explain, at least not to me.

        • hmmm, but what about US’s ability to print USD? When other countries want to buy oil, they first need to create some product, exchange it for USD, then use this USD to buy oil. But US can basically print USD anytime it wants to buy oil.

          • You have a mystical attachment to the price of oil in dollars, Mr.Meofio. If the US can benefit from simply printing dollars to buy oil priced in dollars, why can’t they print dollars to exchange into euros to buy French wine priced in euros, or print dollars to exchange into Mexican pesos to buy tacos priced in pesos? If the US can get free or cheap stuff by just printing dollars, why should the only free stuff they buy be oil priced in dollars?

          • Along the same lines, but rather more severly, consider the risk of them were they to engage other currencies more widely, which of course they can; China putting on the brakes, letting off the breaks, holding 50% of all equities (through SOE’s), setting interest rates and deposit rates (in the interest of their SOE’s), enabling foreign ownership than restricting it, encouraging investment, then refining, encouraging people to invest in Hospitals, and then taking over, limiting evolution of the models enabled, then taking the hieghts of the profitable ones of these, and depriving investors to realize the fruits,…..

            US printing, not nearly as fast as China, or most others, while you merely discuss the old tired lies of conspiratorialists, reality confronts your lies.

            Might some merely want a movement, so more of what has been done to the US, occur to others. (Japan and SK yelling about foreign purchases)

            Whatever eventuates, a new global compact need to accompany it, or there will be a reversion. Of course, populous countries who depend on trade, those who want to industrialize, and those who hold other values, will clearly be taking a different path under such circumstances, it is not surprising to see the path. Your are mistaken to keep perpetuating these old, irrelevant, false notions. They very much are to the detriment of that which you suppose.

    • World 84,820,000[6] 100% —
      1 Russia 10,900,000 13.28% 2013 est.[7][8]
      2 Saudi Arabia 9,900,000 12.65% 2013 est.[7][9]
      3 United States 8,453,000 9.97% 2013 est.
      4 Iran 4,231,000 4 .77% 2013 est.
      5 China 4,073,000 4.56% 2013 est.
      6 Canada 3,592,000 3.90% 2013 est.
      7 Iraq 3,400,000 3.75% 2013 est.
      8 United Arab Emirates 3,087,000 3.32% 2013 est.
      9 Venezuela 3,023,000 3.56% 2013 est.
      10 Mexico 2,934,000 3.56% 2013 es

  8. Michael,

    You have a real talent for making the complex simple. I’ve read every post and enjoyed them all. Thanks!

    • I agree. I have been following this blog for some time now and I have to say that this summer there has been a sharp change or a rapid evolution for the better. I think that the posts are becoming clearer -he was never obscure- and Michael is more confident on his own views. Now, for two months I have had “The Great Rebalancing” waiting on the shelf because I had several books on queue and not much free time. This book will require quiet reading. Now I feel an urgent need to read it. It is for me a privilege to have free access to this blog. I knew about Pettis via Brad Setser, when he was contributing in Roubini’s web site that in turn I visited via Calculated Risk in 2005. I live in Spain and I started reading Calculated Risk because I thougth I could learn a lot about the housing bubble developing in Spain. Nicely, I have come to find excellent explanations on this phenomenon 9 years later, here, at Michael Pettis’ China Financial Markets. By the way I am learning a whole new way of watching economics.

      • Thanks Bob and Ignacio, but much as I would love to take all the credit, I am just helping to remind us of things that we have known and understood for well over 100 years. This framework is indeed a profoundly useful way of understanding the world, and the proof is that every time we put aside our provincialism and the confused math that so impresses economists (and the weaker they are as mathematicians, the more impressed) we always come back to it.

  9. Qualified to Represent

    Brilliantly argued, Professor Pettis! Taking this to be completely true, what would you as an American policy maker do to begin to address the problem of having this exorbitant privilege? Would you limit foreign ownership of U.S. bonds for example- if so, to what extent?

    • I think I would first try to get international cooperation on the topic. There are lots of problems with SDRs, but let us assume that we could create a workable (i.e. well governed) SDR that was priced against a basket of currencies weighed by GDP, for example, and then get every central bank to agree that it only buys SDRs issued by the IMF.

      Ever time a central bank acquired reserves the IMF would automatically create the corresponding SDRs by buying the component currencies. This would spread any reserve currency purchase among the large economies. Those like me, who think the reserve currency status is a burden, would be happy to see the burden shared fairly around the world according to size. Those who think it is a privilege would be happy to see the privilege shared fairly around the world. Any country attempting to manipulate its currency for trade advantage would face global resistance, and the IMF could even have “imbalance” rules that penalize countries whose surpluses or deficits exceed some level for some period of time.

      A unilateral move by the US would be very painful and disruptive for the world, so it should be proposed only as a last resort.

      • Very interesting article.

        Since I like to work these things out in my head, I have attempted to construct a case based on your example. It goes like this:

        A supplier in a certain country (let’s call it “China ‘) sells a product (let’s call it “widgets”) to someone in the US. The US buyer send dollars to a bank in Shanghai (say) in payment. The bank pockets the dollars and exchanges them for RMB, which are then placed in the account of the supplier.

        The Central Bank of China buys the dollars by issuing RMB to the Shanghai bank. So what happens next? The IMF presumably buys an equivalent amount of a basket of currencies that make up the SDR? Some of that basket of currencies is, of course, dollars, so this reduces the supply of dollars that flow back to the US?

        What becomes of the dollars held by the Central Bank of China? Are they sent on to the IMF or do they continue to be held by the CBC?

      • As always, wonderfully provocative. One path this article suggested to me was a revision of what i derided as the lunacy of the threat by Tea Partiers to default on U.S. government debt. Could this indeed have had some beneficial consequences by removing a bit of the allure and certainty of U.S. debt and in that crude, heavy-handed way have moved the conversation forward?

      • I’m not saying that it’s a showstopper, but how would the large international trade in, say, cocaine be reflected in the official tally of trade imbalances? Looks like a source of considerable uncertainty and embarrassment, at least.

      • Hi Mike, wouldn’t reverting back to gold standard been easier than having IMF monitoring everything?

  10. Hi Michael, great article and excellent BOP and reserve currency points. You finish off with some plaudits of why the USA is thought of as the worlds reserve currency and also you wrote that USA rates are low because people like the safe haven aspect. Am I being too pessimistic but I just can’t help thinking is is the beginning of the end for the USA (Japan as well). Government Debt to gdp is around 100% and 200% respectively! They are both incredibly reckless with fiscal and monetary policies and they act as if the bond bubble will go on forever which will give them the low rates. People like Jim Rogers and even now David Tepper are looking for the end of this 30 year bond bubble. I’m not saying that this is going to happen in the next month but sometime surely it will end and rates will start the climb.

    If the USA makes the right decisions yeah they can keep the reserve status for a while longer but if they keep making the wrong fiscal and monetary decisions surely people will eventually start dumping the dollar, reserve or no reserve. The states are currently talking about raising rates but I honestly think they will be lucky to get the funds rate to 1% before the interest payments on their debt start crimping them. They are paying around half a trillion in interest payments each year at low rates on their 17 trillion debt and they talk as if they could just take the rate up with no problems. Obama was on TV during the debt ceiling talks saying the raising the debt ceiling wouldn’t cause any American citizen to take on more debt (laugh). It’s pretty obvious that their solution to all their problems is to take on more debt which has to at some point run their reserve status and low rates into problems..?

    • I am quite sure you realize that the US would in any measure long remain the or a reserve currency. But the important point, is that this is systemically becoming ore difficult. While some may see this as a benefit to the US, others might recognize it as a function of the industrialization models of some, and strategies of those who have developed upon it, and who don’t relent of the benefit, while others begin to do it, creating a set of forces, along with lessor percentages of GDP that lessens the stimulant effect of it (structuring surpluses, and cycling them into the markets of reserve issuers, who have deep capital markets themselves).

      It is univerally assumed that these flows are useful and desired and to meet a need, but they alter forces that obtain in the system (and in the US system) and can create the forces that alter other forces, that reinforce a tendency not existent, were the original force (excess capital flows and reserve acquisition beyond trade cover) causes forces that cycle the economy to focus on different sectors, to make choices that it wouldn’t if others forces obtained (sourcing more of its domestic demand differently). So,…not so quick Laurent, in the case of the US, japan is another of the stage it is in, of the forces that have obtained over the last decades, and none of this is beneficial for the globe more generally. And we talk, as if this is laughable. Perhaps, but least for the parties you imagine.

    • Laurent, you are restating Triffin’s Dilemma.

  11. Excellent article Prof. Pettis! It’s been a while since your previous book. I hope you consider turning the central ideas of this into a standalone work!

  12. Michael,

    I’m interested in your thoughts on the impact of global imbalances on countries such as Canada and Australia who, while being mature economies, have also been recording huge trade surpluses on the back of a strong commodities market. As I understand it, wealth in those nations has been created by digging up raw materials, but they have also been under the influence of the same effects as the USA by importing debt. Is the wealth creation going to counter-balance this debt explosion, or are those countries in line for Japanese-style deflation?

    Many thanks for your thoughtful columns. I also enjoyed your book immensely.


    • I would imagine they both face issues around dynamics in their housing markets; which have steadily risen. It would seem that Canadian, while exporting a lot, still has a very strong industrial base. I think they have very strong positions related to government debt; but then so had many previously. There might be pressures, to find a way to replace sectors that diminish with commodity price drops and the loner term impacts would seem tome how long they stay depressed, the prices. Did they get in positions that brought growth forward; perhaps not. Were commodity prices high enough that there economy became skewed toward sectors (more so Australia than Canada; but then Peru and Chile and others).

      I think their flexible exchange rates will help them, exporting less, lower commodity prices, but when brought back in, in dollars, at lower domestic currencies, much higher impact when moved from USD to their currency, to service domestic fixed costs, pay salaries, taxes, royalties. It really probably is a matter of debt thereafter, and whether denominated domestically internationally, what sectors, etc…

    • Thanks, Sam. Whenever commodity prices drop we all learn what we so eagerly forget when commodity prices are on the rise: excess commodity dependence has been a curse for much of modern history, both because it introduces too much volatility into the economy and because it tends to create social and political institutions that are harmful for productivity growth in the long run. There is an enormous literature on the subject.

  13. Once again a great article, thank you. Isn’t the core of the issue fact that recipient (importer) of such excessive savings i.e. US is unable to deploy these resources in a productive manner. US generally issues Gov debt to satisfy imported savings, and this debt produces less and less “GDP”. If importer was primarily interested in creating structurally free and dynamic economy then reserve currency would not be a burden. Admittedly down the road such economy would become major exporter of its advanced products. Instead of building one’s policy on selling bonds to foreigners wouldn’t better policy be to significantly cut corporate taxes (among other reforms) and sell bonds to domestic savers? I assume profits would increase leading to higher absolute savings creating a virtuous cycle.

    • Perhaps unable, or enough domestic capital that these imports merely raise asset valuations, but more systemically the problem, inabilities for mere continuance of the process as currently configured arises as the US has lessened as a percentage of global GDP, as others rise as a percentage of global GDP. US lessening has been slow and steady, the rise of FOREX reserves holdings has been a process in developing East Asia, largely (with some other sovereigns elsewhere), and almost as if in competition with each other. Not switching to more domestic led economies, and tit for tat on a beggar thy neighbor process, which has led terribly to global imbalances and for prospects of growth in other DEVELOPING world economies, for prospects of industrialization, and this is not useful, or successful, or beneficial, or needing to be supported, as such.

      Reserves in zero-sum thinking have come to be thought of as rewards, as proof of doing good, when they are only useful for trade cover, their intention in a non-mercantilist world is for import cover (long advised three months, now 6 months, with some countries amassing multiple years, and others not even three months cover). (events like Fukushima, Katrina, other events that can devastate economies)

    • Yes, foreign savings only help when domestic investment is constrained by the lack of domestic savings or when foreign savings bring technological or managerial improvements.

      But before I make the answer seem too obvious, I should remind you that in the late 19th Century, when the UK was a major exporter of excess savings, there developed a school of thought that argued the UK’s failure to keep up with the US, Germany, and others was caused by the fact that the UK exported its savings rather than keep them at home for domestic investment. I am not sure I agree, but it is good to remember just how complex this whole issue can be.

  14. Hi. May I ask a few dumb questions?
    – Why doesn’t the US Central bank buy foreign assets to down the FX rate? If risk is an issue, create a sovereign wealth fund with a mandate to invest in a diversified portfolio denominated in foreign currency.
    – Why are US Treasury officials so keen to talk up the US dollar. Are they just misguided?

    BTW, I think very many individuals choose to hold US currency independently of central banks. Just saying.


    • It would be rather more useful for no one to do that, rather than it do that. And because others do have policies that restrict such, where even if they do not, it is an unproductive policy inviting beggar they neighbor policy responses by the other party.

      China switching toward purchasing Yen, and Japanese yelling, Brazil placing tobin tax.

      As to whether you or friends have dollars stuffed under the mattress. Consider, the entire amount of all printed dollars in circulation globally, of which most are in the US, is less than Japans holdings at (1.2 trillion); where of course not all Japanese holdings are in USD. Likely all physical dollars held external to the USD globally, are less than one year of China or Germany’s external surplus. Now, for 95% of all countries, they have currencies weaker against USD, sometimes far weaker than 20 years ago. So, if this is done as modeling what others have done, as US is a lower percentage of global economy, while more countries are trying to do more of what was done, there is a systemic dysfunction that will not allow it, and measures will be taken….

      For example, perhaps your country, those of forefathers(mothers), has devalued consistently over the last two decades.

    • -The Fed doesn’t intervene, Kien, because, to the extent that it does, it loses control of domestic monetary policy. In an open capital market the central bank can choose to target the exchange rate or domestic interest rates, but not both.
      – I think Treasury officials are generally eager to see stability. They some times “talk up” the dollar, but when they put pressure on other countries to revalue their currencies, they are effectively talking the dollar down. There is a school of thought that argues that a gradually strengthening of the currency puts pressure on domestic manufacturers constantly to innovate and invest to increase productivity, whereas a gradually depreciating currency lets manufacturers off the hook. This may well be true.

      • Prof. Pettis,

        I’ve got questions about a central bank having the ability to peg the yield curve. My question is: is that actually possible?

        My hunch is that long end rates should track NGDP expectations and the spread between long end rates and NGDP expectations forms a risk spread. If one gets too large relative to the other, market players can short long end bods and go long real assets or vice versa. Is this accurate?

        People always use World War II as an example of governments having the ability to peg the yield curve, but there were also tight spending and saving controls as well. It would seem to me that pegging a yield curve for an extended period of time would end up causing issues as the stresses would first show up in the exchange rate. Are my instincts correct?

  15. isnt there some kind of automatic adjustment mechanism, whereby reserve currency status leads to chronic current account deficits, followed by running up against debt capacity constraints, followed by rising domestic unemployment, followed by ultra loose monetary policy (as Keynesian stimulus is ruled out by debt levels), followed by devaluation of reserves held by foreigners, followed by increasing reluctance of foreigners to buy said reserves (are we there yet?), at which point reserve status ceases to exist anyway and the direction of the net trade flows must reverse if the (former) net exporters want to continue to grow? the article is mostly written from the US point of view, but trade surplus countries can’t keep competitively devaluing against the dollar unless they are willing to keep buying US (government) debt ad infinitum, in the knowledge that the fed will simply monetise much of it away. of course politicians on both side will fulminate about foreign perfidy for domestic advantage, as they usually do, but how painful does the unwinding process really have to be?

    • The article is written about dynamics related to reserve currency issuance, dynamics, systemic forces, and similar, not from a point of view, I would imagine.

    • Continuous competitive devaluations bring their own problems, usually the problems of excess credit creation and mispriced investment, as Japan showed and as I expect both China and Germany will show. I think we shouldn’t fall into the trap of thinking that if one extreme is “bad”, the other must be “good”. In a well functioning system, which basically means one with lots of moving parts, no dominant players, and no major institutional distortions, there would be automatic mechanisms that prevented large imbalances, which are harmful for both sides. Hyman Minsky thought lots of small crises were better than a few big ones. And a a huge number of tiny crises is, I guess, a system with no imbalances.

      • Another problem with currency devaluations is that they hurt countries who’re dependent on importing key input variables like natural resources as well. This is a particular warning to Japan, which imports all of its food and energy. A competitive devaluation would send input costs skyrocketing, which would have the effect of reducing production.

        • yeah, my point was more that the USA’s ‘exorbitant burden’ is not that exorbitant if you can simply monetise a significant part of the foreign-owned debt – the american consumer gets to enjoy the consumption boom without having to pay the full cost of it, china (and others) get the turbo-charged rapid development. of course things would be more stable if nobody tried to game the system, and I take the point about misallocation of investment and the general ‘morning after the night before’ hangover, but it seems to me that the only part of the world where this is leading to truly brutal problems is Europe, which lacks flexible exchange rates and/or an expansionary monetary policy. I think most people agree that china faces a very difficult adjustment period, but as Pr. Pettis has argued the main obstacles to a successful adjustment seem to be political rather than economic

          • These consumption booms in the US aren’t good things either. They lead to asset bubbles and capital misallocation while the middle class gets robbed and income inequality gets sent skyrocketing. We don’t live to consume things: humans aren’t consumption dummies. In the long run, such policies make the average person here poorer, not wealthier. Wealth doesn’t come from large scale consumption and materialism.

        • I don’t believe currency devaluations hurt domestic production in a simple manner. E

  16. If reserve-currency status causes the US to have high unemployment, why is its unemployment so much lower than Europe’s? It looks more like QE has been used to weaken the dollar vs the euro and export American unemployment to Europe.

