AUser’sGuidetoRestructuringtheGlobalTradingSystem

November2024

ExecutiveSummary

ThedesiretoreformtheglobaltradingsystemandputAmericanindustryonfairergroundvis-à-vistherestoftheworldhasbeenaconsistentthemeforPresidentTrumpfordecades.Wemaybeonthecuspofgenerationalchangeintheinternationaltradeandfinancialsystems.

Therootoftheeconomicimbalancesliesinpersistentdollarovervaluationthatpreventsthebalancingofinternationaltrade,andthisovervaluationisdrivenbyinelasticdemandforreserveassets.AsglobalGDPgrows,itbecomesincreasinglyburdensomefortheUnitedStatestofinancetheprovisionofreserveassetsandthedefenseumbrella,asthemanufacturingandtradeablesectorsbearthebruntofthecosts.

InthisessayIattempttocataloguesomeoftheavailabletoolsforreshapingthesesystems,thetradeoffsthataccompanytheuseofthosetools,andpolicyoptionsforminimizingsideeffects.Thisisnotpolicyadvocacy,butanattempttounderstandthefinancialmarketconsequencesofpotentialsignificantchangesintradeorfinancialpolicy.

Tariffsproviderevenue,andifoffsetbycurrencyadjustments,presentminimalinflationaryorotherwiseadversesideeffects,consistentwiththeexperiencein2018-2019.Whilecurrencyoffsetcaninhibitadjustmentstotradeflows,itsuggeststhattariffsareultimatelyfinancedbythetariffednation,whoserealpurchasingpowerandwealthdecline,andthattherevenueraisedimprovesburdensharingforreserveassetprovision.Tariffswilllikelybeimplementedinamannerdeeplyintertwinedwithnationalsecurityconcerns,andIdiscussavarietyofpossibleimplementationschemes.IalsodiscussoptimaltariffratesinthecontextoftherestoftheU.S.taxationsystem.

Currencypolicyaimedatcorrectingtheundervaluationofothernations’currenciesbringsanentirelydifferentsetoftradeoffsandpotentialimplications.Historically,theUnitedStateshaspursuedmultilateralapproachestocurrencyadjustments.Whilemanyanalystsbelievetherearenotoolsavailabletounilaterallyaddresscurrencymisvaluation,thatisnottrue.Idescribesomepotentialavenuesforbothmultilateralandunilateralcurrencyadjustmentstrategies,aswellasmeansofmitigatingunwantedsideeffects.

Finally,Idiscussavarietyoffinancialmarketconsequencesofthesepolicytools,andpossiblesequencing.

StephenMiran,FormerHudsonBaySeniorStrategist

StephenMiranwasSeniorStrategistatHudsonBayCapital.HecurrentlyservesasChairmanoftheCouncilofEconomicAdvisers.Previously,Dr.MiranservedassenioradvisorforeconomicpolicyattheU.S.DepartmentoftheTreasury,whereheassistedwithfiscalpolicyduringthepandemicrecession.PriortoTreasury,Dr.Miranworkedforadecadeasaninvestmentprofessional.Dr.MiranisalsoaneconomicsfellowattheManhattanInstituteforPolicyResearch.HereceivedaPh.D.ineconomicsfromHarvardUniversityanda

B.A.fromBostonUniversity.

