Dollars are not fragile

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The author is a contributing editor to FT

The US is again negotiating with itself this week to make sure the federal government can continue to borrow. The stakes are familiar. Yet this time there seems to be more concern that the dollar itself is at risk – that everyone else, long frustrated with the US currency, might take an opportunity to stop using it.

The problem with that argument is that there is no such thing as THE dollar. There are many different types of dollars, each with their own qualities. No monetary regime lasts forever. But monetary regimes are not collective delusions either. Dollars won’t all suddenly disappear like smoke if Argentina starts pricing soybeans in renminbi. Each type of dollar has its value and we should be specific about which ones are in danger.

Normally when we talk about currency we actually mean bank deposits. Dollar strength is a measure of the desire among currency traders to exchange deposits in some other country for deposits in the United States. The Federal Deposit Insurance Corporation has made clear through repeated crises that it won’t let any deposit fail, period.

There is no other currency with anything like the FDIC’s explicit guarantee of $250,000 in deposits, or its implied guarantee of virtually anything. Eurozone bank deposits, for example, are only guaranteed by national governments and only up to €100,000. You may not like US bank dollars, but there is no currency that can conceivably replace them.

There are also Eurodollars, dollar-denominated deposits in foreign banks. These too enjoy an almost explicit guarantee from the Federal Reserve, through temporary exchange agreements with foreign central banks in crisis. No other central bank offers anything remotely comparable to the collateral on these swaps. You may not like this system, but again it’s not clear what could replace it.

In financial markets, treasuries function like dollars: they’re not just denominated in dollars, they’re dollars. If the federal government starts missing payments, the value of subsequent treasury bond runs could fall below par. This, in turn, would consume the market values ​​of responsible asset portfolios as well. That would be bad. Treasury dollars are at risk.

Since at least the charter of the Bank of England in 1694, however, sovereign debt has remained the bedrock of the global financial system. You may not like this system – I have some questions about it too – but it’s what we have. And here, pure volume is an undervalued Treasury dollar strength.

Americans think of treasuries as debt and measure them as a percentage of gross domestic product, so we can argue about what kind of debt load might be sustainable. But as Michael Pettis points out, everyone else in the world thinks of Treasury dollars as assets, and no other country has been willing and able to produce sovereign debt assets at a volume similar to America’s.

Adding up federal and local government loans, America had pushed $26.9 trillion of sovereign debt assets into global financial markets by September 2022, according to the most recent comparative data from the Bank for International Settlements. (Yes, I know the Fed holds treasuries too.) China and Japan come next, with just over $8 trillion each in sovereign assets in their own currencies. Very few other countries even measure their sovereign debt in trillions.

We think America’s ability to borrow the mighty dollar is a privilege, but the opposite may just as well be true. America’s eager willingness to borrow helps make Treasury dollars powerful. You may no longer want to hold government bonds in your portfolio. Fine, but what else are you going to keep?

All of these dollars, together, help explain the “bill of lading” dollar — shipments of goods overseas, priced in dollars. Traditional currency theories held that goods were priced in the currencies of origin or destination. More recent work has shown that exporters choose the dominant currencies, because stable prices are more important than the advantage of the sovereign currency.

Dollar prices on bills of lading are stable, in turn, because of all those other kinds of dollars. You may believe that the dollar price of oil is purely a product of American aircraft carriers, but the petrodollar alone does not explain the global evidence of dominant currencies.

There are many reasons to be skeptical that strong dollars are good for America. All those treasury sales don’t seem to have paid for much productive investment, just periodic tax cuts and stimulus programs. But you don’t need to like all these dollars to see that it’s not at all clear what the other choices are.