    • 1. There is no one single factor that explains unemployment. It’s a bit like asking if wearing less clothing makes you feel colder than wearing more clothing, then why is it that people in southern Spain feel warmer than people in Iceland, even though they wear less clothing?
      2. Look at the distribution of unemployment within Europe, specifically among countries that exported versus countries that imported capital.

  17. You realize Hitler ran Coal in his tanks in WWII, and that such processes have only gotten cheaper and cleaner since (with coal an abundant resource, and humans on the cusp of great advances in battery technology)). With less of the blessing deprived of those blessed (and largely only with it). Do Canadian producers sell their oil to Canadian refiners, in Canada in USD? (Norway, Saud, Russia, Venezuela, Emirati, Iranian, Qatari, Australian, Ecuadorian, Columbian, Mexican, Malaysian, Indonesian, Omani, Chinese, etc)

    Oil, just another commodity, to high and substitutes. to low and over-use.

    So, rather than the fondest memories of this aging conspiraotrial This is a description of forces at play in the system, no mere history (and only revisionist, to those given of an admittedly value based subjectivity, who within the frames of their literature are often, knowingly driven, to rationalize grievances, as a tactic, admittedly of discussant themselves in the literature, the time for such is long past).

    If transaction costs were lessened as the EU switched from many to one currency.
    What would you have there are 194 countries, with several less currencies in existence.
    What would be the effect on Saud if they traded in multiple currencies (volatility and losses as the risk of other sovereign default, other sovereign interference threatened the benefits derived from the trade)

    Theft and deprivation, IP, many act as if the world is at the apogee, its not, the question is, can we still be successful at advancing the status of people around the world. Despite the greatest lamentations of liberal cosmopolitans redistributionists (or along the frames of the conspiracy laden redistributionists; westphalian, nationalistic and cultural protectionists), we might would only want to redistribute when the flowers are in the fullest of blooms, and able to have blossomed everywhere. Unless we are Jesus, and able to can multiply stones, and make water turn to wine. Actually, perhaps not to the desire of many, that i essentially what has occurred, but not as comprehensively and completely as it can. Less parochial noises, darwinanism, pseudo-science, post-modernist, and ideological thought need to win the day to continue. Or alterations, and then you might see, what has been holding back progress. In many ways this is moot, battery tech will alter the landscape tremendously, as there already occurs a localization.

  18. If “reserve currency status” of the USD produces debts and unemployment, then why does gold mining produce investments and jobs. Even when gold has been thrown in the dustbin by central bankers- and striped of its reserve status, a monumental 2500 Metric Tons of the stuff are dug out of the ground every year. That is $100 billion/yr in value, and on the order of $90 billion/yr in investment, which is at least 500k jobs. The investment in gold mining would go up hockeystick-style if it was a reserve currency again.

    I understand your argument that USD is a burden rather privilege when other currencies are engaged in a currency war, and using trade tactics. But if step further back from your balance sheet sums, and look at the “value created” with smoothly operating global trade system – (eg, the world’s consumers have grown from 500 million to close to 2.5 billion in 20 years), then the non-zero sum benefit from running a reserve currency. Perhaps the USD is a burden to some other country hosting a reserve currency, but if the alternative is nobody running a reserve currency, then the cost borne by the USA are tiny in comparison to the benefits. Low transaction costs are essential for proper price discovery and investment in goods and commodities- only possible with a standard unit of account.

    In my view, the US benefits enormously having a reserve currency – and the whole world probably benefits even more- smaller countries can be parasitic. That it potentially costs the USA 5 million potential jobs, is nothing compared to the alternative where 500 million jobs might be lost if a reserve currency is destroyed.

    The USD earned its trust as a reserve currency- it was set in motion at bretton woods, but not ordained without gold backing- Today a new reserve currency would have to earn that trust over time- and it is unlikely that EUR YEN or RMB has institutional framework to earn that trust – even if the politician wanted it.

    • You should go to the New York times, the Washington Post, the Christian Science Monitor, Forbes, Bloomberg, Foreign Affairs, Foreign Policy, Reuters, and post this perspective.

      Viewers might wish to understand just how important US reserve currency status is to them, and why it need continue. Let them know that you love Gold, and that Rand Paul should get rid of the FED as well, coupled to why discretionary spending and entitlements are killing us, and how any taxes cuts are inevitably stimulative. Throw in we are dependent upon foreign funding of our debt while you are at it. Great stuff, quick, midterms are approaching.

    • I am not sure what you mean by this, Scott: “If “reserve currency status” of the USD produces debts and unemployment, then why does gold mining produce investments and jobs.” Why shouldn’t gold mining produce jobs whether or not currency reserve status does? After all “printing” unlimited amounts of money in Weimar Germany also created jobs — for the printers.

      • @Michael- I am trying to recall exactly what I meant too… but I was attempting to marshal an argument that there is tremendous value in simply having a “reserve currency”. It literally makes the modern world possible. The benefits accrue to the whole world- even poor african bedouins with mobile phones, but the costs are not spread evenly. I could argue that Bob Mugabe can keep Zimbabwe alive only because of the reserve status of USD, and in spite of the high printer employment for Zim-dollars. Bob benefits (unfortunately) without any cost from USD… and perhaps unemploument in the US increased as joe six-pack loses a manufacturing job.

        However the benefits are wildly greater than the costs, and I remain convinced that the US policy should nurture the reserve status as much as possible, in spite of any relative costs to other countries. It is like always doing more than your share of the dishes in a household.

        The gold comparison was an attempt to show that gold is still dug out of the ground, (even with its weak reserve status) because the benefits of a reliable unit of exchange and value so greatly outweigh the costs of gold iteself. The US government bears the costs of a reserve currency, and similarly gold producers bear the cost of gold-money. The non-money uses of gold are inconsequential, and it is possbile to think of gold miners as “bearing the burden” of a reserve currency.

        Surplus and jobs may accrue to free-loading users of reserve currency and debt and unemployment may accrue to owners of reserve curreny– at least on a limited balance sheet and cashflow perspective. But the value generated from increased trade and lower transaction cost dwarfs any of those net differences and makes everybody better off, IMO. cheers.

  19. The 50-cent army of hackers can’t stop the flow of information.

    Here is the REST (complete archive from Aug, 2007 up to June, 2013) of Michael’s blog:

    All of Michael’s past articles have been archived and are available to global blog-participants who might be interested in learning from them.

    • Thanks Vinezi. I had no idea this existed. I thought all my old posts had disappeared except to the extent that they were reposted on other sites.

      • There are at least three or four major sites and many minor ones that have been reposting all your blog entries for years. They usually aren’t hard to find if you remember the title.

        • Econbrowser carries Michael’s articles but sadly not the comments – an often valuable forum.

          • JamesPF WROTE: “[XX] carries Michael’s articles but sadly not the comments – an often valuable forum….”

            All Comments ARE archived at the site that I linked. In fact, I had no problem going to the 2012 archive and seeing the comments I myself made at that time.

            You can try it yourself. Go here and keyword search my name on the page and you can see all the comments that I made on that archived article by Michael:

            In fact, I could even parse and pull up Judy Yeo’s old comments, even though this person does not seem to be participating on Michael’s blog anymore.

            It’s all there. Nothing to be ‘sad’ about.

  20. So basically you are saying, reserve currency good if reserve currency country grows faster than world.
    Bad if it grows more slowly.

    Or perhaps the other way to say the same thing, if the accumulation of reserves is fed back into household consumption in the reserve currency country, bad; if it goes back to investment – private or government – good.

    Is that right?

    Isn’t this more simply said that imbalances = bad (if they keep increasing) at some point.
    A reserve currency may or may not produce imbalances depending.

    Good stuff,

    • More or less, Dan. Again, this is just a restatement of the Triffin Dilemma.

      • I think it may help to add one bullet point about what you are saying that is different or extends triffin – at least it would help clarify for me.

        Isn’t the problem not an intellectual inability to see the ‘relatively basic arithmetic of the situation but a fundamentally challenging theoretical dissonance.

        IF a reserve currency isn’t always a positive, it must imply markets don’t always deliver optimal outcomes. That’s a problem, not just for the reserve currency analysis but right across Macro.

        Unfortunately for economists, economics has the rather unhelpful property of being underpinned by contradictory truths. It is true that free markets deliver optimal results; it is true that the economy needs a coordinating agent. Deal with it econ.

        This is basically why I love Keynes, he was happy intellectually in a world where great truths were balanced by equal and opposite contradictory truths. It’s why I think Friedman, despite his formidable intellect and indisputable brilliance failed to have much of a shelf life; he wanted on truth – always and everywhere so to speak.

    • ^^ Dan WROTE: “So basically you are saying, reserve currency good if reserve currency country grows faster than world. Bad if it grows more slowly…..”

      • Great site, Vinezi, and extremely easy to manipulate. Now can you find me a way easily to compare household income growth and GDP growth for different countries over long periods of time? My instinct is not just that GDP growth tracks household income growth over long periods (obvious enough) but that when there is a significant divergence, it is usually followed by a collapse in GDP growth and not a surge in household income growth.

        Put differently, if soaring GDP growth relative to household income growth is “good”, the catchup should take place in the form of subsequent surge in household income growth. If it is “bad”, the catchup should take place in the form of collapsing GDP growth. Japan is an example of the latter but I can’t think of examples of the former. By looking at “good’ divergences and “bad” divergences, maybe we can find something interesting to say about how they should occur.

        • ^^Suvy Wrote: “Word. This is SICK!”

          I hope you have not misunderstood the nature of the archive site. It archives things at random automatically, and there is no human involvement. For example, here is a complete archive of YOUR OWN blog at that same site:

          How sick is that?

        • Michael Pettis WROTE: ” Now can you find me a way easily to compare household income growth and GDP growth for different countries over long periods of time?….”

          I have never seen household INCOME in any mainstream international database. They usually have household CONSUMPTION as an entry, but do not seem to track household SAVINGS by itself separately. All of them seem to include household savings along with corporate savings (retained profits) and government savings (revenue surplus) and report it as a lumped “national saving” or “domestic saving” or something like that.

          It is unfortunate, but that seems to be the way they do things at the World Bank, IMF, Asian Development Bank et cetera.

          The US has some information for its own economy alone on household (called “personal”) income here:

        • Here is a very interesting paper from the IMF that shows how the COMPOSITION of domestic savings vary considerably between countries:

          In that article, can see the CLEAR difference in CHART 3 between financial-repression users China & Korea (who seem to have very high corporate savings) and non-financial-repressing India (which seems to have very low corporate savings).

          Here are the HOUSEHOLD SAVINGS for 2007 as shown in the article in CHART 3:
          1) China: 20% of GDP
          2) Korea: 3% if GDP*
          3) India: 20% of GDP

          * Korea household savings used to be much higher, as seen in the Chart 4 in the article (expressed as % of disposable household income), but collapsed after 1997 because after Korea went on a credit-card issuing spree.

          Next, we can look up the HOUSEHOLD CONSUMPTION for 2007 from the online database:

          1) China: 36% of GDP
          2) Korea: 51% of GDP
          3) India: 58% of GDP

          From this, we can calculate the HOUSEHOLD INCOME (= CONSUMPTION + SAVINGS) for 2007 as:
          1) China: 56% of GDP
          2) Korea: 54% of GDP
          3) India: 78% of GDP

          By way of reference, the US has HOUSEHOLD INCOME of about 76% of GDP.

        • ^^Michael Pettis WROTE: “….Great site, Vinezi, and extremely easy to manipulate. Now can you find me a way easily to compare household income growth and GDP growth for different countries over long periods of time? My instinct is not just that GDP growth tracks household income growth over long periods (obvious enough) but that when there is a significant divergence, it is usually followed by a collapse in GDP growth and not a surge in household income growth….”

          I just found the information for Indian HOUSEHOLD SAVINGS (% of GDP) from their Reserve Bank’s database under section ‘National Income’ of the ‘Real Sector’ header:

          Since we already have the information for Indian HOUSEHOLD CONSUMPTION (% of GDP) from the World Bank database, We can just add the two to calculate HOUSEHOLD INCOME (% of GDP).

          Here are the RESULTS for the historical evolution of Indian HOUSEHOLD INCOME (% of GDP) over the last 53 years:

          Now can we do the same for CHINA? Japan? Korea? Brazil? I don’t know. That would depend on how transparent the Central or Reserve Banks of these countries are and how well they have organized their data. Perhaps some of the others who might be more familiar with China (perhaps Mandarin-speakers?) could check with the Chinese Central Bank to see if the corresponding data for Chinese household savings are available to the public?

        • Here are the data for China, with household-savings taken down LABORIOUSLY by hand from the “all-over-the-place in multiple-formats” data at the National Bureau of Statistics of China:

          Two points are IMMEDIATELY noticeable in the data shown in the graph above:

          1) In the post-2000 investment-boom, household CONSUMPTION dropped 11.9 percentage points of GDP (i.e from 46.7% of GDP in 2000 to 34.8% of GDP in 2012). However, household INCOME dropped only by 7.6 percentage-points of GDP, while household SAVINGS increased another 4.3 percentage-points of GDP during that period. We note that the drop in income-share plus the rise in savings-share is equal to the drop in consumption-share during the investment-boom of 2000-2012.

          2) During the 1994-2000 first rebalancing, household CONSUMPTION increased by 5.6 percentage points of GDP (i.e from 41.1% of GDP in 1994 to 46.7% of GDP in 2000). However, household INCOME increased only by 4.2 percentage-points of GDP, while household SAVINGS dropped by another 1.4 percentage-points of GDP during that period. We note that the increase in income-share plus the drop in savings-share is EQUAL to the rise in consumption-share during the rebalancing of 1994-2000 .

        • Here are some interesting graphs I forgot to add to the above-linked list:

          (1) China’s Household Savings as percent of Household Income (ESPECIALLY NOTE what happens during RE-BALANCING-I):

          (2) India’ Household Savings as percent of Household Income (no wild swings here):

          (3) Comparing China to India in terms of Household Savings/Household Income:

  21. Michael-

    Excellent post, kudos. This is where the world is going. In an unbalanced system, the balancing asset should pile up at net surplus nations, a la Keynes “bancor”.

    Take a look at the growth in “gold buying” at central banks of net surplus nations in the last few years, most notably China.

    It’s being called “buying gold” in the western press but it’s not…it’s the world moving towards gold settlement of trade.

    The popular argument is “there isn’t enough gold to settle trade” – and that’s true at current prices. But not at (much) higher prices.

    Look at Zoellick’s work from 2010 on using gold as a floating “reference point”.

  22. I don’t get how complicated it is for people to understand this simple idea: how does it make any sense for the world’s most capital rich country to import capital from much poorer countries that lack the same amount of capital? What else is the incoming capital gonna do other than create asset bubbles and imbalances? It’s really that simple.

    Usually, you hear a counterargument from people who think that current account deficits are a good thing because they allow you to consume more today and consumption is how these people measure quality of life (ex. monetarism, MMT). Of course, only suckers think that consuming and living beyond your means makes you richer. This view leads to a degrading, materialistic culture that views human beings as nothing but consumption dummies. I find it completely dehumanizing and morally wrong. These kinds of ideologies just rationalize people cashing out their houses like ATMs while making people think that this kind of behavior makes us richer. Ideas like this also completely misunderstand the role of real resources in all of these issues.

    On top of this, people who peddle such theories end up saying that the federal government should take on more debt because the federal government can never have cash flow problems (MMT) or they say that asset bubbles and private debt don’t matter (monetarism). One puts bureaucrats in charge of things they don’t understand because of some idea of “democracy” or “equality” while the other basically just excuses the draining of the wealth of the middle class in the name of “free markets” while private debt levels explode. My point is that both sides are filled with idiots.

    • What’s the ultimate point of economic activity then if not to produce and consume more (and better perhaps) goods and services?

      • Does increased goods and services increase our quality of life? We can create a society where people only work for material things, but that’s pretty lame if you ask me. Material things aren’t the most valuable things we have and it certainly isn’t what we should live and strive for.

        • I don’t see many people rushing to become subsistence farmers.

          I would say that family and friends would appear high up on most people’s list of the valuable things in life, with a bonus of working in one’s chosen vocation. That would be as true for me, fortunate enough to have been born into the western world in the late twentieth century as I think it would have been for my grandparents born in the early 1900s. But with the onset of winter, would I wish to swap my life for theirs, two of whom hail from coal mining communities in the Welsh valley’s and the North East of England? Not a chance. And I will happily take the higher consumption and material comfort of the present day.

          With respect, the only thing “dehumanizing and morally wrong” is for those with a higher material standard of living to patronise those without. I don’t think you meant it in these terms and I apologise for any misinterpretation, but I think there is a touch of the Noble Savage in that view, or as Dryden wonderfully put it:

          “I am as free as nature first made man,
          Ere the base laws of servitude began,
          When wild in woods the noble savage ran.”

          • How much material things and money can buy you health? Cuz I see rich people all the time that’re clearly unhealthy and poor people all the time that’re healthy provided they’re not malnurished.

            You do realize that this idea of “progress” is, to a large extent, complete BS. For example, take the progressivist story of the development of agriculture. Living standards dropped significantly after the development of agriculture. Hunter gatherers lived much, much healthier lives.

