One idea currently in fashion in some economic and policymaking circles is that the American dollar is overvalued solely because it is the world’s reserve currency. That overvaluation, the thinking goes, is the root cause of the U.S. trade and current account deficits.
That theory, though, is neither new nor correct. If policies are adopted to devalue the dollar and end its reserve status, they would only damage American businesses and consumers.
The notion that a strong dollar is at the heart of the U.S. deindustrialization that has taken place over the past six decades is a red herring and isn’t true.
Simple transaction demand in a nearly $30 trillion American economy is in fact responsible for a $7.5 trillion daily churn in the global foreign exchange market in addition to activity in a $36 trillion global bond market, of which the U.S. share is close to $30 trillion.
That activity alone is sufficient to support current valuations of the dollar. Once one begins to account for the United States’ considerable lead in innovation and return on investment, one can make a plausible argument that the dollar should be stronger, not weaker, over the medium to long run.
As Ricardo Hausmann has pointed out recently, that once one accounts for the $632 billion in profits earned through foreign subsidiaries by domestic firms, the U.S. has an invisible trade surplus of greater than $1 trillion. Of course, that bolsters the value of the dollar and is another reason why the greenback’s reserve currency status has little to do with its valuation.
In addition, other economic actors have many choices of where to invest. This can be observed in the recent turn of global investors toward holding euros instead of dollars as Germany ramps up spending to bolster its economy and defenses.
But given the breadth and depth of American capital markets, global investors may choose to hold U.S. assets because they are attracted by the return on investment, quality of assets, intellectual capital, innovation, critical materials priced in dollars and, not least, the rule of law.
If the long march to devalue the dollar and weaken the international framework is pursued, such a strategy would ultimately be self-defeating.
Read more of RSM’s insights on the economy and the middle market.
Loss of the dollar’s reserve status would be accompanied by a large financial haircut that would spare no American—even the wealthy would take a significant hit—would most likely be accompanied by a downgrade of the U.S. credit rating and lower the purchasing power of domestic consumers.
The downgrade of U.S. securities would result in higher interest rates and a widening budget deficit, leading to a significant reduction in federal social programs.
The best example of what happens to an economy when it loses its pre-eminent status as a global reserve unit of exchange and store of value is the real decline of the U.K. economy as the dollar supplanted British sterling as the primary reserve currency.
Fads and fashion are not just the province of the global couture industry.
They affect the marketplace of ideas and permeate the policy hothouses and salons that surround them.
Ideas around ending the dollar’s reserve status are loud and tasteless, and we’ve all heard them before. They are not persuasive now nor were they the last time they were in fashion back in the 1960s and 1970s.
Valuation of the greenback is not simply a function of its reserve status. Policies designed to bring that to an end should be fought out in the marketplace of ideas, where they will not hold up in the face of public scrutiny.
