Prometheus 6

I need to insist that I believe the economic & financial sanctions against Iran by the USG are both stupid and reprehensible. That said, I don't share the idea that denominating oil prices in euro (or in a basket of currencies) will actually impact the USD. The recent fall of the dollar against the €, ¥, or ₤ meant those holding €, ¥, or ₤ experienced a windfall in purchasing power RELATIVE to those who had been holding $. The fact that Iran, inter alia, is now not accepting dollars is unlikely to spread to other countries since the $ is simply cheaper, not worthless.

Believe me, there is a huge difference. According to the OECD, the real exchange rate of the USD to the € is 1.3 (Spain) to 1.6 (Finland). That means that 100 €, converted to 160 USD, buys about 1.3x to 1.6x as much stuff in the USA as it would in the EZ.

While I tend to have a Keynesian bias, I do believe real effects on currency and oil sales are grossly underrated. The decline in the US dollar represents a loss of confidence by foreign investors in future business opportunities; also, some national governments may be trying to quietly replace the US dollar as a reserve currency.  The use of dollars to denominate oil prices, by itself, does not prop up the value of the dollar. The soaring price of the euro is pulling other OECD currencies behind it (i.e., the yen, Canadian dollar, pound, Scandinavian kroner), but reflects a response to internal deficits within the EZ. It comes at the same time as a fall in capital flows to the USA, but I would not read too much into this.

The USofA gets away with a lot due to our currency being the world's reserve currency, true?

I believe it would take a catastrophic change in military and economic power to bring that about. I also believe an avalanche starts with the shifting of one rock. 

The USofA gets away with a lot due to our currency being the world's reserve currency, true?

I believe it would take a catastrophic change in military and economic power to bring that about.

Well, that's a difficult question to answer.  In my view, the countries that use the dollar as a reserve currency the most include Latin American, Arab, and SE Asian countries.  Russia and China also hold large amounts of US dollars.  These are all countries with long histories of being pissed off at Washington.  Also, European and Japanese ministers have tried to promote other currencies as alternatives; Japan tried very hard under the Miyazawa Plan* to promote the yen as a reserve currency, to no avail. 

The European Union has an explicitly anti-US approach geared to promoting the euro as an alternative reserve currency.  However, the US Treasury Department (in monographs I have read, mostly  in the '90's) regards these efforts favorably.  Both the Treasury Department and I think it would benefit US interests if the dollar were complemented as a reserve currency by euros and (better still) by Indian rupees, Brazilian real, and Chinese renminbi. 

The reason, of course, is that the EZ and Japan have structural opposition to US imports. Formats and technical regulations act as an effective bar to many Usonian products, especially farm commodities.  Simply put, the EZ and Japan, for their comparative size, are inconsequential as future Usonian export markets, and yet the USA must export several trillion dollars net of imports in order to meet longrun sovereign debt obligations.  

This is why the decline of the US dollar against other OECD currencies has not erased the trade deficit.  The big importers of US products are outside of the OECD.

HOWEVER, the reason why the euro and yen have failed as reserve currencies is that those countries have not in living memory run large trade deficits.  Holdings of euros outside of the Eurozone are necessarily small, since the EZ runs huge current account surpluses with everyone except OPEC and China.  Capital exports (European purchases of equities abroad) are large, but not as large as the EZ current account surplus; so the euro is sequestered to Europe.  Mundell-Fleming corrections ensure that any miniscule dollop of euros that leak outside the EZ promptly come back.

During the period 1815-1933, the pound sterling grew in significance as an international reserve currency because the UK ran a steady balance of payments deficits.  Also, reserve currencies in those days meant hot money. 

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*Even for Japan, Finance/Prime Minister Kiichi Miyazawa was exceptionally pro-Washington; the Plan was intended to stabilize SE Asian capital markets. 

So the USD is the world's reserve currency largely because there's a lot of them in circulation outside the USD. And that's largely because we buy more of their stuff than we sell to them of our stuff.

Which means they've bought all of our stuff that they want.

And since our currency is backed by faith and credit, what's the point of having all those dollars laying around? 

So the USD is the world's reserve currency largely because there's a lot of them in circulation outside the USD. And that's largely because we buy more of their stuff than we sell to them of our stuff.

The US dollar became the most common reserve currency because capital exports exceeded the current account surplus (yes, prior to 1980 the USA usually ran a current account surplus). To clear up a minor confusion, BTW, the current account balance is

+ trade balance (for USA, very large negative number)
+ income from productive factors owned by Usonians but located abroad
- income from productive factors owned by foreigners but located in the USA
+ net transfers to the USA (fairly large negative number)

As you know, the current account balance is now a very large negative number (about -$747 billion in 2007). Historically, the two "middle" components listed above ('net factor income', or 'foreign factor income' (FFFnet)) are positive.

Also historically, the USA actually more than refreshed the supply of dollars by buying equities and bonds, lending money through commercial banks, or FDI abroad. This amount of capital export reversed direction during the 1970's as the US banking system absorbed petrodollars.

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The other paper currency to reach international standing was the IMF special drawing right (SDR), which is really a proxy for a basket of the most widely used currencies; and the UK pound. You might be inclined to disregard the UK pound as an example, since it was a world currency in the time of the gold [exchange] standard, but recall that most pounds circulated in the form of credit and derived 100% of their value from the faith and credit of her majesty's government.

In the period of sterling ascendancy, the UK tended to run chronic trade deficits as well, offset by returns on British assets overseas (it was rare for foreigners to invest in the UK).

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Which means they've bought all of our stuff that they want.

