Wednesday, December 8, 2004

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The tragedy of the dollar commons?

Brad Setser has the best blogging about the possibility of a drastic decline in the dollar's value/the possibility of the dollar losing its reserve currency status. This Sunday stpry by James Brooke and Keith Bradsher in the New York Times contains a tidbit that worries me in particular:

Mr. Asakawa, 46, is the top official at the Finance Ministry here responsible for managing the largest portfolio of United States government securities in the world, worth a staggering $720 billion. As the dollar has slumped this fall, many investors have started to worry that Mr. Asakawa and his counterparts elsewhere in Asia will be tempted to pare their holdings, perhaps causing the currency to plunge much further and setting off a round of interest rate increases in the United States that could send the global economy into a tailspin.

But Mr. Asakawa, at least for now, says that he intends to keep right on adding American holdings to Tokyo's portfolio.

"We've heard the rumors in the last few days that the Chinese guys, the Indian guys, the South African guys are diverting from dollars," Mr. Asakawa said. "We have no plan at all to divert from our dollar-denominated assets."

Still, Mr. Asakawa admits that he has not been sleeping so well lately.

What bothers me is the concern by Japan that others might be tempted to dump their dollars while they still hold so many of them. The Japanese and Chinese central banks own an enormous part of these dollar reserves, and if they don't move, a precipitous fall seems unlikely. However, both the Russians and the OPEC countries have started to diversify their holdings in favor of the Euro. If non-major Asian countries make the same move, the question for Japan and China is whether there is more to gain from moving first and getting a mediocre return on their dollar holdings or holding on and hoping the dollar slide won't last longer. The temptation to unilaterally defect here is quite powerful.

The beginning of the end of the Bretton Woods system was when the French announced in 1968 that they were going to convert their dollar holdings into gold. One wonders if OPEC and Russia represent a similar harbinger.


posted by Dan on 12.08.04 at 02:16 PM


Old meme. New meme: dollar too strong, trade deficit to ruin US economy. Sky continues to fall, just in the opposite direction that we thought.

Dollar Rallies Against Major Currencies

posted by: Mark Buehner on 12.08.04 at 02:16 PM [permalink]

Can this be modeled by a "Prisoner's Dilemma" type of game?

posted by: Kosh on 12.08.04 at 02:16 PM [permalink]

Here's a thought - what effect, if any, will the dollar's fall have on outsourcing?

posted by: Jon H on 12.08.04 at 02:16 PM [permalink]

It's easy to label those concerned about the dollar as Chicken Littles, but the fact is that the dollar must fall, sometime, somehow.

Investors, whether individuals (foreign or American) or national banks, will not forever fund the American deficit.

Something's got to give. Hopefully there won't be a full-fledged run on the dollar, but I wonder whether concerns expressed by investors, central bankers, journalists, academics, and bloggers might be bringing us closer to that.

posted by: Andrew Steele on 12.08.04 at 02:16 PM [permalink]

Oh yeah,

Jon, rather than prisoners' dilemma, Dan suggests the best high-fallutin' idea to apply to this issue: the tragedy of the commons.

Go IU.

posted by: Andrew Steele on 12.08.04 at 02:16 PM [permalink]

What backs the value of the Euro currency?

If the answer is not "the full faith and credit of the United States of America and its taxpayers" then it's worthless as a reserve currency.

The diversification of holdings is a major gamble. The newer designs of the dollar are causing problems for people that have been using the Iranian made $100 exact replicas. Suddenly entire stockpiles of currency the merchant received from a friendly trading partner with Iran is useless. Blowback anyone?

posted by: Brennan Stout on 12.08.04 at 02:16 PM [permalink]

Why is the full faith and credit of the EU worth less than that of the USA? Unlike the USA, the EU nations have budget deficit targets defined as treaty obligations. Sure, they have trouble meeting them, but at least they have some reason to try. No European leader can rush off on a credit-driven national spending binge, as Bush has done, nor are the European economies as dependent on credit-driven consumer spending.

Oh, and Europe's economic output is far less dependent on oil, because of the more diverse and efficient transportation system. Next time an oil crisis hits, that will matter to everyone's bottom line.

In other words, the fundamentals of the euro are excellent. T.R. Reid's The United States of Europe is a good intro to this topic, though admittedly not sufficiently skeptical.

posted by: Jarrett on 12.08.04 at 02:16 PM [permalink]

1) I thought it was the Yen that was going to buy up America and flip the planet on its axis.

2) European fundamentals suck. Their budget deficits arent much better than the US in percent of GDP, the unemployment rate is almost double, their entitlement traps are even worse, and their growth is lower or nonexistent. A stronger Euro just kills their exports driving them towards the protectionist types who already infest the EU. Worse they are going in the opposite direction of a cure by creating more beurocracy and labor protections instead of less. Cheaper imports flooding the markets of companies that cant do jack about labor costs is not a good thing. And oil drives _everyones_ costs. If anything Europe is worse with very limited domestic supplies and extremeley high energy taxes.

3)Asia. Its all about China.

posted by: Mark Buehner on 12.08.04 at 02:16 PM [permalink]

Andrew and Kosh, I think China and the US are locked into a Game of Chicken (rather than a PD): China desperately wants the US to take steps to raise the value of the dollar, while the US desperately wants the value of the RMB to be set by the market (assuming that the market raises the price, of course).

At issue, of course, is the US trade deficit, which China needs to exploit in order to maintain full employment while attempting to manage a soft landing. Yet neither country seems willing to swerve at this point, and one wonders whether the EU will attempt to force one side or the other to pull off the game, given how Europeans will feel when dollar-RMB exports flood their markets.

posted by: Matthew Stinson on 12.08.04 at 02:16 PM [permalink]

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