    • ^^Suvy WROTE: “…..understand this simple idea: how does it make any sense for the world’s most capital rich country to import capital from much poorer countries that lack the same amount of capital? What else is the incoming capital gonna do other than create asset bubbles and imbalances?……”

      A country that imports capital can ONLY do FOUR things with it:
      (a) Capital Maintenance (i.e. use the additional incoming capital to replenish existing capital stock)*
      (b) Capital Deepening (i.e. increase the capital available per worker to absorb the additional incoming capital )
      (c) Capital Widening (i.e. increase number of workers to absorb the additional incoming capital )**
      (d) Capital Destruction (i.e. increase consumption-share of GDP to make room for the additional incoming capital )

      *This actually refers to the depreciation of capital stock, generally estimated to be about 6-7% of GDP for underdeveloped countries, 8-9% for developing countries and about 12-13% for developed countries. The use of incoming capital for this use is only possible if the domestic savings rate falls below the mentioned critical number. Therefore, the use of incoming capital for this purpose is very rare, and is sometimes seen in Sub-Saharan Africa in the aftermath of famine or civil war.

      ** The number of workers could be increased by:
      (1) A decrease in unemployment-rate of the native-born
      (2) An increase in participation-rate of the native-born (including raising the retirement age)
      (3) An improvement in the demographic-profile of the native-born
      (4) An increase in the population of the native-born
      (5) An increase in number of foreign-workers (immigration)

      We note that the US today has a domestic savings-rate of 15% of GDP, and so (a) is not possible in America:

      QUESTION: Therefore, considering (b), (c) & (d), what has the US been doing with all the incoming capital? Has it been used for capital deepening? Or used for capital widening? Or has it been destroyed? Or is it some combination of the three? If so, in what proportion has this been happening?

      Anybody? Some answers here would be helpful…

      • The US essentially steals it to fund the continued trade deficit. The question as laid out misses the role of timing, the key is the bubbles. The US offers for sale to the incoming capital flows an asset worth X in terms of production but at a inflated price because of the bubble. Then when the bubble pops, either the asset is basically worthless (dot com stocks, junk bonds) or severely devalued (commercial property, homes) and priced well below its production value. US buyers then buy back the asset. So, the US sells high, buys low and thus recoups its trade deficit to fund continued living beyond its means. To that end, being the reserve currency is of benefit to the US. Sure, some US investors get caught on the short end of the stick as well, but remember for everyone who buys an overpriced asset, someone sold it for a tidy profit and for everyone forced to sell an asset at distressed prices someone bought it at a bargain price. In general, the beneficiary in both those transactions will be a US entity and when the loser is a foreign entity, the US as a whole benefits. That’s why I call it essentially stealing, because it offers what look to be capital investments but are really wealth transfers to fund its over consumption. Something very hard or impossible to do without the bubbles (or outright fraud).

        It’ll be interesting to see how well it works out this time around with the bubble being in government bonds — short of a default or debt crisis, how will the US buy back at low prices? Usually that’d mean higher interest rates, but unlike homes and commercial property there’s no inherent bias toward the US buyer being the beneficiary.

        I, as a US citizen who has benefited from these bubbles (bought a foreclosed home and after-crash stocks more than once), can attest to that wealth transfer all too well (even though I personally live below my means and am a net saver). I intentionally word my comments harshly because I think we’ve become addicted to it and I know that in the long run its going to bite us big time. I just can’t imagine the rest of the world putting up with us stealing their productivity for that much longer.

    • It’s that poorer countries don’t intend to export capital to e.g. the US. But it’s the result of e.g. the IMF that demands that those countries cut consumption and increase exports. And that means creating a Current Account Surplus. But those countries (try to) increase their foreign currency reserves (as well). And as the USD is the predominant reserve currency, it simply means buying T-bonds and thereby effectively subsidizing the US “way of life”.

      But that also means that the US lives “beyond its means”.

  23. If foreigners stop buying US debt, shouldn’t the adjustment show up as devaluation, not unemployment?

    American companies borrow in American dollars, and the Federal Reserve can print those. If foreign creditors decide to cut off their annual purchases of American assets, the Federal Reserve has the power to step in and buy an equal amount of assets to keep the economy stable.

    This would lead to devaluation of the dollar. That means a decline in American standards of living (fewer imports per dollar), and a shift in jobs from importers to exporters. But it shouldn’t lead to mass unemployment. Devaluations don’t, usually. Even the decline in standard of living should only be to what it “would have been” without the seignorage subsidy.

    So I’m confused. Michael, why do you seemingly predict “unemployment”, rather than “devaluation”, as the chief consequence of an end to unsustainable rates of foreign purchase of American debt?

    Of course, the end of foreign investment would also drive down American stock and real estate prices. The 2000-1 stock market collapse gave the rest of the economy only a mild recession, but the 2008-9 mortgage banking collapse gave us a terrible slump. I suppose when asset bubbles pop, a recession of varying degree is common.

    Is that how we should think of foreign funding of US debt? Is it basically another species of ultimately temporary asset price bubble, with a recession waiting at the end of it?

    • you mean shift in jobs from exporters to importers ….

    • There is some confusion here I think, Daniel. If foreigners purchase fewer USG bonds, the dollar would be weaker and unemployment lower, not higher. Lots of other things matter too, of course, and it depends how disruptive the reduction in purchases are, but generally, foreign central bank purchases are a way of exporting unemployment.

  24. There was an interesting post by Izabella Kaminska of the Financial Times Alphaville, titled “Behold the Euroglut” where she cites a report by George Saravelos at Deutsche Bank asserting that the EU is likely going to start running huge current account surpluses. He states “At around 400bn USD each year, Europe’s current account surplus is bigger than China’s in the 2000s. If sustained, it would be the largest surplus ever generated in the history of global financial markets. This matters.” . . . “Euroglut means that as the world’s biggest savers, Europeans will drive international capital flow trends for the rest of this decade. Europe will become the 21st century’s largest capital exporter. This statement is close to an accounting identity – a surplus on the current account implies capital outflows elsewhere.”

    If true, I think your predicted abandonment of the exorbitant burden of reserve currency by the U.S. will happen sooner rather than later. I also think the nascent U.S. recovery may be short lived, but there may be a nice asset boom beforehand.

    There was also a fairly interesting discussion on Eurodollars in the linked articles at the end on the fact that the US Fed can control its own currency because of the offshore pool of non-US entities capable of creating dollar assets.

    • Whoops, make that “the US Fed can’t control its own currency” and so was more or less forced to extend currency swap lines to other foreign central banks in part because of the inability to distinguish an offshore created dollar asset and a domestic one.

  25. Except for one thing. Having reserve currency allows FED/ and by extension USA installed fiat CB system to control world money supply, and by that, most of the world. That is probably the real reason why USA is not parting with reserve currency for so long . It is better to reduce World growth by constraining money supply then give up the privilege of control. Curiously, author does not mention this most important geopolitical aspect of having reserve currency

    • Hmmmm curious indeed.
      Do you think “they” are paying him to throw us off the scent?

      • May be it is just an idea that is rendered “unpopular” in academic cycles.

        • Where is money supply constrained…..
          Does that money supply increase mean such is good for balanced global growth, or would such lead to even further imbalances more broadly.

          Is this not a movement in the ideologies of those who typically argue of this point.

          Have you found previous assertions to be invalid, then need to hype new perspectives, where this is not about economics, is it, it is about geopolitics, no.

          Have you read nothing of what the author has long described regarding volatility?

          Well, should the US abandon, I suspect you will find out. Are you a fan of Propotkin?

    • Maybe not quite that, Ivars. The Fed doesn’t choose that foreigners peg to the dollar. Foreigners choose to do it, presumably because allowing the Fed to determine their monetary policy benefits them. But at the same time that this increases Fed “control” over global money, it reduces the Fed’s ability to control US monetary conditions.

  26. There are, actually, two main reasons, why having a reserve currency is a burden, in the long term. Hollowing out of manufacturing and debt addiction. Hollowing out of manufacturing is a form of dutch disease, when currency is stronger than it would otherwise be, making product less competitive and forcing manufacturers to move production out of the country. Debt addiction is more a psychological issue. Higher demand for financial products is pushing yields(borrowing costs) down, making investments cheaper, giving a country edge over its competitors. But as the country(government) and people get accustomed to lower yields they are using debts more and more not on investment financing, but on consumption. They are piling up more and more debts until it becomes a sort of addiction. So if it(reserve status) lasts too long(decades), it´s actually distoring, or even destroying, the economy.

    Solution? Similar to geopolitics, going from rigid one polar(one reserve currency) to more flexible multipolar(multi-currency) world. Or more precisely, tripolar at the moment, dollar, euro, yuan. And make the system open, that is, a currency can drop out or join at any time.

    When will it happen? When US finally realizes that having a reserve currency really is, in the long term, a burden. Currently they still believe it´s a privilege, which it is, in short and medium term. So my prediction is: 10-15 years. Maybe 20.

    • I think sooner- 6-7 years including one war. WWIII. After that we shall have USD, remnibi ( 2 main monetary centers) , then EUR and ???? I do not think 4th is yen, more likely something from India if it scoops up territories while China fights Russia.

  27. Hi Michael,
    I am the avid reader of our blog. Thank you very much fro shearing your insides with us.

    Regarding the exorbitant privilege: Do I understand correctly that while economists and US decision makers accept this principle as fact, the practitioners (central bankers, politicians etc.) in Europe, China, Japan and other countries have realized long time ago that it is not so?
    Do these practitioners maintain the status quo only because it is advantageous for their countries?

    • I would not offer that economists and politicians in the US hold such, nor that others necessarily hold the opposite. Just that it has been very useful in fostering development (despite the obtuse remonstrations of redistributionists, and similar of Classical Liberal, Singular Technological, Marxian, Anti-colonial, and libertarian notions; as to all the preferences they have which aren’t realized due to the machinations of this or that).

      Those who follow the ADM definitely understand the structures, insofar as their development. Problem is, so do so many others, when the stimuus offered lessens, as more hope to follow the same path (why 95% of all currencies of countries in the world, are lower against USD than they were in 1995). Probably is as others grow faster than US, Us becomes to comprise a lower percentage of global GDP, the sheer volume of the stimulus, in billions of dollars needs to rise as a correlate of the differential in growth between US and rest, or their will be a hard limit. Questions is, will those who have developed of it, realize it, and enable others, shifting into a structural position as US, with similar roles and responsibilites, or try to make hay while the sun shines. Inevitably the US will benefit when it no longer provides this stimulus, and will still be able to work with many willing partners. Will others have the same maturity, or use the wrong-headed interpretations of history, and interpretations of economics and development? Certainly, it will take time for countries to alter their economic structures, do they have the time? Will maturity eventuate prior to such a disaster for the development of the globe (which I believe can maximize peace and harmony, if done right, not that that world will be peaceful and harmonious, necessarily)

    • Generally yes, Akulis, but there doesn’t have to be a unified view among foreign countries. Central banks often have very different views than producers, for example, China being an obvious case.

  28. the always interesting Richard Koo reminds us of another reason why China’s consumption has been low and may soon rise;

  29. Prof Pettis, I think you missed the most important exorbitant privilege of the reserve currency: its ability to print any amount of the currency, while other countries must bring real goods/assets/capitals in order to get hold of the reserve currency. The reserve currency country can inflate out of its debt by keeping manipulating its inflation rate, which is largely why USA does nor care that much about its debt level.

    • Any country can print any amount of currency. Supply and demand will decide how much this currency will be worth. It is true that the dollar is overvalued but this is the whole issue! An overvalued currency is not a good thing — just ask the Chinese.

    • Rather than just state, provide data, and comparisons, because, of course, the ability to gain the currency (reserve), in the open market, by another who has printed, really merely makes your point moot. In other words, insofar as another, can buy dollars, than this is really a non-statement, or at least, no one, missing your point. Over and over, this nonsense.

  30. We have lived for about 30 years and raised children in a very expensive area (Palo Alto California). Though I am well paid, in relation to 98% of the population, and invested well the small capital I was able to accumulate, in last ten years I had to use up a significant percentage of our savings from previous years. The cost of living is killing us. If we cannot make it with the very decent salary I am making, I understand why the average person cannot save. The economy in this area is booming as many have stock options or get big bonuses but the average person is having a hard time but relies on credit.
    Which brings me to the question whether the average American has a choice as to how much he/she save. No! When the people around you have access to money from stock options or from credit, the cost of living gradually goes up and you have no choice but to save less or borrow more. It is a gradual process and the individual has no control of it.

    • It seems to me that the boom in California is driven by speculative investment in tech start-ups. Some argue that there is some sort of tech-bubble, do you agree? If so, California is passing from the trech bubble 1.0 to a housing bubble, and then to tech.bubble 2.0. This migth be a consequence of the exorbitant burden. Don’t you think?

  31. Hi Michael,
    I wonder if you could spare a moment to explain something basic?

    Let imagine there are only two countries in the world. Country A and Country B. Their trade is perfectly balanced. For some reasons, Country A decides to increase its export to Country B. It decides to purchase large quantity of Country B treasury bonds.
    1. is the fact of purchasing T-bonds sufficient to increase the export to Country B (will goods and services follow the capital flows automatically) because of an appreciation of Country’s B currency?
    2. or, the result will depend on how the purchase of treasuries be financed by Country A (taxation, internal borrowing etc.)?
    It seems counter-intuitive that all County A needs to do in order to spur its export is to purchase other country treasuries.
    Thank you

    • if there are only two countries, country A can’t purchase country B’s bonds unless it already has some of country B’s currency, and the way to get that is to run a trade surplus with country B. if you run a trade surplus and acquire country B’s currency, the only thing you can do with it is spend it in country B – either you buy more of their exports, leading to a balance of trade, or you can invest in country B, or buy bonds, etc. in other words it makes more sense to think that the capital account deficit is a result of the current account surplus, not the other way around

      • Or buys Country A’s currency on the open market, right? Or, unless the bonds of Country B, are denominated in a generally stable currency, to finance some investment. Kazakhstan Dollar Bonds this week.

        Say the need these to make an infrastructure investment where they will have to import iron and copper; Peru, Australia, Chile, Canada might not want Kazakhi Tenge (and RMB, Baht, Dong, Rupees, Rupiah, West African Francs, Pesos, Rubles, Lari, Dinari, Koruna, etc) and too manage all these (when there can be natural disasters, political uprisings, coups, crop failures, famines, inter-state conflict, etc)

        The Chinese do not fund American purchases, they bring money into the market, competing with other money, impact the amount of money in the particular market (treasuries, coprorate bonds, equities, real estate) and drive up asset values, while, via treasuries, lowering interest rates, forcing investors, to stay in market, or leave the market, or maybe even cycle capital abroad in search of yield.

        It is not a linear function, and then merely look at the data to see who prints and where, far more printing goes on external to the US, than interior….

      • Thanks for your replay Jonathan, but we can further assume that a functioning FX market exists. Under this assumption Country A raises funds internally, exchanges Country A currency for Country B currency and uses the proceeds to purchase Country’s B treasurers. In this case Country’s B currency will appreciate causing exports to Country B to be more profitable. Therefore by purchasing Country’s B treasures, Country A increased its share of global demand.
        I think this is, in a nutshell , Michael’s a argument abut distortions to trade causing by large purchases of foreign treasures.
        Am I right?

        • yes but expressed like that it doesn’t sound like an automatic accounting identity. also if the central bank of country A simply prints the money, exchanges it for B’s currency n uses all of it to buy B’s government bonds, A’s currency will devalue relative to B so net exports to B should increase, but that doesn’t tell you by how much – PPP theory doesn’t always work as it should. what if B’s government just sits on the money ad infinitum rather than spending it? what if the international trader keeps A’s currency rather than spending it? in both cases nothing forces A to run a corresponding current account surplus (does it?) in contrast if A sells goods to B and gets paid in currency B, there is nothing else to do with the money other than a) keep it or b) spend it in country B; if the money gets exchanged, the new owner still has the same dilemma. in both cases that DOES count as a capital account deficit. (?)

  32. ^^Michael Pettis WROTE: “….When German institutions – government, businesses and labor unions – negotiated among themselves at the turn of the century a sharp reduction in wage growth for its workers, they were obviously attempting to reduce German’s high domestic unemployment by gaining trade competitiveness. Because these polices forced up the savings rate, and perhaps also explain why the investment rate dropped, they resulted in huge current account surplus (or which is the same thing, excesses of savings over investment) that were counterbalanced within Europe……”

    This is one view. It may be correct, but here is ANOTHER view for all of us to consider:
    (1) There was no pattern of wage-repression in Germany.
    (2) The reunification-related investment-bubble of the 1990s had led to over-investment in Germany.
    (3) Germany decreased its investment rate during the 2000s to compensate for (2)
    (4) Since the savings-rate did not change much, (3) automatically led to rising surpluses during the 2000s.

    Here are the data that back-up this ALTERNATIVE view:
    (a) There was no pattern of wage-repression in Germany*.
    (b) Germany had an investment bubble in 1990s related to its reunification adjustment.
    (c) Therefore, Germany decreased its investment rate during the 2000s.
    (d) Since the savings-rate did not change much, this automatically led to rising surpluses during the 2000s.

    (1) As seen in the linked graphs, there was a short burst of increase in savings-share (% of GDP) during 2006 & 2007. This may correspond to the fact that nominal wage-growth did fall behind nominal GDP-growth for those 2 years in 2006 & 2007. But these 2 years were an exception and there is no evidence of a general trend towards either wage-repression or any forced savings-increase in any period as a whole.

    (2) When we compare wage-growth with productivity-growth, we get the same result, i.e. that wages have, in general, been keeping up with productivity. Here are the graphs for wages v/s productivity:

    Something for all of us to think about…….