Well, it's silly to imagine that the rest of the world has no expectation of ever buying anything from the USA in the future. In 2007, non-Usonians bought US$ 1.17 trillion worth of goods & services from the USA. That's not as much as Usonians bought from foreigners ($1.987 trillion), but it's still quite a lot.

Of course, the definition of "trade deficit" is precisely that.

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And since our currency is backed by faith and credit, what's the point of having all those dollars laying around?

Technically, currency is NOT backed by faith and credit; the sovereign debt is. That's a longstanding foundation of what "sovereignty" means. If a truly sovereign state arbitrarily renounces its debts, there's nothing creditors can do. They could boycott that country's credit markets for all future time, but unsurprisingly never have. Still, the unlikelihood of the federal government defaulting on its debts is reflected by the low interest rates the federal government pays for borrowed money.

Dollars are valuable insofar as they may be used to buy assets in the USA, or in dollarized economies; also, to buy the output of the US economy. If the entire rest of the world really decided it had no intention of spending all those trillions of US dollars accumulated in foreign accounts, and this lack of intention became common knowledge, then dollars would become worthless. That does seem a little unlikely, however.

Well, it's silly to imagine that the rest of the world has no expectation of ever buying anything from the USA in the future.

Fair enough...

Technically, currency is NOT backed by faith and credit; the sovereign debt is. 

I think that's what you call a difference that doesn't distinguish,

recall that most pounds circulated in the form of credit and derived 100% of their value from the faith and credit of her majesty's government.

Dollars represent credit rather than value nowadays. 

After I went to bed I realized I had made this blunder. Sorry about that.

ME: Recall that most pounds circulated in the form of credit and derived 100% of their value from the faith and credit of her majesty's government.

I knew that somewhere I'd screwed up.

After 1816, a pound automatically represented a claim on her majesty's government worth a fixed quantity of gold (about one quarter of a troy ounce). After switching to a gold exchange standard (as opposed to an actual gold standard) the object was to peg official [sovereign] debt to the price of gold, rather than guarantee the value in exchange of all pounds in circulation. What this meant was that the Bank of England was obligated to operate a "gold window" to keep the pound at a fixed rate of exchange to gold.

A solvent bank meant one that was capable of fulfilling its legal obligations to redeem pounds for gold at a fixed rate. But there was no obligation for anyone to keep a stash of gold identical to liabilities, and with banking as we now understand it, there would be little sense in doing so. An asset now means both possession of something tangible, such as an acre of land, or something with market value, like a share of stock; but it is most likely to mean (from the bank's persepective) a loan to somebody else, repayable at a fixed date. Insisting that all assets take the form of gold, or else be regarded as fraudulent, would essentially outlaw economic growth or technical innovation.

In any event, the period of gold-based money was accompanied by per capita growth rates of about 0.8% annually; under credit-based money, about 2.4% annually.

The difference is quite important. While money is issued by a government, sovereign debt refers only to the debt of that government. If you hold the debt of Enron, for example, the USG has no obligations to you. Moreover, the fact that Enron defaulted on its debt has no impact on the soundness of the USD.

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Dollars represent credit rather than value nowadays.

This is not a valid way of describing money. Nearly all money has the same fundamental dynamic; the dollar differs from other currencies mainly insofar as it is used for a huge proportion of international transactions. Nearly every time the yen is used in commerce, a buyer or seller is Japanese. The euro has somewhat more exposure, but not much. Moreover, its soaring value right now represents scarcity, and long-term contraction. Fiscally, the EZ is somewhat more virtuous than the USA, but not much more so; and while the EU proposes to eventually supersede the USA as a world superpower, it is not one now.

So singling out the dollar is misleading. I'm not certain if you meant to.

How about nowadays? If by "nowadays," you mean, "since 1971" (when the USA finally severed the ties to gold), just remember that the USD was the last major currency still tied to gold. And I can't accept that a fixed amount of gold is the sole form of value. Anything is valuable if you can exchange it for something else.

Credit is measured in units of value. So saying "dollars represent credit rather than value" is like saying, "James' car is now green, whereas it used to be heavy."

Well, it's silly to imagine that the rest of the world has no expectation of ever buying anything from the USA in the future.

OK, but it won't be cars or TVs they buy. It'll be our real estate.

Then what will we have?

So singling out the dollar is misleading. I'm not certain if you meant to.

The dollar's position and utility in the world economy is different than that of other currencies, no matter how or why it achieved that position. So I am singling it out.

OK, but it won't be cars or TVs they buy. It'll be our real estate.

It depends.  It might also be indentured labor.  This has occurred in the past.  

However, there's a point to bear in mind: the entities that accrued all those debts would have to own real estate in order to sell it. While it's useful to understand national income and product accounting (NIPA), it needs to be remembered that just because a firm in Silicon Valley owes another firm in Dusseldorf a billion dollars, that doesn't mean you or I are seconds in that debt. These are entities that might be based in the USA, or have limited liability ownership in a US-registered corporation.  But when a firm goes bankrupt, the liability doesn't accrue to people in the neighborhood.

The dollar's position and utility in the world economy is different than that of other currencies, no matter how or why it achieved that position. So I am singling it out.

All right.  But just so you know, there's a lot of mythology about dollars having unique attributes.  It's actually different only in the scope and scale of its international usage. 

But just so you know, there's a lot of mythology about dollars having unique attributes.

See now, that's what I asked about in the beginning.

I know my standing as an economist, which is as close to dead last as makes no difference. That's why I ask you stuff. I've come to believe you by default (though ALL my defaults can be easily overridden).