Dollar Hegemony

There’s a funny irony in the whole “dollar hegemony” story one sometimes hears.

Going back to the closing of the gold window during Nixon administration, and even before that, the argument is that the West and Japan propped up the dollar as tribute to the emperor, in exchange for implied security guarantees. Foreigners were overpaying for “worthless paper”, and Charles De Gaulle may have hated that (espcially when Americans used the paper thus propped to buy up French firms), but they were spending to save a status quo threatened by Soviet domination. They were purchasing American military and economic strength, because they depended on a strong America. The United States wasn’t putting a gun to their heads to pay up. The Soviet Union was.

Now here’s China, the newest of US dollar purchasers. I’d argue that among other things, what China is purchasing with its overpayment for US securities is American military and economic weakness. China’s undervalued currency contributes to the “hollowing of smokestack America”, and a postindustrial United States, with disruptable global supply chains and limited capacity for vertically integrated domestic military production, is a less formidable rival than Rosie the Riveter’s America.

Please note that this is not an anti-China post. I don’t think that China’s currency policy is primarily driven by geopolitical rivalry, it is mostly about economics and development. I just think when the costs and benefits are summed, changes in the sectoral composition of America’s economy enter into the benefits column. Nor do I think this is condemnable on China’s part. In fact it is admirable. Managing geopolitical rivalries are part of what governments do. One ought not condemn the government that does its job well, but the one which for all its bluster manages its situation poorly.

This is cross-posted as a comment to a post of Brad Setser’s.

5 Responses to “Dollar Hegemony”

  1. HZ writes:

    I think you give China too much credit to have such a grand design. It is more likely the result of the inflexibility of the Chinese system to respond to changes.

  2. HZ, I agree. I don’t think there’s any grand design or conspiracy. For any policy choice by any government, there are many factors, arguments, and motivations. Political expedience and inertia usually predominate over elaborate plans.

    But every policy, whatever its underlying conveniences, has a greater or lesser probability of being put into place, and a greater or lesser likelihood of surviving, and it is here, “at the margin” as economists like to say, the the vast spectrum of pros and cons that surround and embellish the interestes of particular factions, politicians, and bureaucrats, make a difference. My only claim is that the effect of China’s status quo currency and trade policies on the US economy makes it more likely, not less, that the policy remains in place (and that there is nothing wrong or insidious about that). I agree that the primary reason the policies remain in place may well be inertia — interest groups coalesce around any status quo, change becomes burdensome and difficult, and China’s system (maybe worse than others in this regard, maybe not) has a difficult time overcoming the resistance, even if there would be clear benefits to a change.

    But I don’t think that from the perspective of the Chinese goverment, that there are yet clear benefits to any change. Economists nervous about “global imbalance” see benefits, and already-employed Chinese would see benefits in an appreciated currency. But the currrent policy gives government a growing economy that employs surplus labor and mutes social unrest, plus the ability to tax its people without complaint via seignorage (even if the seignorage gains are shared with purchasers of Chinese goods as implicit export subsisies).

    The geopolitical story is just a bit of icing on the cake. I only bring it up because I think commenters who dwell conspiratorially on dollar hegemony and America’s “exorbitant privilege” to print dollars and have foreigners prop them up are missing an important difference between then (the 60s and 70s) and now.

  3. BTW HZ, thanks for the comments to the currency and money-supply stories. More on that soon.

  4. HZ writes:


    I agree with your analysis on inertia and bias. But let me comment a little more on your original point of “hollowing out”.

    I think still too much emphasis is placed on the physical manufacturing. If you go back 600 years, the high tech of the day was printing. But today do you really care about where your books are printed? So as today’s manufacturing gets increasingly standardized, the real value-add will be in figuring out what and how to make (i.e. “content”), not the actual making. The best way to see this is to look at the profit margins. Most manufacturing is low margin. Some, like semiconductor, where technology is still rapidly evolving and capital cost is high, the margin is still high, but they will mature too one day.

    In the long run I think the competition is about the political system, not economics. Our focus should be on having honest and effective government, respected court system, educated and enlightened populace, attraction to top talents, and means to distribute economic output. If we suceed, we will do great. If China will have all these too then it deserves to be the leader, and US will have nothing to fear from it like UK has nothing to fear from US. If it fails to evolve, it will stay a second-rate economy. The fear will be for its devolution into instability, not from its economic competetiveness.

  5. HZ — I agree with you, in all the good scenarios. In a world that remains peaceful, where governments may vary in some specifics but are broadly fair and competent, and where trade remains free and open, it really doesn’t matter where the smokestacks are. In fact, the competition among nations would be to concentrate in high value-add, low environmental impact cross-border service provision, as this permits nations to get the “stuff” they need without the risky, ugly, hard, low-margin work of manufacturing.

    In economic terms, I agree 100% that the United States’ problem isn’t that it doesn’t do much manufacturing. The US’ economic problem is that its high value-add specializations don’t create enough service exports to satisfy our appetite for foreign manufactures. If we were selling enough films and software to cover the cost of our Playstations, there’d be no economic issue as far as I’m concerned. Economically, the “hollowing of smokestack America” is not a bad thing, and may be quite a good thing.

    But in bad scenarios, the “hollowing of smokestack America” can matter a great deal, for noneconomic reasons. If there are wars, it really does matter where the plants that can be converted to airplane and weapons manufacture are located. “Little wars”, like the Iraq war is so far, don’t matter, because while not all other countries may be “with us”, none that matter are so irked as to disrupt our supply chains. The Saudis are still selling us oil, China is not confiscating US multinational investments or preventing containers from heading towards Long Beach.

    But in a war — God forbid — against China, or in much more likely scenarios, like Iran’s oil is taken off-market or there is a revolution in Saudi Arabia at the same time as the US must project power, it matters a great deal that the US is no longer “vertically integrated”. Markets can deal with supply shocks; supply chains always evolve, break, and re-form, but in war what an economist might see as temporary disequilibrium means permanent defeat for a nation-state.

    I don’t think the US and China are going to go to war, although I do see rough times ahead as both countries deal with the economic imbalances they’ve helped create for one another. But in the medium term, I see China’s development as a miracle, and I think that the US, China, and India are natural allies who will find their shared interests.

    So, in the base case scenario, I agree with you. The most crucial thing is getting good governance, opening borders to both capital and labor, and overcoming xenophobia. If we do these things, the smokestacks should be placed where they exact the fewest costs and create the most value, and markets will sort that out very well. Whether that turns out to be Alabama or Anhui province doesn’t much matter.

    But, nevertheless I am troubled by the “hollowing of smokestack America”, because the base-case, most likely scenario is not the only scenario. I do think it possible that the US will find itself with broken supply chains and a geopolitical crisis at the same time. The US is my country, so I may be biased, and I readily concede that the US has been involved around the world in all kinds of mistaken, inept, or corrupt meddling. But as imperfect as America is, I think it’s the best Leviathon the world could hope for as we try to evolve to a more borderless, less nationalistic, and less impoverished world. I don’t think that the power vacuum that would result if the “bubble of American supremacy” were to suddenly pop would be good, for the US or for aspirant rivals.

    Hopefully we’ll have a long period of general peace, so that economics can do its work of mixing everybody up and making the world richer and more interdependent all at the same time. But I think the odds of that would be better if no one could imagine that, aside from its nukes, the US has become a paper tiger. Unfortunately, I fear America’s sprawled out supply chains and postindustrial economy may embolden someone to test the tiger with a flame. If that happens, the outcome will be globally bad.