    • I wonder what Michael thinks about this? A recent paper did an accounting decomposition of German (and other countries’) trade balance shits, breaking changes into two categories: changes in the fraction of of foreign expenditure on home country’s exports, and changes in countries’ total expenditures. I quote from the blog summarizing the paper:

      “X/M = (m*/m) (D*/D)
      where X and M are export and import volumes, m* is the fraction of foreign expenditure spent on the home country’s goods, m is the fraction of the home expenditure spent on foreign goods, and D* and D are total foreign and home expenditure. This is true by definition.”

      Using this accounting identity, the paper shows that Germany’s trade surplus is attributable NOT to expenditure shifts (a growing fraction of global demand falling on German goods), which is a catch-all for competitiveness, but rather from Germany representing a shrinking fraction of global demand. Which is to say that Germany was not more competitive per se, but instead that its spending grew slower than foreign spending on its goods did.

      Slower growing expenditure is consistent with slowing investment and with slowing wage growth (slowing consumption growth). Are the two very different? I suppose you could say slowing investment expenditure is not so different from depressed wages at the general level: the point is that the economy produces more than it spends. Instead of investing and consuming, Germany built up a big foreign asset position. (And those assets turned out to be a bit of a bad bet, to put it mildly!)

      But I am curious about what this means. The blog post says “The point here is that if you only knew the growth of income in Germany and its trade partners, and nothing at all about German wages or productivity, you could fully explain the German trade surplus of the past decade.” Which leads to this striking conclusion:

      “These are tremendously important results. In my opinion, they are fatal to the claim (advanced by Krugman among others) that the root of the European crisis is the inability to adjust exchange rates, and that a devaluation in the periphery would be sufficient to restore balanced trade. (It is important to remember, in this context, that southern Europe was running trade deficits for many years before the establishment of the euro.) They also imply a strong criticism of free trade. If trade flows depend mostly or entirely on relative income, and if large trade imbalances are unsustainable for most countries, then relative growth rates are going to be constrained by import shares, which means that most countries are going to grow below their potential.”

      To me, there seems to be a small leap of faith here – perhaps in drawing too strong a line between relative income changes and competitiveness. Rather, they must be very closely related. Germany’s surpluses became the credit that helped other countries’ income grow faster than Germany’s did; likewise, if Germany did not reduce/slow its investment spending, with low unemployment, you might think wages would have had to rise, which might have affected the m* side of the equation, not just the D* side. In that story, m* and D* remain distinct – except that the causes of their changes are intimately linked, if not the same.

      Perhaps the broader point is to see Germany as running surpluses to goose foreign income just to maintain its fraction of global demand – that, in fact, without its surpluses, Germany’s uncompetitiveness would be revealed.

      Or have I got lost in muddled thinking?

      Here is the blog post summarizing the paper:

      • I could be wrong, but I tend to see this, not the extent of the analysis, per se, but certainly the dynamics insofar as suppressed wages, suppressed consumption, etc, in relation to the German model, as Michael has described.

        The perspective you offer is interesting because it extends notions related to the imbalance as far as I see related to global development.

        This really goes to the heart of longer term dialogues, where inevitably in development, we are concerned that countries can evolve past initial stages of industrialization, to more consumer, demand driven economies, that can further impact greater development more globally.

        So this involves:

        Free Trade (particularly gains along theoretical lines, specialization, etcl
        Rise of Global Middle Class
        Switch of power from West to East (demands for greater voice in the global insitutions that have encouraged and facilitated the rise of many, who now want greater voice, Why?)
        {Despite North-South or East West dialogues, would greater voice of China, India, Russia, South Africa, whomever, the G20 even, if posssible, benefit Tanzania’s development? If we divorce the dying memes of aging post-modern (decolinization, anti-imperialism) belief constructs of the 1950’s to 1970’s(further to today, dwindling, or idealistic, supposedly moral stances), does the structural relations in the system portend that greater voice in systems institutions will enable or stymy the rise of other nations hoping to advance? Would the voice of authoritarian parochial powers, and their great and grave interests, and needs, internal political, and domestic socio-economic, inevitably have interests and vocalizations of a nature, that might prefer to see others stymied?

        Really good questions (if such were not at least perceived to be the case, why would there be such grave over-capacity experienced globally, as Schumpetarian Destruction aggrevates these conditions and trends further).

        While the utility of Free Trade for global development should be realized, imbalances, reticience to change, parochial mind frames, biological frames might actually cause policy responses and perspectives that may see an undermining of the current system configuration. Perhaps a reinvigoration thereafter.

        Michaels perspectives, as to the structural movements of players in the system seems to be most relevant in this circumstance. As I have tried to assert, if the system is to continue and maximize development, more countries will have to move into position as the US, and more countries will have to cycle their economies toward domestically driven growth, inevitably, regardless.

        The question is will they do it in time. Of course, the potential repercussions otherwise far outweigh the political and social difficulties that will arise from attempts to change (the same issue that prevents countries from transiting the middle income trap). But this will move regardless of structural forces outside of anyones control, inevitably. The question is for those countries not able to successful transit the middle income trap, would they prefer their position to that of their nations development, the globes development, and if so, really what voice should be given to such stances more broadly. The league of democracies might eventuate of others irrelevant ideological stances, and better woudl forward thinking countries make that movement if the actually had their countries, cultures and peoples interests in the primacy of considerations.

      • ^^Alex WROTE: “Using this accounting identity, the paper shows that Germany’s trade surplus is attributable ….”

        Summary: What Drives Trade Flows? Mostly Demand

        1) Yes, ‘demand’ drove the trade flows in Europe over the past decade.
        2) But what drove ‘demand’ in Europe over the past decade?
        3) DEBT drove demand in Europe over the past decade.
        4) Germany was lender, peripheral countries were borrowers.
        5) Therefore, demand was lowered in Germany, while demand was raised in peripheral countries.
        6) Automatically, Germany ran surpluses, while peripheral countries ran deficits.

        Debt was the MECHANISM by which ‘demand’ was manipulated and hence surpluses and deficits created.


        Wages rose faster relative to productivity in peripheral countries than in Germany

        A1) Why did wages rise faster in the peripheral countries?
        Because they were ‘spending’ more & more at the same wages/expenditure ratio.
        A2) How were they ‘spending’ more & more?
        By borrowing more & more money from Germany (i.e. a rising Capital Account Surplus).

        B1) Why did productivity rise slower in the peripheral countries?
        Because they were producing lower & lower proportions of domestic demand.
        B2) Why were they producing lower & lower proportions of domestic demand?
        Because of they were getting the difference from Germany (i.e. a rising Current Account Deficit)

        DEBT in the COMMON Euro was the mechanism by which wages/productivity was manipulated and hence surpluses and deficits created.

  33. In Markets over Mao Nicholas Lardy (with blurbs from Lawrence Summers, Robert Zoellick, Robert Rubin, Steven Roach and Dwight Perkins) demonstrates that markets, not govt, have driven Chinese economic growth and (2)banks have not starved SMEs of credit, even though “many private firms lack any access to bank credit.” (p. 109)
    He concludes that recent reforms will lead to more rapid growth of the labor-intensive service sector, which will lead to more rapid growth of employment and wages. This along with higher real interest rates on household deposits will lead to higher disposable income, which will increase consumption.
    “In short, there is a substantial misallocation of capital, which, if corrected, would allow China to sustain relatively rapid economic growth with a smaller share of resources devoted to investment, one of the key rebalancing objectives of China’s political leadership.” (p. 125)
    In order to get GDP growth rates of 3-4%, Michael assumes household income growth rates of 5-7%. If Lardy assumes “relatively rapid” GDP growth rates of 6-8% (2×3-4%), that implies household income growth rates of 10-14%. And I thought Michael was being too optimistic.

  34. Within the US, the role of the $ as the international reserve currency at the heart of the unbalanced world trade and monetary system that emerged in the 1970’s, has been both an exorbitant privilege for a few and a significant burden for many.

    Gross trade (exports + imports) really took off relative to US nominal GDP in 1972, following Nixon’s decision. Before, gross trade had been fairly stable around 9% of nominal GDP from 1947 to 1972. It took off from 11% of GDP in 1972 to a peak of 31% in 2008, now 30% as of Q2 2014 (source: Bureau of Economic Analysis).

    So, let’s look at winners and losers from the increasing exposure of the US economy to global trade since 1972.

    Seignorage has indeed been the main benefit for the US of having its domestic currency also the international reserve currency. It has allowed it to incur a current account deficit, ie. consume more goods and services than it could pay for, without having to sell gold or FX reserves, themselves having to be acquired via the external sale of real goods and services. All the US had to do was to issue more $. This was the secret of the “exorbitant privilege” or “deficits without tears” as Jacques Rueff called it, allowing the US “to take without giving and to buy without paying”. Well, there was a small price to pay, which was that US debt would grow. But, for a long time, that was acceptable too because all the US had to do to service the debt was to issue yet more $. To the extent that the rest of the world grew faster than the US (if only because it was less advanced), US debt would have to grow relative to US GDP to accommodate the need of the rest of the world for $ reserves. But there is more: to the extent that growing US debt served partly as the monetary base of many domestic credit systems of foreign countries, credit growth has thus been duplicated around the world in the dual credit pyramid characteristic of the $-exchange-standard. World non-financial debt has thus grown from ~ 100% of world nominal GDP in 1972 to ~ 212% in 2013 (the problematic level of 2007 was 175%…).

    It is therefore no surprise that, after having been relatively stable around 140% of nominal GDP from 1947 to 1981, US total debt (excluding central bank liabilities) took off in 1981 to reach a relative peak of 366% in 2008. As of Q2 2014, after the Fed erased $2.4Tr of debt due to a “change in methodology and data sources”, took another $4Tr on its balance sheet from the commercial financial sector and after $1.5Tr of mortgage write-down, total debt is still 332% of GDP (source: Federal Reserve). The balance sheet worsened. That’s a burden, but for the US financial sector, that was a blessing (at least as long as bad debts didn’t materialise): profits (net interest) grew alongside debt from 1.5% of nominal GDP in 1972 to 3% in 2013 (source: Bureau of Economic Analysis).

    It should be noted that the $ exchange rate depreciated -25% vs. major world currencies from 109 in 1972 to 82 in 2014. If demand for $ was strong due to aggressive reserve accumulation for trade purposes, it seems supply was not so shy either.

    Like the balance sheet, the employment situation also worsened. In 1972, out of working age population (20-65) of 101m people, 81m had a job (80%), of which 69m had a full time job (68%) and 12m a part-time job (12%). Unemployment was 4.5% of working age population (4.6m people) and under-employment (unemployment + part time for economic reasons + loosely attached to labor force) was 7% or 7m people. Currently, out of working age population of 188m people, 146m have a job (77%), of which 119m have a full time job (63%) and 27m have a part-time job (14%). Unemployment is 5.2% of working age population (9.8m people) and under-employment is 13% or 24m people (source: Bureau of Labor Statistics, US Census Bureau). Let’s call it a burden for the under-employed people above all and for society overall as the cost of their support is mutualised.

    Let’s now look at the wage situation. Median real household income has hardly moved from $45k for 84m households in 1972 to $53k for 161m households in 2012 in $ of 2012 (+0.4% p.a.). According to Piketty’s World Top Income Database, the top 5% of households (4m households) were making $184k each in 1972 while the bottom 95% (80m households) were making $38k each (in $ of 2012). In 2012, the top 5% (8m households) were making $378k each while the bottom 95% (153m households) were making $36k each. The top 5% of the income hierarchy collectively saw its income grow by 7% p.a. for 40 years in nominal terms while living standards stagnated and even dropped a bit for the other 95%. Income inequality worsened. Overall, labor share dropped from 66% of national income in 1972 to 61% in 2013. Despite falling labor share of production, consumption grew from 69% of national income in 1972 to 79% currently (source: Bureau of Economic Analysis, Federal Reserve).

    Symmetrically, capital income grew +7% p.a. from 26% to 31% of national income. Within capital income, corporate profit grew 7% p.a. from 9% to 12% of nominal GDP. Foreign profit of US corporates has grown significantly faster than domestic profit over the period but domestic profit has still grown faster than GDP thanks to a lower wage bill (source: Bureau of Economic Analysis, Federal Reserve).

    US Households Net Worth has grown +7.2% p.a. overall from 1972 to 2013, in line with profits and income from capital. As % of nominal GDP, net worth went from 357% in 2012 to 467% in 2013 (source: Federal Reserve). According to Piketty, the top 10% controlled 65% of total wealth in 1972 and 75% today. Said differently, each top 10% households has $7.6m now versus $700k back in 1972. Each bottom 90% households has wealth of $133k now versus $20k in 1972 (equivalent to $111k of today’s $, a +0.4% annual increase in real terms). Increased debt accounted for about ~ 2/3 of the overall increase in Net Worth while increased equity accounted for ~ 1/3. Wealth for the few collecting interest ; debt for the many paying interest. Inequality worsened.

    Meanwhile, poverty exploded. Food stamps recipients went from 12m or 5.6% of population in 1972 to 46m now or 14.5% of total US population (source: US Department of Agriculture).

    So, the picture is starting to emerge that the top 5% have effectively been indexed for their income on corporate profit growth – perhaps due to their incentive compensation for management positions – while the other 95% have been capped in real terms for 42 years and counting – perhaps due to their exposure or threat of exposure to cheaper foreign labor competition and higher domestic under-employment. At the bottom of the ladder, poverty has spread very significantly. Labor share has therefore been falling in deficit countries like the US. The countries with cheap labor themselves have repressed their labor share so as to attract FDI and accelerate their development via investment and net export. Labor share has therefore also been falling in surplus countries like China. If labor share has been falling everywhere, it doesn’t take a rocket scientist to realise where weak demand and weak consumer price inflation is coming from. It is not a monetary phenomenon but an inherent feature of the world trade and monetary system where countries don’t compete on intrinsic comparative advantages but on labor costs and FX arbitrage. That’s why credit easing is not only ineffective but also dangerous: it exacerbates the problem by prolonging the imbalances and the related debt accumulation for longer.

    To conclude: for 5-10% of US citizens, the rise of global trade with the $ as its reserve currency has indeed felt like a privilege, with nice consistent growth in income and wealth over 42 years. For the large majority however (90-95%), it has rather felt like a burden, losing jobs, incurring debt, seeing real purchasing power decline and real wealth stagnate, sometimes falling into poverty. Actually, the comment by Professor above who is “well paid in relation to 98% of the population” but still “killed by the cost of living” suggests that the beneficiaries of the exorbitant privilege are even less than the top 5-10%, more like the famous 1%.

    We could do the same analysis and reach the same conclusion for Europe with a different mix of income inequality (less) and unemployment and under-employment (more) even though European currencies pre-1999 and the Euro since have not been a reserve currency to the same extent as the $.

    As to why this unbalanced situation was allowed to develop until the point where excess debt and inequitable income and wealth distribution become burning issues, your explanation that the mechanisms were poorly understood and that we are just “starting to see” them clearly is not entirely convincing. From Keynes in the 1940’s, Triffin and Rueff in the 1960’s, Allais in the 1990’s, you now and many others along the way, the explanations have always been substantially the same and have never been very difficult, not going much beyond straightforward accounting and common sense. As for the visible effects, the least attentive contemporary observers would have noticed them 10 years ago while those paying attention discerned them in the aftermath of the early 1990’s crisis. A more plausible explanation therefore for why the US continue to adhere to the exorbitant privilege fiction could be that the top 5-10% carry much more influence over policy than the other 90-95%. And this has not changed, it is still very much the case. May be that’s where the resistance to change of the $ status is to be found. I mean, what was the dominant US policy response to the 2008-2009 crisis caused by the imbalances of the world trade and monetary system? The wealth effect, which is the Federal Reserve central bank extending its protection to the 5-10%. For sure, the 90-95% indirectly benefit as well since the occurrence of a credit crunch will undoubtedly impact the economy and employment. But it is clear the 90-95% are protected only to the extent that their interest overlap with the interest of the 5-10%. For the rest, they remain fully exposed to the same burdens imposed on them by systematic labor arbitrage at the heart of global trade relations. It doesn’t get any clearer than that.

    Having said that, if your more diplomatic explanation that things were not properly understood facilitates a policy change by providing face saving cover, then i’m all for it.

    Thank you

  35. Professor Pettis,
    when the US debt becomes unsustainable?

    • If i may, without prejudice to Michael’s response, there is no magical domestic debt / income level which, considered in isolation, triggers financial instability.

      In 1929, total debt was ~ 200% of nominal GDP in the US and 10y Treasury yield was ~ 3.5% so say effective cost of debt was 4.5%, equivalent to interest costs of 9% of nominal GDP. Assuming 10y amortization period, debt service was absorbing 29% of GDP.

      In 2007, total debt was ~ 330% of nominal GDP in the US and 10y Treasury yield was 4.8% so say effective cost of debt was 5.8%, equivalent to interest costs of 19% of nominal GDP. Assuming 10y amortization period, debt service was absorbing a shocking 52% of GDP (the surprising thing was not that spending collapsed but that so many people saw nothing coming).

      To go back to an interest charge equivalent to 9% of GDP like in 1929, you have to go all the way back to the late 1960’s and to the late 1970’s to find debt service of 29% of GDP. Yet, the worst crisis since 1929 only happened in 2008 and not before.

      Overall debt is as strong as its weakest debt / income link, whether in the household, non-financial business, public or financial sectors and not only within one single country but globally. In the 1980’s, the weakest links were in Latin America ; in the early 1990’s, the weakest link was Japanese corporates ; in 2007, US households ; in 2011, Southern European governments. In the late 1920’s, European governments and banking sectors and US stock loans were the weakest debt / income segments (in 1928, US investors were borrowing at high single digit interest rates to invest in stocks with dividend yield of 1%). Tomorrow, the weakest link could well Chinese corporates and / or the Japanese government. Or somebody else. Who knows? What we know for sure is that with global debt continuing to relentlessly rise versus global production, the number of weak links keeps increasing. Black swans swim on a lake of excess debt.