Pleasedirectenquiriesto

research@

AUser’sGuidetoRestructuringtheGlobalTradingSystem

PAGE

40

Contents

ExecutiveSummary 1

Chapter1:Introduction 3

Chapter2:TheoreticalUnderpinnings 5

TheRootsofEconomicDiscontentLieintheDollar 5

TheTriffinWorld 5

EconomicConsequences 8

TheCoreTradeoff 11

ReshapingtheGlobalSystem 11

Chapter3:Tariffs 13

TariffsandCurrencyOffset 13

Inflation 14

Incidence,Revenue,andTradeFlows 16

CurrencyOffsetandFinancialMarkets 18

HowLikelyisCurrencyOffsettoOccur? 20

TariffImplementation 21

GraduatedImplementation 21

GraduatedScales,LeverageandSecurity 22

TariffsandCompetitiveness 24

FiscalDevaluations 24

DistortionsandOptimalTariffRates 24

Chapter4:Currencies 27

CurrencyPolicyandRisks 27

MultilateralCurrencyApproaches 28

Feasibility 29

UnilateralCurrencyApproaches 30

IEEPA 30

ReserveAccumulation 32

Chapter5:MarketandVolatilityConsiderations 35

TariffsThenDollarsorInvestments 35

MultilateralCurrencyApproaches 36

UnilateralCurrencyApproaches 36

InAllCases 37

Chapter6:Conclusion 38

References 39

Disclosures 41

Chapter1:Introduction

Americans’opinionofhowwelltheinternationaltradeandfinancialsystemsservethemhasdeterioratedsubstantiallyoverthelastdecade.Amongvotersifnotamongeconomists,theconsensusunderpinningtheinternationaltradingsystemhasfrayed,andbothmajorpartieshavetakenpoliciesthataimatboostingAmerica’spositionwithinit.

WithPresidentTrumpwinningreelectionwithastrongdemocraticmandate,itisreasonabletoexpecttheTrumpAdministrationtoundertakeasubstantialoverhauloftheinternationaltradeandfinancialsystems.Thisessaysurveyssometoolsavailablefordoingso.IncontrasttomuchWallStreetandacademicdiscourse,therearepowerfultoolsthatcanbeusedbyanAdministrationforaffectingthetermsoftrade,currencyvalues,andthestructureofinternationaleconomicrelations.

Duringhiscampaign,PresidentTrumpproposedtoraisetariffsto60%onChinaand10%orhigherontherestoftheworld,andintertwinednationalsecuritywithinternationaltrade.Manyarguethattariffsarehighlyinflationaryandcancausesignificanteconomicandmarketvolatility,butthatneednotbethecase.Indeed,the2018-2019tariffs,amaterialincreaseineffectiverates,passedwithlittlediscerniblemacroeconomicconsequence.Thedollarrosebyalmostthesameamountastheeffectivetariffrate,nullifyingmuchofthemacroeconomicimpactbutresultinginsignificantrevenue.BecauseChineseconsumers’purchasingpowerdeclinedwiththeirweakeningcurrency,Chinaeffectivelypaidforthetariffrevenue.Havingjustseenamajorescalationintariffrates,thatexperienceshouldinformanalysisoffuturetradeconflicts.

PresidentTrumphasalsodiscussedadoptingsubstantialchangestodollarpolicy.Sweepingtariffsandashiftawayfromstrongdollarpolicycanhavesomeofthebroadestramificationsofanypoliciesindecades,fundamentallyreshapingtheglobaltradeandfinancialsystems.

Thereisapathbywhichthesepoliciescanbeimplementedwithoutmaterialadverseconsequences,butitisnarrow,andwillrequirecurrencyoffsetfortariffsandeithergradualismorcoordinationwithalliesortheFederalReserveonthedollar.Potentialforunwelcomeeconomicandmarketvolatilityissubstantial,buttherearestepstheAdministrationcantaketominimizeit.

Fromatradeperspective,thedollarispersistentlyovervalued,inlargepartbecausedollarassetsfunctionastheworld’sreservecurrency.ThisovervaluationhasweighedheavilyontheAmericanmanufacturingsectorwhilebenefitingfinancializedsectorsoftheeconomyinmannersthatbenefitwealthyAmericans.Andyet,PresidentTrumphaspraisedthereservestatusofthedollarandthreatenedtopunishcountriesthatstopusingthedollarforreservepurposes.Iexpectthesetensionswillberesolvedbyasuiteofpoliciesdesignedtoincreaseburdensharingamongtradingandsecuritypartners:ratherthanattemptingtoendtheuseofthedollarastheglobalreservecurrency,theTrumpAdministrationcanattempttofindwaystocapturebacksomeofthebenefitsothernationsreceivefromourreserveprovision.ReallocationofaggregatedemandfromothercountriestoAmerica,anincreaseinrevenuetotheU.S.Treasury,oracombinationthereof,canhelpAmericabeartheincreasingcostofprovidingreserveassetsforagrowingglobaleconomy.TheTrumpAdministrationislikelytoincreasinglyintertwinetradepolicywithsecuritypolicy,viewingtheprovisionofreserveassetsandasecurityumbrellaaslinkedandapproachingburdensharingforthemtogether.

Theremainderofthisessayisstructuredasfollows:first,Ireviewtheunderlyingeconomiccausesofoureconomicimbalances.Second,Iexploretariffdrivenapproachestoredressingthesegrievances.Third,Ireviewcurrency-drivenapproaches,bothmultilateralandunilateral.Finally,Idiscussmarketconsequences.

