The falling US dollar has emerged as a source of profound global macro-economic distress. The question now is how bad that distress will become. Is the world economy at risk? There are two possibilities. If global savers and investors expect the US dollar's depreciation to continue, they will flee the currency unless they are compensated appropriately for keeping their money in the US and its assets, implying that the gap between US and foreign interest rates will widen. As a result, the cost of capital in the US will soar, discouraging investment and reducing consumption spending as high interest rates depress the value of households' principal assets: their houses.
The resulting recession might fuel further pessimism and cutbacks in spending, deepening the downturn. A US in recession would no longer serve as the importer of last resort, which might send the rest of the world into recession as well. A world in which everybody expects a falling US dollar is a world in economic crisis.
By contrast, a world in which the US dollar has already fallen is one that may see economic turmoil, but not an economic crisis. If the US dollar has already fallen -- if nobody expects it to fall much more -- then there is no reason to compensate global savers and investors for holding US assets.
On the contrary, in this scenario there are opportunities: the US dollar, after all, might rise; US interest rates will be at normal levels; asset values will not be unduly depressed; and investment spending will not be affected by financial turmoil.
Of course, there may well be turbulence: When US wage levels appear low because of a weak US dollar, it is hard to export to the US, and other countries must rely on other sources of demand to maintain full employment. The government may have to shore up the financial system if the changes in asset prices that undermined the US dollar sink risk-loving or imprudent lenders.
But these are, or ought to be, problems that we can solve. By contrast, sky-high US interest rates produced by a general expectation of a massive ongoing US dollar decline is a macroeconomic problem without a solution.
Yet so far there are no signs that global savers and investors expect a US dollar decline. The large gap between US and foreign long-term interest rates that should emerge from and signal expectations of a falling US dollar does not exist. And the US$65 billion needed every month to fund the US current-account deficit continues to flow in. Thus, the world economy may dodge yet another potential catastrophe.
That may still prove to be wishful thinking. After all, the US' still-large current-account deficit guarantees that the US dollar will continue to fall. Even so, the macroeconomic logic that large current-account deficits signal that currencies are overvalued continues to escape the world's international financial investors and speculators.
On one level, this is very frustrating: We economists believe that people are smart enough to understand their situation and capable enough to pursue their own interests. Yet the typical investor in US dollar-denominated assets -- whether a rich private individual, a pension fund, or a central bank -- has not taken the steps to protect themselves against the very likely US dollar decline in our future.
In this case, what is bad for economists is good for the world economy: We may be facing a mere episode of financial distress in the US rather than sky-high long-term interest rates and a depression. The fact that economists can't explain it is no reason not to be thankful.
J. Bradford DeLong, professor of economics at the University of California at Berkeley, was assistant US Treasury secretary during the Clinton administration.
Copyright: Project Syndicate
A gap appears to be emerging between Washington’s foreign policy elites and the broader American public on how the United States should respond to China’s rise. From my vantage working at a think tank in Washington, DC, and through regular travel around the United States, I increasingly experience two distinct discussions. This divergence — between America’s elite hawkishness and public caution — may become one of the least appreciated and most consequential external factors influencing Taiwan’s security environment in the years ahead. Within the American policy community, the dominant view of China has grown unmistakably tough. Many members of Congress, as
The Hong Kong government on Monday gazetted sweeping amendments to the implementation rules of Article 43 of its National Security Law. There was no legislative debate, no public consultation and no transition period. By the time the ink dried on the gazette, the new powers were already in force. This move effectively bypassed Hong Kong’s Legislative Council. The rules were enacted by the Hong Kong chief executive, in conjunction with the Committee for Safeguarding National Security — a body shielded from judicial review and accountable only to Beijing. What is presented as “procedural refinement” is, in substance, a shift away from
The shifting geopolitical tectonic plates of this year have placed Beijing in a profound strategic dilemma. As Chinese President Xi Jinping (習近平) prepares for a high-stakes summit with US President Donald Trump, the traditional power dynamics of the China-Japan-US triangle have been destabilized by the diplomatic success of Japanese Prime Minister Sanae Takaichi in Washington. For the Chinese leadership, the anxiety is two-fold: There is a visceral fear of being encircled by a hardened security alliance, and a secondary risk of being left in a vulnerable position by a transactional deal between Washington and Tokyo that might inadvertently empower Japan
After declaring Iran’s military “gone,” US President Donald Trump appealed to the UK, France, Japan and South Korea — as well as China, Iran’s strategic partner — to send minesweepers and naval forces to reopen the Strait of Hormuz. When allies balked, the request turned into a warning: NATO would face “a very bad” future if it refused. The prevailing wisdom is that Trump faces a credibility problem: having spent years insulting allies, he finds they would not rally when he needs them. That is true, but superficial, as though a structural collapse could be caused by wounded feelings. Something
RSS