When the Buck Stops

The age of the dollar has been great for America—but it may end soon.

On a trip to Guangzhou, China, in the early 1990s, I couldn’t help but notice that the accessory of the moment for stylish young men was a cell-phone holster. In those days, a typical holster only sometimes contained an actual cell phone—but it almost always contained a dollar bill, tucked behind the plastic window, folded carefully so that George Washington could gaze out on capitalism with Chinese characteristics.

U.S. greenbacks may not be fashion statements in many places (I doubt they’re hip in Guangzhou any longer), but almost wherever you travel, people are glad to accept foreign cash so long as it bears the graven image of an American president.

The dollar’s status as the global currency confers more advantages on the United States and its citizens than you might think—advantages far beyond convenience for international travelers (though let us not underestimate that). The dollar’s popularity has moved real resources from the rest of the world to the United States. And on a much larger scale, through an economic sleight of hand in global financial markets, it has allowed the country to sustain an otherwise impossible standard of living. These wonderful tricks, unfortunately, may not work much longer. When they start to fail, as they eventually must, the dollar’s peculiar global role will suddenly become a focus of attention. You don’t know what you’ve got till it’s gone.

There is a difference—known as seigniorage—between what dollar bills cost to manufacture (pennies) and what those same dollar bills can buy once they’re in circulation. The government does not distribute dollars by dropping them from helicopters; in effect, it spends them on things such as hours worked or goods procured. Merely by printing a dollar bill, the government grants itself a claim on a dollar’s worth of real things.

Essentially, the Chinese youth sporting a dollar bill on his belt has surrendered in exchange—possibly through a long chain of intermediaries—a dollar’s worth of real stuff to the United States. The more people there are around the world who are willing to hold the currency that America prints, and the greater the quantity of dollars they wish to keep, the larger this transfer of real wealth will be. So it matters to the United States that your cab driver in São Paulo is pleased to accept dollars, or that your cocaine connection in Medellín actually prefers greenbacks to pesos. When those deals go down, we all get a piece of the action.

Altogether some $750 billion in paper money and coins is in circulation today, and most of that is reckoned to be held abroad. As they say where I come from, that’s a nice little earner. Alas, the connection to crime is apparent: Even nowadays, crime is a cash business, comparatively speaking, and a portable, reliable, and above all anonymous store of value has great utility if you are up to no good. No one knows for sure, but I’d guess most of the $100 notes in circulation (the largest denomination currently issued) are oiling the wheels of criminal enterprise. The European Union clearly wants a share of the international seigniorage business for its currency, and it has issued 500-euro notes (worth around $660 each) to secure its competitive advantage in the sector. One wonders—the European Central Bank hasn’t said—what legal transactions require notes of that denomination. Even in Frankfurt, cab fare rarely runs that high.

Valuable though it is, however, the seigniorage that the United States captures from abroad is small beer compared with the rewards that accrue to the country from the dollar’s standing in global capital markets. In dealings with foreigners, it is good to be able to transact in one’s own currency. Let the other guy—the foreign customer or supplier—cope with the accounting complications and carry the exchange-rate risk. Should you need to borrow abroad, it is especially good to be able to do it in your own currency.

And, my word, how America needs to borrow abroad. The country’s current-account deficit exceeds 6 percent of the gross domestic product and looks likely to continue to grow. This deficit—the gap, roughly, between what the country buys from foreigners and what it sells to them—has to be financed by borrowing. The United States, to draw an admittedly imperfect analogy with households, is adding to its overdraft each year, to the tune of more than 6 percent of its income. In the recent past, countries that have borrowed so heavily have sooner or later suffered financial collapse—think of the Latin American debt crisis of the 1980s, or the East Asian financial meltdown of the late 1990s. So how can the United States sustain such borrowing with little apparent strain? Well, those earlier financial breakdowns were also exchange-rate crises. When the Thai baht collapsed, the domestic-currency burden of Thailand’s foreign-currency debts soared, flattening the economy. Should the dollar collapse, the domestic-currency burden of U.S. foreign debts will hardly change, because the United States has borrowed in dollars, not in its creditors’ currencies. If the dollar does crash, the foreign creditors will get screwed first.

In other words, the United States can cheerfully borrow at this extraordinary rate—and thus absorb, year after year, more resources than it produces, all without arousing alarm in financial markets or having to pay punitive rates of interest on its debt—in part because of the dollar’s global eminence.

But there’s still more. As I said, the household analogy is imperfect. A family whose spending persistently exceeded its income would see its debts mount. America’s net debt is barely rising in relation to national income, despite the massive borrowing. Why? One reason is that while America pays a very low rate of interest on its debts, which are mostly in the form of Treasury securities, it receives a very high rate of return on its foreign assets, which mostly represent ownership stakes in foreign companies. This return offsets some of the borrowing. Furthermore, the dollar’s gentle decline in recent years has magnified this effect, increasing the dollar value of America’s foreign assets (selling them would now yield more dollars), while leaving the value of all those dollar-denominated debts unchanged. With apologies to George Soros, call this the alchemy of finance: The United States has found a way to borrow that adds almost nothing to its debts. And it’s mostly thanks to the dollar’s status.

One question, though: Who are these financial geniuses placing themselves so reliably on the losing side of these transactions? Who are these people lending hundreds of billions of dollars to the United States and getting less than nothing as their rate of return? Funny you should ask. Maybe, in the bowels of the People’s Bank of China, there are officials who 15 years ago were flashing portraits of George Washington in the markets of Guangzhou: Somebody in that institution has been wrestling with a bad case of raging dollar-lust. In recent years, Asian central banks, with China’s in the lead, have supplied—at a loss—most of the foreign credit that has kept the American economy going.

They have their reasons, of course. China’s enormous accumulation of central-bank dollar reserves is a consequence of its desire to keep the dollar dearer—and its own currency cheaper—than it otherwise would be. And that desire, in turn, is fed by China’s wish to keep its exports competitive and its workforce employed. But this cannot go on indefinitely. Recent signs suggest that the bank is already starting to diversify its reserves away from dollars. And there are intimations of a more liberal exchange-rate regime.

All kinds of economic forces are nibbling at the dollar’s reserve-currency status. The euro is one factor; Asia’s economic emergence is another; improving financial technology (for a host of arcane reasons) is a third. More and more, the world will move toward a system where many currencies share in that status, and in the benefits it confers. That’s quite unfortunate for the United States, but it need not be disastrous. Still, if it happens too abruptly, the inevitable unraveling of the weird financial bargain that the United States and China have struck could be scary. If the People’s Bank dumps its dollars, and the dollar collapses, America itself might not become insolvent—but it would have a serious inflation problem to deal with, its interest rates would have to rise, and a lot of overindebted American families might go bust.

No question, the United States is going to need China’s cooperation in managing this disentanglement smoothly. What will be interesting to see is how much, geopolitically speaking, China will extract in return. As the dollar becomes less special, the euro continues to catch on, and the rupee and the renminbi become international currencies, China will gain full and equal access to the positions of global economic leadership it so evidently craves. In the end, that would have happened anyway, but America’s overexuberant exploitation of the dollar’s standing has handed China a great political asset. This will surely be cashed in for a very good seat at the economic table—and, we are likely to find, for other prizes besides.