      And of course, overall asset valuation matters. Leverage on a total capital stock which is expensively valued relative to production is much more dangerous than leverage on a total capital stock which is cheaply valued, like was the case in the US in the 1960’s and 1970’s. In 1929, total US capital was expensively valued compared to nominal GDP. In 2000 as well. In 2007 as well. In 2014 as well. It is a fact that rising leverage applied to an asset class has initially the effect of inflating the overall value of said asset class. Whether in the 1920’s or in the 21st century, this always happen when monetary policy is too loose for too long. This is the self-reinforcing boom – bust pattern investment framework described by Georges Soros. The present situation is that such speculation on borrowed funds – on top of already excessive non-financial debt – is not confined to one or a few asset classes here and there but is generalised to many asset classes across many markets. We know from experience that this self-reinforcing boom will inevitably be followed by a self-reinforcing bust whereby leveraged players are forced to liquidate their positions at any price to meet their debt obligations. This is the investment framework that made Soros’ fortune.

      Said differently, nothing brings about deflation better than a prolonged period of credit easing (also called deflation). Which is why Bernanke famous November 2002 speech “Deflation, making sure it doesn’t happen here” should be re-titled “Deflation, making sure it does happen here”, as empirically demonstrated in 2009. With their totally misguided policy response to the 2008-2009 crisis, policymakers have prolonged the trade and financial imbalances responsible for the crisis and have thus pushed the world into a major dead-end.

  36. Professor Pettis,
    is it not true, that if US is in fact interested in other countries buying as many US Treasuries as those countries can, keeping them “frozen” and then issue US dollars against those Treasuries to be used by the US government for domestic projects or entitlements?
    Why are countries like Kazakhstan and Russia and many others are allowed to issue their local currency only against US dollars in their reserve?
    I think those questions give ammunition to a theory of “exuberant privilege” as well. Sorry if I do not keep me terminology straight, but I hope you understand my questions.

    • Jon

      You are correct, what you state is NOT true.
      For a new perspective, limit your reading, reviewing (no news or talk radio, or other news sites) for a few weeks to the previous blog postings here, and you should be able to rather more quickly gain a new way to review the issue you mention, and very many other issues.

      The US has the ability to print its own money.
      Russia and Kazakhstan have the ability to buy FOREX in the market, and they are in no way REQUIRED (there is no force or institution in the world that could REQUIRE them to do so). They do have USD in their Foreign Exchange reserves. But a point of note that people should understand, having more of others people money should not be considered as an unassailable good, this is no matter of having more or less savings than your brother, sister, childhood rival….no matter of having more revenues, as a coffee shop, than another coffee shop in town, thus you are successful.

      Ultimately and inevitably, reserves are only useful to purchase, to import needed goods and services.

      Initially international institutions suggested counties for a domestic purpose of stability, and risk mitigation, to have Foreign Reserves to enable 3 months of imports. Recently this has been raised to 6 months. Some illucid financial policy makers, pundits and related have argued that countries might want to have more to insure against financial volatility (most countries who have not moved to domestic demand model of stable growth, needed little in the way of convincing vis a vis insuring against financial volatility, because elite in those countries are reluctant to make the political and social changes in their societies that would see broader based prosperity, and prefer the status quo of elite polity relations and social dynamics, imho).

      This is made more difficult, because some countries are resource abundant, and they are subject to potnetial vast market movements when they primarily export a few globally important raw materials, thus have sovereign wealth funds to hold surpluses such that there is not great internal volatility; one year GDP of a hundred, next 150, next 70, due to the strong placement of a few valuable commodities in their GDP) as they try to diversify their economies and move into a more balanced position where commodity sales are a lower percentage of their GDP over time (UAE, Dubai, Oil, but services, retail, tax=free, off-shore banking, entertainment, tourism, air travel hub, aluminum smeltering, cementious products, shipping, etc).

      These countries hold a different position than other countries in the world economy.

      But no, while RT and others, might continue to rail against the USD as a global reserve currency, and spread conspiracy theories, around such, no one requires they hold USD, both those that supply them their goods, might prefer that dollars are available for their purchases.

      You can look here, but Reserves globally are about 60% in USD, and we have been encouraging countries to diversify. Like Biden told the Chinese leadership in 2011 or 2012, no, no you can keep your money, thanks, we have enough.

      • Who cares what Biden told Chinese leadership?
        The FACT is that there are ” Currency Board Arrangements” for the countries in IMF, where their respective Central Banks are allowed ONLY to issue their new currency when the CB have enough US dollars or English pounds in their reserve. Google it.

        Now, if the US is so “tired” of its exorbitant “burden” why not change the IMF rules? And are you telling me that these countries agreed to this arrangement VOLUNTARILY? Why in the world would they allow the US and GB CB to have so much control over their currency?

        • They were forced int a currency board and by whom?
          As stated who is requiring to do this?
          Why are others not doing it?
          No, I am not the one who has to provide the direction to the statutes (not commentary) on this matter.

          • I will put on hold my feelings about the subject, and will tell you just the facts,
            At the time when Russian Federation was written, there were more than a thousand USA “advisers” . But so it would not sound as conspiracy theory, you can judge yourself
            Now YOU will tell me if any sane person would actually WANT to have this in the Constitution of HIS OWN country:
            Russian CB is the depository of the International Monetary Fund in the Russian currency and it conducts operations and transactions provided by the Articles of Agreement of the International Monetary Fund and the agreements with the International Monetary Fund.

            Article 22: CB of Russia IS NOT ALLOWED to issue credits to any entities of Russian government, nor purchase Treasuries of the Russian government.
            Article 6: The Bank of Russia may defend its interests in court, including international courts, the courts of foreign states and courts of arbitration.
            OK, so basically it means CB of Russia is allowed to buy US Treasuries ( which it does plenty), but NOT the Russian ones. Just a brilliant law, is it not?
            And then, in case of any disagreement, CB of Russia is allowed to sue Russian government in IMF court of even in the US court. This is just fantastic!
            Try to find any of similar laws, for example, for CB of China. Try to imagine the situation when the president of China CB sues Chinese government in the USA court. Does it sound funny to you? In Russia, it is not a joke. It can actually happen. The fact is the CB of China belongs to government of China, it is not a completely separate entity as it is with Russian CB.
            But again, China did not loose a Cold War, did it?

            “Article 22” (of the Russian Constitution)

            “1. Everyone shall have the right to freedom and personal immunity.

            2. Arrest, detention and remanding in custody shall be allowed only by court decision. Without the court’s decision a person may be detained for a term more than 48 hours.”

            there are 137 articles

            checked 122 in case there was a mistake in your writing….
            Has nothing to do with Central Bank….

            Then read rest of constitution…..
            the following pertain to economic issues
            “Article 8

            1. In the Russian Federation guarantees shall be provided for the integrity of economic space, a free flow of goods, services and financial resources, support for competition, and the freedom of economic activity.

            2. In the Russian Federation recognition and equal protection shall be given to the private, state, municipal and other forms of ownership.”

            “Article 35

            1. The right of private property shall be protected by law.

            2. Everyone shall have the right to have property, possess, use and dispose of it both personally and jointly with other people.

            3. No one may be deprived of property otherwise than by a court decision. Forced confiscation of property for state needs may be carried out only on the proviso of preliminary and complete compensation.

            4. The right of inheritance shall be guaranteed.

            Article 36

            1. Citizens and their associations shall have the right to possess land as private property.

            2. Possession, utilization and disposal of land and other natural resources shall be exercised by the owners freely, if it is not detrimental to the environment and does not violate the rights and lawful interests of other people.

            3. The terms and rules for the use of land shall be fixed by a federal law.”

            article 71 discusses the jurisdiction of the Russian Federation, point g and h discuss ability to make policy around economics and finance
            article 72 point n, trade treaties

            OK article 75 reads, (and your point is?!?!?!?!; RUBLE)
            “Article 75

            1. The monetary unit in the Russian Federation shall be the rouble. Money issue shall be carried out exclusively by the Central Bank of the Russian Federation. Introduction and issue of other currencies in Russia shall not be allowed.

            2. The protection and ensuring the stability of the rouble shall be the major task of the Central Bank of the Russian Federation, which it shall fulfil independently of the other bodies of state authority.

            3. The system of taxes paid to the federal budget and the general principles of taxation and dues in the Russian Federation shall be fixed by the federal law.

            4. State loans shall be issued according to the rules fixed by the federal law and shall be floated on a voluntary basis.”

            You are reading someones non-sense, plain and simple. Do you see them get excited, does it make you excited (possibly outraged or angry, likely that is the point of those who are spreading LIES).

          • Article 6

            1. The citizenship of the Russian Federation shall be acquired and terminated according to federal law; it shall be one and equal, irrespective of the grounds of acquisition.

            2. Every citizen of the Russian Federation shall enjoy in its territory all the rights and freedoms and bear equal duties provided for by the Constitution of the Russian Federation.

            3. A citizen of the Russian Federation may not be deprived of his or her citizenship or of the right to change it.

          • Russian Federations “Federal Law on the Central Bank of the Russian Federation”

            amended by many laws from 2003 to 2014; the other postings are the original one enacted in 1993

          • So now that you looked at the correct document, can you please get off your high horse and finally stop pretending that you know more than other people?
            Yes, the references document should be Russian Federations “Federal Law on the Central Bank of the Russian Federation”

            So what is your response now to my questions? Or you did not answer because you have nothing to say?
            The questions remain, who would in their right mind in Russia pass the Federal Laws to prohibit Russian CB to buy Russian Treasuries and to have Russian CB to be completely independent from Russian government while at the same encouraging RCB to buy US Treasuries?
            When USA had financial crisis, what did Bernanke do? That is right, QE 1 through infinity. And what Russian CB is supposed to do when its economy is in trouble? They can not even issue Rubles if they do not have enough dollars in reserve. In 1990s people in Russian would get paid with barter product instead of money and had to exchange it for food because they did not have enough Rubles in circulation. No joke. You know what RCB president said at the time: ” Give me US dollars, and I will print rubles”
            And are you still telling me that the US is an innocent bystander who has no interest in other countries buying US Treasuries?

        • “In September 2013, Kazakhstan announced a move from an exchange rate regime linked to the dollar to one formally linked to a basket of currencies: the dollar, euro and ruble. ” (

          a basket of currencies, prior they had a peg (of their own choosing, not demand, what are you reading, are there advertisements on the side of it,do people talk about gold a lot)

          Exchange rate regimes as described by IMF (of course, no power to demand)

          “Currency Board Arrangements

          A monetary regime based on an explicit legislative commitment to exchange domestic currency for a specified foreign currency at a fixed exchange rate,”

          if exists, whose legislature, as the IMF doesn’t have one, then, i guess you can than move to the Kazakhi legislature.

          From Wikipidia below (you might want to find the rationale for the Kazkhi choice, and then their alteration in 2013):

          Pros and cons[edit]
          “The virtue of this system is that questions of currency stability no longer apply. The drawbacks are that the country no longer has the ability to set monetary policy according to other domestic considerations, and that the fixed exchange rate will, to a large extent, also fix a country’s terms of trade, irrespective of economic differences between it and its trading partners. Typically, currency boards have advantages for small, open economies which would find independent monetary policy difficult to sustain. They can also form a credible commitment to low inflation.”

          So,who gave you the garbage…..(are there lots of ad’s, talk of Gold, concern of money printing, desire to relieve the US and world of the FED, criticism of International Institutions, condemnation of the UN, links to RT, Novosti, PressTv, GlobalTimes, use of words like Fraudster, Bankster, writings from Pepe Escobar, videos of Jim Rogers, etc)

      • My favorite parts are :
        Article 22. The Bank of Russia SHALL NOT BE ENTITLED to extend loans to the
        Russian Federation Government to finance the federal budget deficit and buy
        securities at their primary placement.
        The Bank of Russia shall not be entitled to extend loans to finance deficits in
        the budgets of the government extra-budgetary funds, budgets of the constituent
        entities of the Russian Federation and local budgets.
        Article 23. Federal budget funds and assets of the government extra-budgetary
        funds shall be kept in the Bank of Russia
        So Russian government budget funds must be kept away from the government, in the Central Bank, which by the way is independent of Russian government and the RCB can even sue the Russian government in the US Court, if it chooses so. Just brilliant law, is it not?

  37. (1) Even without a Confucian tradition, Indian households seem to have the same PERSONAL savings-rate as Chinese households

    (2) The only reason that China has a higher NATIONAL savings-rate is because it has a lower household consumption-share than India:

    (3) The only reason that China has a lower household consumption-share than India is because it has a lower household income-share than India:

    (4) The only reason that China has a lower household income-share than India is because of it practices Japanese-style financial-repression:

    So China’s unprecedented 50% National Savings-rate has NOTHING to do with Confucian culture. It is just the natural outcome of a state-policy of systemic financial-repression. This was probably first seen in an large & organized fashion in the USSR during the first 2 plans of Stalin between 1928-38.

  38. Hi Michael

    Do you think the burden of reserve currency status would be passed on to those countries with semi reserve currency status, such as the CHF and SGD? I am mentioning these economies as they are small and open and their currencies seem to play the role of a safe haven in their regions. Flows would thus have a disproportionate effect on their economies.

    Granted that they can push some of the reserve currency burden to the US, but would any of the effects be sticky and stay with them? Thanks

  39. Recently there is an article in NYTimes saying US opposition to China’s proposal of Asia Infrastructure development bank. What do you think?

    • US this or that….

      I tend to think that unviersalized notions of such can, and need be, summarily rejected.

      Better, some in US, a few in US, this group or that group in the US, this interest or that Interest in the US, perhaps, then as a matter of policy of the US govenrment, I can scarce imagine this, but would imagine, there can be aspects, proposals, difficulties, and interestes that coincide that support, do not support the establishment of the bank….but of course, this type of way to review the world, obtains to all things, when you here, something very pointed, and linear as this (X) does that (Y), often these notions are wrong, speak to interest of a group in a dialogue, or are ideological, conspiratorial, or merely entertaining, remember that news outlets are businesses, when people read, they get paid, or might have a way to get money from some revenue stream, notions about the rise of this, and the challenge of that, may create revenue for some, but not speak to trends that are actually occurring (even while numbers are telling a certain story, or direction, journalism overshoots to the upside and downside as do markets).

  40. In this blog, Michael has clearly explained that the global imbalances we see today are related to the fact that different countries in the world have different types of economies. Therefore, the investment-driven economy of China and the net-exports driven economy of Germany, for example, tend to be counterbalanced by the consumption-driven economy of the US. His research suggests that even though each of the economies may be individually and separately imbalanced, the situation has continued for so long because they complement each other’s deficiencies on a joint basis. In other words, over-production in one economy meets over-consumption in another economy, thereby keeping prices stable in the global markets.

    Taking this insightful line of thought a little further we ask the following questions about how the US economy INTERNALLY behaves as it interacts with China, Germany and so on in global trade:
    1) Why has the US consumption-share of GDP risen so quickly of late?
    2) Why have the boom & bust cycles been getting bigger in the last 15-20 years?
    3) How long can the US keep running a deficit in order to provide reserve currency to the world?

    Since these are somewhat tangential points that would just clutter-up Michael’s blog if I posted the analysis here, I have put up it up online separately. Here it is:

    This may be of interest to all the regular blog participants here, and ESPECIALLY so to readers who may have an interest in US, UK or the Anglo-Saxon world in general.

    • I wouldn’t say that the boom bust cycles over the past 15-20 years have gotten bigger. I’d say we’ve experienced the opposite as every small dip has been countered with large scale monetary and fiscal expansion (thus expanding liquidity). I think we’ve experienced a phenomenon called volatility suppression. Prof. Pettis along with many other thinkers (ex. Nassim Taleb, Hyman Minsky, etc.) have spoken about this concept whereby prohibiting small fluctuations causes the system to show no visible risks. As all of the risks are hidden under the surface, you basically get no fluctuations and instead get large, gigantic shifts.

      • ^^Suvy WROTE: “I wouldn’t say that the boom bust cycles over the past 15-20 years have gotten bigger….. xx ……I think we’ve experienced a phenomenon called volatility suppression……”

        Both these points are implicitly covered in the article:

        As explained in Section 4.2, a rising CAD allows the boom to LAST LONGER and also allows the imbalance to GROW BIGGER than it would otherwise have. The ‘lasting longer’ part is what APPEARS as ‘volatility suppression’, and the ‘growing bigger’ part is the ultimate COST of that ‘volatility suppression’. Nothing is free. For proof of ‘amplification of boom & bust’, please see the government BUDGET DEFICIT increases indicated in figure 10: In 1989-92 it was a 1.5% of GDP increase; in 2000-03 it was a 4.5% of GDP increase; in 2007-09 it was a 10 % of GDP increase. These are massive rises and will keep getting worse if this trend is not reversed.

    • Thanks Vinezi,

      I’m skeptical of the ability to perform relevant counter-factual “what if” scenarios of economic trajectory since, in the complex economic system, everything relates to and interacts with everything else so that it is not possible to freeze one parameter – in that case the current account deficit at 2% of nominal GDP – and to assess how the rest would have evolved.

      But, since you have tried to do it, may i ask the following two questions?

      (a) What would have been the approximate real growth trend of the US economy over the period under consideration as well as its volatility in your counter-factual scenario with a constant current account deficit of ~ 2% o GDP. For sure, economic growth would have been less volatile than in the real life experience but would it have been slower as well and, if yes, to what extent? And where would US debt be today relative to GDP in this hypothetical scenario?

