Little has changed in international currency issues since last week. The BRICS conference was held, and six new countries added. Then everyone went home with nothing really done. Exchange rates have changed little nor have trade flows. But what about these variables in the longer-run for our nation’s currency? Is it, and are we, “doomed” as some pundits fret or is that a phantom menace? Why or why not?
Remember that there are two aspects to the international status of the U.S. dollar.
One is as a common settlement currency used by many nations in paying for imports or exports or in borrowing, whether by governments or businesses, or in their paying principal and interest on existing debt. The analogy in terms of “functions of money” learned in introductory econ is as a “medium of exchange” between countries.
The other aspect is the dollar’s function as a “store of value” internationally. Do citizens of other countries, or businesses, or governments themselves or their central banks use the dollar to park money they don’t need right now? This may occur through the buying of U.S. government bonds or simply by buying corporate stocks or bonds issued by U.S. corporations or state and local governments. This is the “reserve” aspect of the dollar as a “reserve currency” just as it was for the British pound prior to World War I.
So start with the issues. Is it really all that important to us that international trade take place in U.S. dollars? If it benefits us, how does that happen? Then there is the specific case of international trade in petroleum. Crude oil has been priced in terms of U.S. dollars for the best part of a century. It is a common belief that this practice somehow confers great benefits on our nation and that if the practice ended, or even was eroded slightly, it would spell doom for the U.S. economy.
Both of these beliefs are nonsense. Yes, widespread use of the dollar by others does increase demand for the currency. The Federal Reserve thus can create more dollars without pushing up the effective money supply within the U.S. economy itself. So to the extent that others have U.S. dollars in bank accounts around the world for settlement purposes, there is a mild benefit to us. Yet the U.S. dollar share of all settlement has trended down with no discernible harm.
The special case of oil pricing is a tough nut because the belief that it is a prosperity versus destitution variable is so deeply entrenched. Yes, having crude priced in dollars means that the cost of imported oil may fluctuate with market conditions, but not visibly with the exchange value of the dollar relative to other currencies. But is this all that important?
No, it isn’t true for others. In late 1979, Jimmy Carter appointed Paul Volcker to head the Federal Reserve, understanding, along with everyone else, that he would sharply curtail the money supply and raise interest rates. As this was be implemented, Ronald Reagan was elected president on promises to increase defense spending and cut taxes. A Democratic-majority Congress went along and we entered the contemporary era of “borrow and spend.” With much higher deficits and tighter money, interest rates soared, with the prime rate business loans passing 20 percent and 30-year Treasury bonds over 14 percent. High U.S. interest rates sucked money in from around the globe and the U.S. dollar soared in value relative to other countries.
Thus any barrel of oil at a stable cost in dollars suddenly was more expensive in terms of German marks, British pounds, French francs and Japanese yen along with guilders, krone, pesos, pesetas, lira, cruzeiros and sundry other currencies. Suddenly, buying oil meant that other countries did not have foreign currencies left to pay for food, machinery or other raw materials if they wanted to keep cars and trucks running.
They screamed. In 1985, the U.S. and four other countries agreed to manipulate their currencies to keep the dollar from getting too expensive. In the event, the tide was already turning. Two years later, there was another meeting to keep the dollar from getting to cheap.
So did we get off scot-free in all of this? Well, our crude oil import bill did not fluctuate the way those of France or Germany did. But the “strong” dollar had the effect of taxing U.S. exports, especially of farm products and subsidizing imports of autos, steel and other goods. Many now think fondly of the 1980s as a sort of economic Garden of Eden, but in reality, it was one of wrenching adjustments. The “step on the money brake pedal while tromping on the fiscal gas pedal” policies killed 400,000 jobs in the U.S. steel industry, and those of another 350,000 auto workers. This decimated the “Rust Belt” and accelerated market incentives to move production to Mexico or Asia.
It also forced the most painful adjustment on U.S. farmers since the Great Depression with hundreds of thousands going through bankruptcy. It accelerated the transformation of the structure of agriculture into fewer and larger operations.
Moreover, one must understand that even as the price tag on oil continues to have a dollar sign, the value of the U.S. dollar compared to other currencies is part of the complex process of international supply and demand that determines what the dollar amount will be. We are not somehow completely insulated from dollar fluctuations, especially those driven by our own folly.
A recent news story asked if the United Arab Emirates accepting Indian rupees for a million barrels of oil “spelled doom” for the dollar. Of course not! And organizations like BRICS trying to invoice trade in their own currencies is no threat, either. Unless you had two hermetically sealed economies that traded in a way that the values of imports and exports between them equal exactly, their own currencies’ relative exchange value still would be determined in international foreign exchange markets. If not, there would be incentives for arbitrage that would quickly drive the equilibrium to this point.
In the past, India has used rupees to buy dollars in international currency markets. It pays the dollars to the Emirates for oil. Then the Emirates sell these dollars for their own money, dirhams.
Now India will pay rupees for the oil and the UAE will change the rupees into dollars and then perhaps into dirhams. If India sells rice to the UAE, they will accept dirhams and change them into dollars. The currency unit on the tankers’ manifests will not be dollars, but the pricing effectively still will all be in international markets that center on the dollar, euro, pound and yen.
So much for settlement issues. The role of the dollar as the preferred place for foreigners to park their money is a more complicated one, and one that gets more fraught with peril as we ratchet 40 years of borrow and spend to high levels. But that is another column.
St. Paul economist and writer Edward Lotterman can be reached at firstname.lastname@example.org.
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