Thisessayisnotpolicyadvocacy.Iattempttodiagnosetheeconomicdisequilibriuminthetermsoftradethatunderliesthenationalists’critiqueofthecurrentsystem,describeacatalogueoftoolsthatcanbeusedtoaddressit,andanalyzethesetools’relativeadvantagesordisadvantagesandpotentialconsequences.

Myanalysisreflectsonlymyownviews,notthoseofanyoneonPresidentTrump’steamorHudsonBayCapital.Thegoaloftheanalysisistounderstandtherangeofpossiblepoliciesthatmightbeimplemented,sothatourteamandclientscanevaluatetheconsequencesintheeconomyandfinancialmarketsthatmightresult.

Chapter2:TheoreticalUnderpinnings

TheRootsofEconomicDiscontentLieintheDollar

TheTriffinWorld

Thedeepunhappinesswiththeprevailingeconomicorderisrootedinpersistentovervaluationofthedollarandasymmetrictradeconditions.SuchovervaluationmakesU.S.exportslesscompetitive,U.S.importscheaper,andhandicapsAmericanmanufacturing.Manufacturingemploymentdeclinesasfactoriesclose.Thoselocaleconomiessubside,manyworkingfamiliesareunabletosupportthemselvesandbecomeaddictedtogovernmenthandoutsoropioidsormovetomoreprosperouslocations.Infrastructuredeclinesasgovernmentsnolongerserviceit,andhousingandfactorieslayabandoned.Communitiesare“blighted.”

AccordingtoAutor,DornandHanson(2016),between600,000andonemillionU.S.manufacturingjobsdisappearedbetween2000and2011duetothe“Chinashock”ofincreasedtradewithChina.Includingbroadercategories,thejobsdisplacedbytradeduringthatdecadewerecloserto2million.Even2millionjoblossesoveradecaderepresentsonly200,000peryear,afractionofthechurnofjobsthatoccurseveryyearbecauseoftechnology,risingandfallingfirmsandsectors,andtheeconomiccycle.

Butthatlogicwasflawedintwoways:first,theestimatesofjoblossesduetotradeincreasedovertimeasnewresearchemerged,forinstanceAutor,DornandHanson(2021);the“Chinashock”wasmuchlargerthaninitiallyestimated.Indeed,plentyofnonmanufacturingjobswhichdependedonlocalmanufacturingeconomieswerelostaswell.Second,manyjoblosseswereconcentratedinstatesandspecifictownswherealternativeemploymentwasnoteasilyavailable.Forthesecommunities,thelossesweresevere.

Theproblemiscompoundedbythereversalof“theendofhistory”andthereturnofnationalsecuritythreats.Withnomajorgeopoliticalrivals,U.S.leadersbelievedtheycouldminimizethesignificanceofdecliningindustrialplant.ButwithChinaandRussiaasnotonlytradebutsecuritythreats,havingarobustandwelldiversifiedmanufacturingsectorisofrenewednecessity.Ifyouhavenosupplychainswithwhichtoproduceweaponsanddefensesystems,youhavenonationalsecurity.AsPresidentTrumpargued,“ifyoudon’thavesteel,youdon’thaveacountry.”1

Whilemanyeconomistsfailtoincludesuchexternalitiesintheiranalysisandarethereforehappytorelyontradepartnersandalliesforsuchsupplychains,theTrumpcampdoesnotsharethattrust.ManyofAmerica’salliesandpartnershavesignificantlylargertradeandinvestmentflowswithChinathantheydowithAmerica;arewesosurewecantrustthem,ifworsecomestoworst?

SuchproblemsarecompoundedbyaggressiveChineseespionage.AccordingtoreportsintheWallStreetJournal,2

inSeptemberalone,“theFederalBureauofInvestigationsaidaChinesestate-linkedfirmhacked260,000internet-connecteddevices,includingcamerasandrouters,intheU.S.,Britain,France,Romaniaandelsewhere

[and]aCongressionalprobesaidChinesecargocranesusedatU.S.seaportshadembeddedtechnologythatcouldallowBeijingtosecretlycontrolthem.”Thesecurity,espionageandsabotagevulnerabilityofsensitiveimportsfromChinacontinuestogrow.