      (b) Are you able to draw the approximate reciprocal counter-factual scenario for China if US current account deficit would have remained stable around 2%? What would have happened to Chinese growth in this “what-if” scenario? Where would Chinese debt be today in this hypothetical scenario?

      Thank you

      • DvD wrote: “….I’m skeptical of the ability to perform relevant counter-factual “what if” scenarios of economic trajectory since….”

        That counter-factual was an approximate one for VISUALIZATION purposes only. You are correct that it would be impossible to say EXACTLY what those curves would have looked like with a constant CAD of 2%.

        To answer your questions:

        (a) I don’t know. It is impossible to say exactly what the GDP growth-rates would have been like using a simple visualization example. It is likely that growth would have been slower, but it would have been of BETTER ‘quality’, without the extreme waste of the housing bubble (I-2 in 2003-06) and the excesses of the latter-part of the internet bubble (M-1 in 1997-2000). In general, slower growth with lower resulting peak-imbalances at the end of the business-cycle is better than faster growth with higher peak-imbalances at the end of a bubble.

        (b) As for China, even though the export surplus contributes only a small amount to its overall GDP growth, I suspect a lot of industrial over-capacity was built (investment part of GDP) in anticipation that China’s export surplus would KEEP GROWING as it had from 1% of GDP in 2001 to 10% of GDP 2007. So it was partially the RISING US CAD (mirroring the rising Chinese CAS) that kept China’s investment-binge going for so long, Once the US CAD collapse in 2008, instead of curtailed the investment binge, China merely ACCELERATED it. This was a huge mistake. Instead of letting the bubble collapse and cleaning up the mess, China went in the wrong direction and blew up the bubble even further. This will not end well.

        • Vinezi

          Good points. But I think it useful togo back to beginning, 2001, further into past, and through to present and view these things in a unified fashion (and as is useful for understanding other coutnries, models, the evolution of system, and future trajectories). It seems to me in the Chinese case they made decisions, that ultimately cycled the system inevitably in the direction it had, made a calculation that the world in 2008 would soon move past the downturn (some policy makers might have actually thought it was Wall Street greed and exotic financial products, merely). Of course that hasn’t happened, because societies (even those more authoritarian on the spectrum) do not have the control they imagine (which is what makes the juvenile conspiracy theorists so laughable and detrimental toward more sanity in discussions, and why these philosophies as thinkers are exposed to systemic functions). Importantly, with what you say, DvD says, Michael says, and so many others, and, imho, what I have added, i suspect that rather than look at (1997-2000), (2003-2006), and movement to today, that something far larger is afoot.

          It would really benefit developing and developed world reviewers, policy-makers, market participants, and such to really understand how the world, rather than movement of power merely, is cycling to a new system, that there are altering dynamics of emerging properties, that is requirous of new approaches for optimization of what is coming.

          In many ways it is not dissimilar to the following:

          A great body of theoretical, practical, and critical thought, understanding and praxis grew up around the design and use of wagons. the size of horses to pull wagons which had wheels of varying diameters, with varying numbers of spokes, with a certain size area, constructed of different materials, of varying weights and densities, to carry people ad materials, or to house people, to serve vital functions in a society, a region, enable the transmission of this or that, the evolution of this or that.

          Then along came the steam engine, the combustible engine, steamship, the automobile, the airplane, the spaceship, the jet propulsion pack.

          This while many people are still going, but wagons, wagons, alas wagons is all i know.

      • ^^DvD WROTE: “….And where would US debt be today relative to GDP in this hypothetical scenario?…”

        If we take Case A as constant CAD/GDP of 2% and CASE B as a cyclical CAD/GDP varying between 0% and 4% with a overall average CAD/GDP of the SAME 2%, then the external-debt RELATED to the financing of the CAD (since the US finances the CAD with reserve-currency debt) would be the SAME in both cases.

        However, Case A, while possibly generating lower growth-rates, would have smaller and shorter business cycles with limited recessions and a lower increase in Government debt/GDP (internal borrowing) due to smaller Estoppels. In Case B, while the growth-rates might be higher, it would be accompanied by larger and longer boom-and-bust cycles with deeper recessions and a higher increase in Government debt/GDP (internal borrowing) due to much larger Estoppels.

        Therefore, Case B would generally lead to HIGHER OVERALL debt/GDP levels than Case A.

        This is why extreme boom-and-bust cycles are inefficient; because their potential for higher average growth-rates is offset by the corresponding faster-increase in OVERALL debt such that the effective debt/GDP LOAD rises and makes them unsustainable.


        You could think of it as a case of an oscillating system:

        If you put a CONSTANT load on a naturally oscillating system, the system will soon adjust to that load and then behave in a steady-state manner.

        If the load is temporally-varying, however, it will result in a transient component super-imposed on the steady-state component. If the frequency of the imposed load matches up with a critical frequency of the system, then all hell will break loose and you will get this:

        In our case of the CAD:
        1) A constant-CAD is like a constant-load with frequency=0.
        2) The natural INTERNAL business cycles of the economy define the natural frequency of the system
        3) A varying-CAD is like a load with a frequency of its own.
        4) If it ‘latches on’ to the underlying cycles, it can create ‘resonance’ and wildly amplify the boom & bust.

        Let me know if you disagree.

        • Agree.

          You are on to something with your oscillator equations: the chart of the S&P500 since 1994 looks exactly like your third example with a sinusoidal force creating resonance (hopefully only a coincidence for it suggests S&P500 at ~ 550… but may be no coincidence at all as the pro-cyclical amplifier is not really difficult to identify, is it?). Do the equations also explain why the drops are faster than the rises?

          Anyway, you seem well equipped to launch a quantitative version of the “boom – bust” Quantum Funds. I think you’ll do well. Good luck!

          And the Fed wants to start raising interest rates soon. Really???? Happy retirement Ben, at least you got your own personal exit strategy right.

          • I completely agree with you on the Fed raising rates. It’s an insane idea that’ll worsen the depression. The deficit would also explode as debt servicing costs would shoot up. A yield curve inversion is a terrible idea. If Yellen is actually dumb enough to raise rates, I think the Fed won’t exist in 15 years and for good reason. There’s no way Yellen can be that dumb, or maybe I’m dumb for thinking that bureaucrats with no skin in the game can be that dumb.

          • ^^DvD WROTE: “Do the equations also explain why the drops are faster than the rises?”

            Yes, they do. The equations are completely general.

            All we have to do is to account for the fact that the underlying natural business cycles are NOT truly sinusoidal (as assumed in the linked simple-example). The natural business cycles could be modeled as an infinite series, for example, that accounts for the slow rise and the fast fall. Once that is done, the oscillation model can easily be extended to the economy and studied using past data.

            This could be a good subject for someone’s Ph.D. dissertation. I did mine many years ago and I have no intention of repeating that experience. Perhaps some of the freshman grad-students here on this forum might want to give it a shot?

          • ^^DvD WROTE: “The chart of the S&P500… xxx ….And the Fed wants to start raising interest rates soon….”

            A) The S&P was around 150 in 1984. It is now at around 2000 in 2014.

            There are two confounding factors in these indices that should be accounted-for separately if we wish to track the real earnings of the underlying companies: Inflation & Real Interest rates.

            1) Accounting for inflation, in 2014 dollars, the S&P was 350 in 1984.

            Therefore, we can re-write (A) in 2014 dollars as:

            A*) The S&P was 350 in 1984 and is now at 2000 in 2014.

            2) Still further, the REAL interest rate in 1984 was around 8.5%, now it is around 1.7% in 2014. Since stocks are merely an alternative to debt, the P/E ratio for stocks would also have scaled in the same proportion and hence risen automatically by a multiple of 5. This would have sent the S&P (in 2014 dollars) from 350 in 1984 to 1750 (350 X 5) by 2014.

            So, apart from the falling real interest rate and the cumulative inflation, what is the contribution to the S&P by the companies THEMSELVES over the last 30 years? Was the last 30-year stock-market boom merely a function of falling interest-rates? If so, what will happen if interest-rates rise? Will P/E ratios go back to 8-10 as they used to be? Will the stock market then be headed for a repeat of the 70s? Or would it become like Japan’s Nikkei?

            What are your views?

          • Suvy,

            The dilemma in which the Fed is visibly caught since 1997 is itself a manifestation of the Triffin dilemma.

            Either the Fed let the economy go into recession to let the imbalances adjust or they cushion the economy against recession but they can only do so by prolonging and exacerbating the imbalances. Which makes the next crisis bigger than the previous one and so the Fed intervention also bigger, and so on so forth. This is the amplified oscillator structure shown by Vinezi. You have bigger booms due to bigger Fed intervention and bigger bust to correct bigger imbalances. During the up phase, financial markets are happy to play this situation as a win-win (either the economy is good and it’s good for asset values or the economy is bad and the Fed intervenes and it’s good for asset values), so leverage up for the carry trade party. Then, during the down phase, financial markets realize it’s in fact a lose-lose proposition: no matter how long the Fed follows this “when in trouble, double” strategy, they will always end up losing control of the economy as long as the root causes of the imbalances are not addressed and the reset of asset values at that point is thus extremely violent. QE was just there to buy time to address the root causes. But now, time is up and the root causes have not been addressed. So we are entering the down phase of the oscillator. For sure, the crash will be amplified if the Fed raises interest rates (which it won’t) but the crash will happen anyway even with 0% interest rates through the implacable and self-reinforcing dynamics of falling prices forcing leveraged players to liquidate. As with the oscillator, the movement of the equity market will be endogenous. The influence of the Fed is only at the margin, as a secondary force that can either amplify (easily) or dampen (more difficult).

            The Fed can’t get out of this dilemma as long as the US has not resolved the Triffin dilemma. The Triffin dilemma has been formulated 54 years ago. Let’s hope it won’t take as much time as Fermat theorem…

          • ^^DVD WROTE: “The dilemma in which the Fed is visibly caught since 1997 is itself a manifestation of the Triffin dilemma…”


            1) IF you have a pegged-currency AND,
            2) IF you have an open capital-account, THEN,
            3) You will lose control over your own monetary policy.

            Historically, the US has never ‘pegged’ its currency as it is a believer in ‘free-markets’. However, we note that the large economies of the world (East-Asia, Petro, Euro) are now effectively pegging their currencies to the US Dollar by intervening in changes to their exchange rate vis-a-vis the USD. Therefore, the currency of the US is AUTOMATICALLY ‘pegged’ by these actions of other countries, regardless of what the US thinks about it.

            If we accept this argument, then we can see that:

            1) The US now has a pegged-currency (by implication)
            2) The US has always had an open capital-account (‘free market’)
            3) Therefore, we can conclude that the US has now lost control over its own monetary policy.

            Using this, we arrive at a strange conclusion: From here on, US monetary policy will be decided by East-Asians, Middle-Easterners & Europeans.

            What do you think?

          • Vinezi,

            This way of looking at the stock market is very conventional but doesn’t tell you anything very useful. You just take corporate earnings as a given (most people take sell side analysts forecasts, which are always wrong at inflection points, which are the only points that matter) and yes they do move in the same direction as consumers price over time and you just try to justify a multiple put on these forecast earnings based on where interest rates are. This approach, which is used by 99.9% of market participants, has one main inconvenient: it looks at the stock market in isolation, in a way that is detached from the economic process. As such, it completely lacks economic substance and for that reason always misses the most important turning points in the cycle.

            You have to replace companies activity and earnings generation in the overall economic context.

            P = E / (r – g)

            Where P is corporate equity value ; E is corporate earnings ; r is discount rate and g is long term earnings growth.

            At the aggregate level, E is value added – labor costs – interest costs. If labor costs are a decreasing share of value added, for final demand to remain able to absorb value added on a continuous basis, hence for earnings to be able to grow, the demand side of the economy needs to incur rising debt (it could also draw on savings but that has already been done long time ago in the US). So, E is debt-funded and g is debt-dependent in a situation where labor share is decreasing. But if debt rise faster than consumers income, debt service must also rise faster than consumers income and since debt service has first priority over spending, demand addressed to the corporate sector must eventually fall when debt capacity is saturated. At that point, earnings go down, sometimes suddenly. Supply-side leverage – aimed at enhancing ROE – on top of demand-side leverage is effectively double leverage which magnifies the problem. Financial investors leverage (so called carry trade) on top of supply-side and demand-side leverage magnifies the problem even more. That’s why drops are faster than rises. This, in a nutshell, is the dynamics behind the oscillator pattern representing corporate earnings and equity values. It can be a stable oscillation in the sense that economic functions accept upper and lower limits (earnings don’t go to 100% or 0% of national income) or it can become an amplified oscillation which degenerates if for instance the central bank decides that it is a good idea to lower interest rates to the minimum so that not only debt / income go to the maximum but also that equity multiples can expand dramatically (any resemblance with today’s situation is not completely fortuitous). In that case, the oscillation can really become extremes.

            The discount rate r depends on risk free rate which depends partly on inflation (which must fall if consumers pay is a falling share of total income, which also means that companies are losing pricing power), partly on real rates (which must remain low – by force if necessary – for debt to be sustainable in a highly leveraged system, bearing in mind that eventually interest rates embed credit risk which rises if relative debt rises) and partly on equity risk premium (which must rise if earnings are debt funded, especially when earnings are at peak level). So r is also debt-dependent and as such also oscillates.

            The Fed has reloaded demand in 2009 by collapsing interest rates to 0% and by also collapsing risk premiums to tight levels, hence it has reloaded earnings growth and thus equity values (both numerator and denominator). But it has not addressed the drivers that amplify the underlying dynamics, which is falling labor share – and hence rising leverage – due to systematic labor and FX arbitrage allowed by the current set-up of the world trade and monetary system.

            That’s why i was intrigued by your amplified oscillator pattern. It seems to capture the dynamics of corporate earnings and equity values in a highly leveraged environment much more profoundly that your subsequent conventional way of looking at the stock market, which lacks economic substance.

            And by the way, this is not specifically a US issue. Just like the S&P500, the MSCI World representative of the world equity market cap also looks exactly like an amplified oscillator.

            Bottom line: at the peak, corporate earnings have to come down either because demand is debt funded and debt capacity has been reached and debt service is constraining demand for goods and services addressed to the business sector or because rebalancing is taking place in the economy and labor share is increasing and therefore profit share is decreasing. In both cases, corporate earnings and equity values are going down. There is nothing central banks can do about it. If they allow the credit and financial cycle to magnify the usual oscillating business cycle, they can only create the resonance that results in the amplification of the cycle.

            This is precisely what central banks have done for the past 17 years and the reason why we have had an uninterrupted succession of spectacular booms and busts that are very damaging for the economy and the real people and families involved.

            Given the tremendous amplification provided by non-stop QE during the boom phase, the upcoming bust phase promises to be quite something again. Any suggestion that has appeared in US press that Bernanke should get the economics Nobel Prize are greatly premature.

          • ^^DvD WROTE: “…..But if debt rise faster than consumers income, debt service must also rise faster than consumers income ….”

            This is usually true, but not always. For example, debt HAS indeed been rising faster than consumers income over the last 30 years. However, debt-SERVICE has NOT been rising faster than consumers income over the same period. Here is the reason for this divergence:

            Since interest-rates cannot go any lower on a secular basis, there are TWO scenarios to consider for the future:

            (1) Interest-rates stay low for a generation. If this happens, the US will see slow growth for a generation, since the ‘tailwind’ of falling interest-rates will no longer exist.
            (2) Interest-rates begin a secular climb upwards for the next 30 years. If this happens, the US will see rising unemployment, since the secular rise in interest-rates will then act as a ‘headwind’ to domestic consumption and investment.

          • Vinezi,

            You are confusing interest costs with debt service. Debt service is interest costs + principal amortization. And now that a material portion of personal income is in fact transfer payments from the public sector and that public sector acts more and more as demand provider of last resort (as shown in your analysis of the US economy), it makes sense to define demand side of the economy as households + public sector, while the business sector is the supply side. On that basis, it is very clear than debt service of the demand side has been and still is rising much faster than income of the demand side of the economy. So demand will inevitably slow again.

  41. HI, prof and everyone.I’m really wonder how you guys do to read all these comment and you prof to write much of it. I suspect some illegal chineese slave/student working for you behind the scene…
    In your last master piece it seems a huge controversy happened. I think posts were deleted before i red it but remeber prof, TROLL ARE ALIVE!
    I would like to bring you on Africa. In this piece you say that a common currency allow country to export unemployment easily. I was wondering french adjutment in late 80’s result in old french colonies go bankrupt in 90. I just dind’t find the data. Does anybody know where i can find it?
    And what about commodity supercycle? Because it clearly ended. We saw growth stop sharply in Argentina Russia and Bresil and others. But, if you take Angola, Cameroon and Ethiopia all very differents. Forecast are still pretty good. To me in Africa it’s more an investment boom in sector like banking retail and construction that we are seeing that an export boom.

    • The franc currency union in Africa is one of those things I have always wanted to know a lot more about, Cedric, but have never gotten around to, and I certainly don’t have the data to say much about it. As soon as I can find a decent history, I will eagerly dive in (and if you know any good books please tell me).

      More generally I am pessimistic about many African economies because of their dependence on hard commodity exports. Unfortunately this is an old story. Whenever commodity prices surge, we get excited about certain developing countries and assure ourselves that this time it is not just a “commodity thing”, and we have almost always been disappointed. It may be true that banking and retail are doing well, but very often they do well mainly because commodity exports are doing well. One problem with extractive economies is that they tend to be structured in highly pro-cyclical ways. Everything goes up and down together.

      By the way don’t take the forecasts too seriously. Consensus forecasts are generally accurate when we are inside a cycle (i.e. there is no major economic shift) and useless when we leave the cycle, so in a world of difficult adjustments and rebalancing, the forecasts are not likely to be terribly useful, or, to be more specific, they are useful when we don’t need them and useless when we do.

      • The rise of mobile and technology go a long way toward altering some of the dynamics and structural forces that obtain in the African case(s). It is a boon for entrepreneurship and for the growth of those near the bottom that they can access all sorts of information (market prices for chickens, crops in the city, the unbanked to banked, education, medical services via mobile phones etc). The dynamic forces change and alter. Africans seriously need to work on limiting the rises in population that are occurring, as such dilutes everything on a per capita basis, and creates even more burdens for cash-strapped, institutionally weak societies, in a world of great competition for development at the developing world level. more clear-headedness, and great work to dispel old notions that delimit the mind-frames of domestic constituencies, around aging disempowering philosophies. The work of the Ibrahim foundation, need to reach more on the continent.

        Cedric, did the Franc Union collapse around the time of the creation of the Euro, did they create an artificial peg to the Euro. For example in the 1990’s the Czech Koruna used to be 25 to USD, and after Euro, it sat for the longest time for that around the Euro, and with movements in USD/Euro, it altered in relation to that, as USD weakened in relation to Euro, the Czech strengthened against USD, as Euro did. Something like that at work?

        • My real problem is that i don’t find current account global and details back to late 80s. I search trhought the IMF, World Bank other organisation but i don’t find data.

          The franc CFA zone was peg to the franc after the WW2. France was in late 80s forced to adjust due to anticipation in Maastrich Treaty( it started the peg of the Franc to the Mark) plus the impact of the oil shock and Franc reevaluation after plaza talks. I also know that debt issue by old french colonies were politcaly backed but not economicaly. Problems in Africans countries started at the same time that clearly suggest that it’s the same chock who bring the pain.

          What is VERY important fact is the moderation in African debt nowdays. They are allowed to have 3% budget deficit 70% debt over gdp ratio. Debt services decrease and debt over gdp ration is stable(arround 20%). So there is no debt bubble arround here.

          • ^^”What is VERY important fact is the moderation in African debt nowdays. They are allowed to have 3% budget deficit 70% debt over gdp ratio. Debt services decrease and debt over gdp ration is stable(arround 20%). So there is no debt bubble arround here.”

            Please note that this ‘moderation’ of which you speak refers to the EXTERNAL debt (i.e. borrowing from abroad).

            You are correct that after peaking in 1995-96, the external-debt ratios plummeted over 10 years to reach a low-point of 20% of GDP on average by 2005-06

            But how did this responsible “moderation of external debt” happen in Africa? Here is the answer:

            As a parallel, if China forgives America’s debt, then there will be no debt-bubble in America either.

    • ^^Cedric WROTE: “…..But, if you take Angola, Cameroon and Ethiopia all very different. Forecast are still pretty good. To me in Africa it’s more an [x] boom in sector like …..”

      Are these African booms sustainable?

      A) Angola has an export-driven economy (like Germany from 2002) based on export of crude-oil at high prices:

      B) Ethiopia has a deficit-fueled investment-driven economy (like Spain up to 2007):

      C) Cameroon has a deficit-fueled consumption-driven economy (like Greece up to 2007):

      Ethiopia and Cameroon are funding MOST of their trade-deficits with international aid:

      Even though ‘aid’ is better than debt, it is neither scalable nor sustainable. When the aid ends or tapers-off, the boom ends in Cameroon & Ethiopia. In addition, if the slowdown of energy-heavy investment in China sends oil prices down, the boom in Angola will also end.

      • Looks like the links pasted in the comment above were all pointing to the same graph by mistake. Here are the CORRECTED links to all the appropriate graphs:

        Are these African booms sustainable?

        A) Angola has an export-driven economy (like Germany from 2002) based on export of crude-oil at high prices:

        B) Ethiopia has a deficit-fueled investment-driven economy (like Spain up to 2007):

        C) Cameroon has a deficit-fueled consumption-driven economy (like Greece up to 2007):

        Ethiopia and Cameroon are funding MOST of their trade-deficits with international aid:

        Even though ‘aid’ is better than debt, it is neither scalable nor sustainable. When the aid ends or tapers-off, the boom ends in Cameroon & Ethiopia. In addition, if the slowdown of energy-heavy investment in China sends oil prices down, the boom in Angola will end.

      • You have to look more closely if you wanna prove that Cameroun fund his debpt by internationnal aid. Vietnam get more internationnal aid than Cameroun but the boom is clearly not funded on internationnal aid. You absolutly don’t know if this money is well invested and create wealth or destroy it. If it’s bullshit investment and corruption honnestly i don’t really understand what is the problem.

        • ^^ Vietnam get more internationnal aid than Cameroun but the boom is clearly not funded on internationnal aid.

          Vietnam may get more aid than Cameroon.

          But Vietnam also gets a LOT more FDI to fund its trade-deficit, whereas Cameroon is far more reliant on aid to fund its trade-deficit.

          Therefore, if aid dries up, Cameroon’s deficit-fueled boom will end, whereas Vietnam will still have FDI left to fund its deficit and continue its boom.

          It is not the magnitude of the aid alone, but rather the size of the aid relative to the size of the trade-deficit that matters.

          • Aid mean nothing, first how many countries go bankrup because of stop of foreign Aid? Aid is not more or less reliable that bond market. And you say, aid is a problem .As if aid was aid, and not FDI. But’s all about FDI transformed in AID to make NGO happy. But at the end of the day do you know many real major aid program outside HIV in africa?
            Government spending is 20% of Cameroon deficit 4% growth 5%. Debt duel boom? You see Africa like was south east asia in 97. But growth started in 2000 in SSA after DEBT RELIEF. and 2001 and 2007 dind’t change much to the trend. South East Asia was faking it’s currency regime that african countries don’t do, They are not export depend and most of the growth come from the inside. Plus The rise and the decline of commodities already happened And it changed nothing to the growth story.

          • ^^Cedric wrote: “….Plus The rise and the decline of commodities already happened And it changed nothing to the growth story….”

            WHEN the group at the top of this graph (net commodity exporters) and the group at the bottom of this graph (net commodity importers) CONVERGE, only THEN will the ‘decline’ of commodities be complete.

            ALSO note the ‘reversion to mean’ that will be seen in this graph when the ‘decline’ of commodities is complete:

            This will happen when China’s investment-growth rate approaches ZERO or even goes negative (i.e. the Chinese material & energy intensive investment-boom ends).

            Once this has happened, let us then take another look at the growth story you mention.

          • ^^Cedric WROTE: “….You see Africa like was south east asia in 97. But growth started in 2000….. South East Asia was faking it’s currency regime that African countries don’t do, They are not export dependent….”

            Here is how the debt-crises of old will return to Africa….

            A) THE BOOM:

            1) External-debt is forgiven.

            2) African countries promise to keep their External-debt/GDP ratio small in the future.

            2) African economies experience a commodities-boom. As a result, their currencies strengthen and their NOMINAL GDP in USD sky-rocket, increasing by as much as 400% in just 6-7 years in NOMINAL USD terms.


            3) As a result of (1) & (2) African countries AGAIN borrow HEAVILY from international lenders, while temporarily keeping external-debt/GDP ratio small because of the massive NOMINAL growth in their GDP in USD terms.

            C) THE BUST:

            1) But as soon as the commodities-boom ends, their currencies will weaken. This will automatically send Nominal GDP in USD terms downwards.

            2) Even as their GDPs in nominal USD terms shrink, their EXTERNAL DEBT in USD will remain CONSTANT (this is the KEY point). Therefore, their external-debt/GDP ratio in USD will rapidly rise again. In addition, their external-debt/exports ratio will ALSO rapidly rise again.

            3) Servicing this external-debt in USD will then become very difficult because of their weak-currencies and reduced USD exports. This is very similar to what happened during the ASEAN external-debt crisis of 1997.

            From all of the above familiar, constantly-repeated trend-patterns, we can conclude that the old-fashioned debt-crises will return to Africa once the current commodities-boom ends.

            Do you disagree? Let me know your thoughts.

          • Cedric WROTE: “…..And you say, aid is a problem .As if aid was aid, and not FDI. But’s all about FDI transformed in AID to make NGO happy. ”

            ODA Aid is not the same FDI (Foreign DIRECT investment). We could call ODA aid as a form of FGI (Foreign Government Investment), if that sounds better.

            Cedric WROTE: “…..But at the end of the day do you know many real major aid program outside HIV in africa”

            I don’t think that most of this ODA aid is connected to HIV. Here is why:

            Aid per HIV-infected person = (HIV Cases)/(Total Aid)
            = (HIV Cases)/(Per capita Aid X Population)
            = (HIV Cases/Population)/(Per capita Aid)
            = (HIV incidence rate)/(Per capita Aid)

            A) The countries with highest ‘HIV incidence-rates’ are all located at the SOUTHERN TIP of Africa:

            B) On the other hand, the countries with the highest ‘per capita aid’ are all located in the MIDDLE of Africa:

            There does not appear to be a direct link between HIV-incidence and international aid.

          • “This will happen when China’s investment-growth rate approaches ZERO”
            It’s not because China won’t import that Vietnam Thaland and likes will do the same. Factories are ALREADY moving from China. Don’t expect a huge commodity slump. Because the first purpose of chineese commodity import is export to rich contries. So the only question is can they buy the same amount of goods in years to come? And what kind of price rise can they take.
            This is gross domestic debt:
            It’s 30% and it’s LOW.
            You can’t proove that african is due to commodities. It clearly started with debt relief. Please look at Russia South Africa Brazil, who realy surf on commodities boom. Why Gabon or Nigeria are not is such shape? If you take Gabon oil revenu decrease. How do this very poorly managed country do to grow?

            More, you and prof might not notice this but default ALREADY happened in SSA! So please with this real live debt default stop speculate. Ghana experienced a stupid debt binge and a very poorly managed public spending. And it changed almost NOTHING to the forecast. Even if in this case, the problem is more about debt managment that the level of the debt. It’s still a toy model.

            The growth story to me in Africa is much complex that a Chineese one or even a Indian one because, because it’s NOT centraly planned. But what african people need is rich countries buying cheap products to avoid a major collapse of commodities. And what we are about to see is a the rise of services because China rebalancing will put a important pressure upward on services. So the real focus should be on EU Japan and US, because i think president Xi is doing the job.

    • You realy want to know more about this because at least of one thing. Actually there are two different union CEMAC and UEMOA and the UEMOA economies seems to diverges but in CEMAC economies converges.

      Cleary banking boom has nothing to do with commodities. Lending rate are hight not really because of risk but just because banking facilities didn’t reach custommers. They are now bank spreading everywhere, even in countryside. They are no Goldman Sachs but you can borrow money.
      I’m optimistic, because i think cheap products that came from China to Europe find customers that have real money. If China adjust, factories will move to Vietnam and likes, and few in Africa. But the new services Chineese people will buy probably will come from Africa. So commodities will nerver go back so low. Plus China is really wanting to buy MORE commodities from abroad rather than produce it itself because of corruption, and environmental purposes.
      To me the worriest thing would be that europe go bankrup massively, and that asian factory shut down. If so chineese will probably shut their investment in africa. And close border to african cheap workforce by any means.

      I’m more about data than history so i can’t really give you good advices on african hisotry. In french there is Chindiafrique by Jean Joseph Boillot. But it’s more about the future than the past.

      • ^^Cedric wrote: “…. In french there is Chindiafrique by Jean Joseph Boillot. But it’s more about the future than the past….”

        It would have been nice for the whole world IF Africa (meaning the part south of the Sahara) were going down the same road that the Asian countries are. Unfortunately, however, sub-Saharan Africa (SSA) is NOT going down the same road.

        We had covered this in the discussion section of one of Michael’s older articles, but you can still see the problems faced by SSA as listed in this article:

        Here are some inter-connected and basic things that SSA needs to do before it can join the Asian countries and travel down the path of rapid industrialization:
        (1) Decrease reliance on aid
        (2) Increase domestic savings rate
        (3) Decrease dependency ratio
        (4) Increase productivity
        (5) Manage Population Growth

        Let me know your thoughts.

        • There is many to say, first your indicators are good indicators for industrialise economies it’s not the case of most african economies. Take the jump of nigerian GDP 50%. Do you really think it has not a impact of all those you show me? Were they revised? Nobody know the total workforce in countries like Ghana Ivory Coast ect… These indicators or irrelevant because nobody what’s going on.
          Then you assume that SSA should industrialise in a world of service surge. Sorry I don’t buy that. Africa will never be industrialise like China.
          To finish, your indicator like saving rate are clearly going up, aid is going down but you still think nothing is changing.
          I personnely trust only data from private company like internet users, and simple macroeconomics one like current account and gdp who as you know are wrong.
          Plus you forget one thing in you explanation, it’s that governement deficit move in Africa. They were a surplus before 2007 there is now a deficit. There is no surge in governemetn spending because of 2007 crisis. But there is a sharp curb on taxe revenue. And now deficit is arround 3% growth is arround 6% and taxe revenue is stable. So the overall SSA debt fragility is clearly reducing.

          • ^^Cedric WROTE: “To finish, your indicator like saving rate are clearly going up, aid is going down but you still think nothing is changing…..”

            (1) There are many different types of savings rates. The World Bank reports the ‘gross DOMESTIC savings’ rate, which refers to savings WITHIN the local economy. The IMF reports the ‘gross NATIONAL savings’ rate, which refers to the gross domestic savings rate PLUS ‘net current-transfers’, where ‘net current-transfers’ is sum of migrant remittances, foreign aid and so on.

            Here are the WB data for ‘gross DOMESTIC savings’ rate:

            Here are the IMF data for ‘gross NATIONAL savings’ rate:

            If you take another look at my original comment, you will see that I specifically mentioned that SSA needs to raise its DOMESTIC savings rate. As seen in the WB data, average DOMESTIC savings in SSA are below global average and are lower than they were during the 70s & 80s. In addition, when the current commodities-boom ends, the domestic savings rate will go down further.

            (2) Aid is not going down. Aid is going UP.

            The reason the Aid/GDP rastio has been going down since 2006:

            …is because NOMINAL GDPs in USD terms are rapidly rising since 2006:

            The reason NOMINAL GDPs in USD terms have risen so rapidly is because of strengthening of local currencies. When the commodities boom ends, the currencies will weaken again. As that happens NOMINAL GDPs in USD terms will fall, while AID figures will remain the same. This will cause aid/GDP ratio to go back up and the illusion of ‘reducing’ aid dependency will be dispelled.

            Let me know your thoughts

        • Thanks for the alteration on the alturl,I have checked out your blog and same problem, same problem using Firefox, Chrome, Int Expl, haven’t tried Opera cause would have to download. If not a problem and in future can use, much appreciated.

        • Vinezi:

          Out of curiosity, an academic, finance person, mathematician, or policy maker?

  42. Hi Micheal,

    There is one more form of consumption besides investment and domestic, which you have not emphasized but might be systematically important: war

    The military-industrial complex as a highly entrenched special interest group in Washington certainly benefits greatly from the ability of the US to wage wars funded by foreign capital flows.

  43. latest from the Fed:

    Fisher talks about Fed policy spilovers internationally.

    What’s the takeaway Mr.Pettis?

    • It’s hard to disagree with Fischer, who manages to explain subtly how difficult it is for monetary policies not to have foreign spillover effects without being at all impolitic.

      • Is his statement not implying that US fed policy will henceforth be constrainted by considerations of spilovers? Is this not a seachange? Is this not a signal to brazil, china, etc, that Fed accepts responsibility for easy money? Is it not an acknowledgment of Ronald McKinnon’s analysis of Fed easy money policy suppressing rates in the South?

        • accepts responsibility…… (dated and laughable)
          acknowledgement………. (ibid)

          Would that then also extend for the impetus to growth, prior? Or would this only be in the negative, in the critical caricature.

          It seems thanks and praise are in order, the old memes die, surely.
          Now we can get back to what is real and sustainable, and places who want to keep avoiding the alterations necessary on the domestic front, now realize that we are all in it together, or will necessarily move apart. More capacity, tightening of ranks, and attempting to squeeze global markets that need far more demand than productive capacity are in order. Time to move on the political and social front, free up the reigns of the bulk of your citizens and enable further growth globally, as yours has been enabled. More investment in asset bloat and productive capacity need give way to more stable, balanced, and toward (income) equal societies to rationalize as many previous mal-investments as possible and create the ability to drive growth (as is and will remain necessary, especially as so many in the world aren’t free in markets, nor in desire to enable their citizens greater choices and opportunities, subsumed to old notions of manipulation). Such dies in the present environments, and a hearty cheers for it.

  44. Since the US is the primary reserve-currency country with 2/3 of international reserves held in USD, it should NOT report debt as other normal countries do. Reserve-currency debt held overseas will never come back into the US economy (i.e. it is a form of quarantined debt) and so does not affect monetary conditions within the US. The US can force interest rates to almost-zero on that debt and the world will still hold it, therefore, the interest can simply be added to that quarantined debt.

    Therefore, here is what I suggest as correct debt-reporting format for the US as a reserve-currency issuing country:

    A) Overall US Debt
    B) Standard US Debt = (A) – (C)
    C) Reserve Issue Debt


    (A) Overall US Debt = (1) + (2) + (3) + (4)

    1) Government Debt = (a) + (b) + (c)
    (a) Publicly-held Government Debt
    (b) Intra-government Debt (e.g. Social Security)
    (c) Debt held by Federal Reserve

    2) Household Debt = (a) + (b)
    (a) Mortgage Debt
    (b) Consumer Debt

    3) Non-Financial Corporation Debt

    4) Net Financial-Corporation Debt = (a) -(b)
    (a) Gross Financial-Corporation Debt
    (b) Loans made to (1), (2) & (3) by Financial-Corporations


    B) Standard US Debt = (A) – (C)


    C) Reserve Issue Debt = USD Reserves Held Globally
    =2/3 X Non-gold International Reserves
    =2/3 X 12 Trillion USD = 8 Trillion USD = 50% of GDP


    NOTE: For all non reserve-currency countries, (C) = ZERO, and (A) = (B) or Overall Debt = Standard Debt.

    Something to think about…..

  45. Fofoa has been taking about this topic and the solution in great detail for years.

    One day economists will catch up.

    I’m impressed you made a large part of the leap yourself Michael. I’ve always enjoyed your writings. if you’re interested. Ask some questions, introduce yourself, you’ll be welcomed.

  46. I disagree to a certain extent. For a long time the US having the world’s reserve curreny certainly was indeed a “Exorbitant Privilege”. It meant that foreigners were subsidizing the US. It lowered unemployment in the US but it also meant rising US debt. But now when the liquidity is drying up the disadvantages of taking on too much debt becomes Obvious and then the people start to use the words “Exorbitant Burden”.

  47. Britain loosing its pre-eminence was also the result of a deliberate (and succesful) attempt by the US to dethrone the British Empire.

  48. Professor Pettis, I wonder if you would consider writing a dedicated opinion piece on what should be the next steps for the U.S. Government and the Federal Reserve. It appears the day of reckoning is getting closer as economic numbers out of Germany and China continue to disappoint.

    I know from your writings that you have said in a world with inadequate consumer demand the economy with the consumer demand (i.e. U.S.) is in a better position than the export driven countries. However, there is reason for anxiety in the U.S. as witnessed recently by the stock market jitters and continuing economic malaise in the U.S.

    I think there are two reasons why I think this will be an economic contagion in which the U.S. will have to lead the fight aggressively. First, Germany seems to be austerity crazy and has historically relied on the U.S. to drive global growth and thereby ride on U.S. coattails. China as a developing country with less affluent consumers will need many years to adjust. Second, large U.S. multinational companies (transnationals if you wish) which have mostly done incredibly well through the crisis, will now see foreign earnings deteriorate in both local currency terms and from translating to a stronger dollar. The second is very real even if it only psychologically impacts most U.S. consumers. A disintegration of the Euro is a necessary move for many Euro countries, but in the immediate term this will be an incredible shock to global equity and bond markets.

  49. Mr. Pettis, another fantastic article. Quick question – one thing the article didn’t quite clarify: you say” (1) It can increase productive investment, (2) It can increase nonproductive investment, or it can increase consumption, or (3) unemployment can rise”. Why are there not enough productive investments to make the other two options unnecessary? I see this from the perspective of someone who develops real estate and whose girlfriend is a PhD electrochemistry candidate; she researches lithium ion battery design and can never find enough funding.

  50. @Vinezi Karim,

    You said that reserve-currency debt held overseas will never comeback into US economy. That might be not true in the future as Russian central bank tries to support its currency illustrates. With dwindling US & world consumption there will be other candidates that might resort to expand their national consumption by selling $ to support their currency to prevent famine or local revolt.

    • ^^Stan WROTE: “You said that reserve-currency debt held overseas will never comeback into US economy. That might be not true in the future as ….”

      Let us forget about specific actions of individual countries and look at the big-picture of the world as a whole. The ONLY way that any reserve-debt can return to the US is if the TOTAL USD reserves held abroad in any given year is LESS than the total USD reserves held abroad in the previous year.

      That will NEVER happen. Yes, Russian reserves may go down, but some other countries will increase their reserves by even more, such that the TOTAL USD reserves held abroad will keep going up in a MONOTONOUS (and not just secular) fashion. This is because, as the world economy grows and/or trade expands, the need for USD reserves just grows along it with.

      The only way to change this arrangement is for the USD to be replaced by another mainline reserve currency, so that countries have a REAL choice of which currency to hold as reserve. The GBP-economy is too small and so the Pound is unavailable in sufficient quantities. The Yen after 1992 has a huge question mark against it due to Japan’s stagnation and demographic problems. The Euro, while representing a composite economy that is as large as the US economy, has SEVERE problems with the lack of political, fiscal, financial and policy integration, as we are now seeing in Europe. The Chinese RMB is problematic despite the large economy because the communist party there governs by opaque-diktat and will never be trusted by the markets. So there is NOTHING on the horizon that can even come close to the USD in availability, transparency and stability to act as a true-alternative reserve currency.

      Therefore, even if King-Dollar is ugly, fat and lazy, the world is still stuck with it until a qualified alternative appears to challenge it. Until that happens, the stock of USD reserves will keep growing in a monotonous fashion and so the reserve-debt held abroad will not return to the US.

      Let me know if you disagree.

      • Vinezi:

        So, your argument is strong, whoever doesn’t see that is blind. Or aging conspiratorialists who have wasted a grave portion of their intellectual life on non-sense (perhaps are “feeling” it, even worse).

        It seems grounded in fact, so…1998 pay down debt, Murray Feldstein, insure against “financial volatility”, seems as if China was reaching a plateau and shot up their investment,
        consumption started to fall,
        financial repression,
        structuring surpluses,
        rise in US CAD as everyone and their brother fought to devalue as much as China and structure large surpluses proportionally,
        great growth globally,
        lots of money printing around the world (especially in fast growers and surplus “structurers”),
        a tremendous amount of asset bloat (rentiers inhibiting domestic development globally, inhibiting broader based prosperity with extremely high rental costs),
        a considerable amount of excess capacity (productive, then falling commodity production, financial repercussions),
        inane discussions of shifting power (of new state led development models, such ensures disintegration and reformation among longer term participants, where developing countries do not want to be the mercantilized vassals of over-productive larger mal-invested states/geographies),
        the failure of a real and stable global middle class to materialize,
        (10 USD a day of spending is minimal, global poverty lines have barely budged in decades, while costs of basic goods and rents have everywhere, commodity investment returns few jobs and high capital costs, excessive global productive capacity ensures trade tensions in a longer stagnation period),
        countries further afield are inhibited in development of this,

        So, while realizing the potential for a global condominium to address these matters is limited, where the G20, as can be imagined, is even less effective than the G7, in reaching consensus (as can be imagined), you really think that the US will continue to cycle large amounts of the USD externally, when this story is becoming more understood and in 1998 we were moving toward eliminating the federal debt (as the financial narrative cried “where will global capital go in a crisis” and “they are taking these and will spend them in the future when their population ages”; the latter being seen by you to not be the case).

        You really think that this will continue to occur?
        If the US we to decide to default, or were to place taxes on foreign holdings of US assets, or were to

        After all the US has more internal waterways (navigable) than the rest of the world combined.
        Although some areas are water stressed, it has a healthy per capita ratio of this and the great lakes are the largest source of fresh water above ground in the world.
        It has been a swing producer in agriculture for as long as anyone with a memory can remember,
        it can absorb immigrants, and continue to absorb them in the numbers it chooses,
        it has a very healthy people per square kilometre ratio (most of India and Chinese population would fit in an area but from New York city to the Mississippi river)
        Technology is leading to a localization, more and more is able to be done by self, and is, the zeitgeist spins in that direction more generally
        The Prosumer, bastardized by Marketing, was actually the Producer-Consumer, not merely someone who participates in technology enhanced focus groups.
        New models exist, new models are desired, and the zeitgeist, ethos arises around DIY, Makers, Robotics, higher efficiency devices, new financing models for renewable energy, great advances in battery technology, etc….

        So, it seems that many who have arisen in the system have been reticent to change, previous transiters of the middle income curse would seem to need to move into structural positions as the US, to enable further global development. If global development is inhibited, (by the great and varying actions and viewpoints and beliefs that revolve around this matter) you think the US will continue to provide the impetus that it has, and not choose other actions…..

        What if the US chose to inhibit the further accumulation of dollars or simply defaulted?

  51. In total disagreement with “exorbitant burden” and subsequent debate here. Benefits of priviledged are wrongly, poorly, inadequatelly addressed in this post. Costs are not presented convincingly. My counterargument to you all is that any dimunition of dollar centrality will result in economic contraction for US economy. In some respect, 1971 could have been America’s 1931 (UK suspends convertibility), but it wasn’t becasue the float succeeded and the balance was favorable to the US. With the balance no longer favorable, any suspension (what Pettis is advocating) will result in US economic marginalisation. The only way America can survive as a hegemon, is by transfering the costs of reserve accumulation holding to Japan and China, via international monetary repression, to bankrupt them both. It should be China, not America, that take the fall.

    My references which I welcome you to refute:

    1- Theories of International Currencies and the Future of the World Monetary Order AUTHOR: Hyoung-kyu Chey
    2 – Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System AUTHOR: Barry Eichengreen
    3 – Dollar primacy and American power: What’s at stake? AUTHOR: Jonathan Kirshnera

    From HistoryNet discussion:
    Russell Ally’s “Gold, the Pound Sterling and the Witwatersrand, 1886-1914″ (pp. 97-122) should had been placed before the previous article because in addition to examining the Witwatersrand history he succinctly explains how the gold standard of 1886-1914 was really a “sterling standard.” British commercial and financial supremacy depended on the gold-convertibility of the pound, which was the responsibility of the Bank of England (p. 103). The discovery on the Witwatersrand in 1886 came after “a frantic search for the metal all over the world.” The “Second Industrial Revolution” spanned two decades from 1871 to 1890 — decades during which industry and trade reached unprecedented levels. “The gold standard could not have accommodated the growth without a corresponding increase in the stock of gold” (p. 99). The South African discovery coincided with similar events in United States, Canada, Russia, and Australia. The economic emergence of the United States and Germany challenged the hegemonic monetary position of Britain. In this context the weekly remittances of South African gold were crucial. The South African War and, more importantly, World War I indicated how the British Imperial system was dependent on the Witwatersrand gold fields (p. 114)

    From the Telegraph, a discussion:
    The Bretton Woods conference in 1944 heralded the end of sterling’s predominance in international trade, and the triumph of the American dollar. The agreement defined both the dollar and the pound as reserve currencies, a sop to British pride rather than a reflection of the truth, ignoring the UK’s very large balance of payment deficit caused by the war. That reserve status meant that other nations must accept dollars or pounds to settle debts.

    • Fascinating debate, but you haven’t really made an argument, Miquelle. You say that costs are exaggerated and benefits underestimated, but you don’t say how. You say that that “any dimunition of dollar centrality will result in economic contraction for US economy” and you call that a counterargument, but it isn’t. It is just a statement. Why will it cause the US economy to contract?

      I don’t know if Pettis is right, but at least he has made a logical case that by preventing countries from running surpluses against US deficits, it will cause the US economy to expand. There is plenty of support for the argument that at least under certain conditions trade protection can cause growth to rise, and preventing foreign central banks from accumulating dollars, the policy followed by all protectionist countries, should do that. When Britain went off gold in 1931, that was the same as forcing countries to stop buying pounds, and their growth immediately picked up. Meanwhile France stuck to gold, and its growth dropped sharply until 1936 or 1937 when it gave up on gold.

      I don’t understand why you say “the only way America can survive as a hegemon, is by transfering the costs of reserve accumulation holding to Japan and China, via international monetary repression, to bankrupt them both. It should be China, not America, that take the fall.” Pettis has argued, logically at least, that its role as hegemon is costly, and not worth it. You would need to explain why engaging in battles around the world is profitable. It is hard to find evidence that the US economy did worse before it became the hegemon.

      Then you say “My references which I welcome you to refute:

      1- Theories of International Currencies and the Future of the World Monetary Order AUTHOR: Hyoung-kyu Chey
      2 – Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System AUTHOR: Barry Eichengreen
      3 – Dollar primacy and American power: What’s at stake? AUTHOR: Jonathan Kirshnera”

      I only read the second of those, and I think so far Pettis has the upper hand on that one. Maybe I will read the others, but naming the books does not mean you have presented an argument to refute. If it does, I could just say that I have refuted you, and my argument is

      — The Great Rebalancing, AUTHOR michael Pettis

      Finally, what does the part about gold have to do with the burden argument? Pettis says that eliminating the gold constraint is part of the reason why you can have an exaggerated version of the Triffin Dilemma. I have to go through my books, but i think Triffin makes the same point.

      I would like to see Pettis seriously debated about his exorbitant burden claim. He seems very convincing to me, but that may just be because I am not smart enough to see through his arguments. I wish someone would explain logically why he is wrong and not just assert it. This is such an emotional subject that it is hard to find someone who presents his arguments cooly and logically (kudos to Pettis), but that is what it will take, at least to convince me he is wrong.

      • @RobertThrones
        and your evidence is where sir? Did Mr. Pettis do a balance sheet of costs and benefits? It seems there is wholesale agreement here in comments that he did a lousy job on costs.

        why not actually consult the literature I cite first? You have a comprehensive presentation of the benefits.

        why not address the issue in the quotes rather than expostulate about who has the upper hand on costs and benefits which you clearly have no handle on?

        I should think that any expostulation bears hearing its pros and cons. We’ve heard the cons, but the pros matter.

        When American companies, oil majors, construction, are faced with the dilema of financing in non-dollar currencies, then we’ll talk about the burdens of hegemony. Until then, the transactions costs for US shareholders are zero, while others are sitting on timebombs hoarding currencies not under their control, not of their own issuance, and of no use to them, if the US let’s deflation eat away their value.

        America is the only state which can manipulate its debt burden by deflating its currency. Its exorbitant priviledge lies in the ability to finance growth through seignorage, lowered volatility and risk, and monetary sovereignty. Trifin dilema is irrelevant. Gold was mentioned becasue this is what marked Bretton Woods. Your question indicates you dont know the first thing about the subject. Thank you for vapid assertions about Mr. Petti’s knowledge of the Eichengreen. What a joke.

        For purposes of international trade China, Russia, Brazil, all will stick to dollars and pray their hoards dont lose value. SDRs will attract them, with IMF playing role of central bank. Struggle for its rates will reflect current struggle between sovereigns, and a global central bank will basically presupose global centralised government. America will be the last to sign on to this. America would thus have to prove to the world that indeed its dollar is a public good, not worth buckling the trend, but worth preserving provided the Fed were sensitive to spillovers. This is precisely what the Fed did. Mr. Pettis’ argument doesn’t hold water. Empthy threats to deceive BRICS to more readily accept dollar sovereignty. Either way, America is alredy constrained in its monetary rates. Just doesn’t give a rat’s ass about average American’s debt burden.

        The fabled savings glut is nothing but a ploy to keep America’s from defaulting en masse. Without dollar sovereignty, do you imagine for one millisecond this would have been possible.

        Tedious reading know-nothing smart-alecs on here.

        • Maybe this would be less tedious if you were not so bitter and could construct an argument. You should also learn some basic finance and economics. You sAy that America is the only country that can borrow in it’s own currency and draw from this “fact” some very foolish conclusions that express only rage and no logic. Europe, Japan, England, Switzerland, China, and many other countries can borrow in their own currencies and borrow almost exclusively in their own currencies. Some corporations in these countries, like some American corporations, borrow in foreign currencies for hedging purposes. All of these currencies are reserve currencies, but they all discourage excess reserve accumulation. Japan and Switzerland are the latest to do so explicitly, but Europe and the UK want their currencies to weaken and China forbids foreign purchases except in the form of bilateral swaps. Your entire argument is based on a complete mistake of reserve currencies. Now that I have fully explained to your mistake I think you may become less filled with hatred. Also I think you will find some comments, I hope mine too, not so tedious.

        • 1. Wholesale agreement that he was wrong on the costs? Not at all. Most people agree with him. On this site anyway. Again, you say these blowhard things but you give no arguments.
          2. America is the only country that can borrow in it’s own currency? Do you have any idea of how foolish a statement this is? It is just wrong. So completely wrong, in a way that means this entire conversation has gone completely over your head.
          3. Are your theories based on economics or on a deep and excessive sense of inferiority? I cannot disprove the latter, and the only actual fact you provide, I am sorry to say is wrong. See point 2 above. Wrong, wrong, foolishly, amazingly, almost charmingly wrong. People like you almost always make this mistake (and the one about the “importance” of pricing oil in dollars) without ever understanding that it cannot possibly be even remotely true.
          4. Sigh.

    • Well….of course this has been handled at length,
      but, for food for thought read Vinezi’s thoughtful review of the historical data and future movements, then compare to what you believe; of course to refute your theories, search the blog hear, and see if it does. Likely, you will have much more to argue about (or reconsider, I would rather imagine)

  52. Why not restore the trade-balancing role once provided by gold with a digital currency, such as the

    The Numero: Beyond Gold and Fractional Reserve Banking:

    Although the scheme proposed may need a little refinement, it seems not only to be workable but to provide many advantages over dollars or gold.

  53. The G20 leaders statement this week-end in Australia is perfectly in line with Paul Volcker’s judgment from last May: ” that is not enough – it means little without substantive agreement on the need for monetary reform and practical approaches towards that end”. In fact, not a single world on the currency wars raging at the very moment. At least, we can trust the petits fours were delicious.

  54. I always thought of the reserve current status like resource that could and would be mined by the government. It gives the government extra money though lower rates on its bonds, but, like natural resources, it comes with a resource curse and less happy fates at the level of workers.

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