Inthistelling,persistentovervaluationofthedollaristhekeymechanismfortradeimbalances,keepingimportsfromabroadstubbornlycheapdespitewideningtradedeficits.Sohowisitpossiblethatcurrencymarkets,whicharethelargestmarketsintheworldintermsofsheertradingvolume,don’tequilibrate?

Theanswerliesinthefactthatthereare(atleast)twoconceptsofequilibriumforcurrencies.Oneisrootedinmodelsofinternationaltrade.Intrademodels,currenciesadjustoverthelongtermtobalanceinternationaltrade.Ifacountry

/homenews/administration/376408-trump-if-you-dont-have-steel-you-dont-have-a-country/

https://

/politics/national-security/scale-of-chinese-spying-overwhelms-western-governments-6ae644d2

MANUFACTURINGEMPLOYMENT

Shareoftotalemployment

Manufacturingemployees

20,000 40%

15,000 30%

10,000 20%

5,000 10%

0

1940

1950

1960

1970

1980

1990

2000

2010

0%

2020

Figure1ManufacturingemploymentintheUnitedStates.Source:BureauofLaborStatistics

runsatradesurplusforasustainedperiod,itreceivesforeigncurrencyforitsgoods,whichitthensellsforitsdomesticcurrency,pushingitsdomesticcurrencyhigher.Thatprocessoccursuntilitscurrencyisstrongenoughthatitsexportsdeclineandimportsincrease,balancingtrade.

Theotherequilibriumconceptisfinancialandcomesfromsaversselectinginvestmentalternativesamongdifferentnations.Inthisequilibriumconcept,currenciesadjusttomakeinvestorsindifferentbetweenholdingassetsdenom-inatedindifferentcurrencies,onanexanterisk-adjustedbasis.

However,thelatterclassofmodelsbecomesmorecomplicatedwhenanation’scurrencyisareserveasset,asisAmerica’s.BecauseAmericaprovidesreserveassetstotheworld,thereisdemandforU.S.dollars(USD)andU.S.Treasurysecurities(USTs)thatisnotrootedinbalancingtradeorinoptimizingrisk-adjustedreturns.Thesereservefunctionsservetofacilitateinternationaltradeandprovideavehicleforlargepoolsofsavings,oftenheldforpolicyreasons(e.g.reserveorcurrencymanagementorsovereignwealthfunds)ratherthanreturnmaximization.Much(butnotall)ofthereservedemandforUSDsandUSTsisinelasticwithrespecttoeconomicorinvestmentfundamentals.TreasurysboughttocollateralizetradebetweenMicronesiaandPolynesiaareboughtirrespectiveoftheU.S.tradebalancewitheither,thelatestjobsreport,ortherelativereturnofTreasurysvs.GermanBunds.

Suchphenomenareflectwhatcanbedescribedasa“Triffinworld,”afterBelgianeconomistRobertTriffin.InTriffinworld,reserveassetsareaformofglobalmoneysupply,anddemandforthemisafunctionofglobaltradeandsavings,notthedomestictradebalanceorreturncharacteristicsofthereservenation.

Whenthereservecountryislargerelativetotherestoftheworld,therearenosignificantexternalitiesimposedonthereservecountryfromitsreservestatus.ThedistancefromtheTriffinequilibriumtothetradeequilibriumis

small.However,whenthereservecountryissmallerrelativetotherestoftheworld—say,becauseglobalgrowthexceedsthereservecountry’sgrowthforalongperiodoftime—tensionsbuildandthedistancebetweentheTriffinequilibriumandthetradeequilibriumcanbequitelarge.Demandforreserveassetsleadstosignificantcurrencyovervaluationwithrealeconomicconsequences.

InTriffinworld,thereserveassetproducermustrunpersistentcurrentaccountdeficitsastheflipsideofexportingreserveassets.USTsbecomeexportedproductswhichfueltheglobaltradesystem.InexportingUSTs,Americareceivesforeigncurrency,whichisthenspent,usuallyonimportedgoods.Americarunslargecurrentaccountdeficitsnotbecauseitimportstoomuch,butitimportstoomuchbecauseitmustexportUSTstoprovidereserveassetsandfacilitateglobalgrowth.ThisviewhasbeendiscussedbyprominentpolicymakersfromboththeUnitedStates(e.g.FeldsteinandVolcker,2013)aswellasChina(e.g.Zhou,2009).3

AstheUnitedStatesshrinksrelativetoglobalGDP,thecurrentaccountorfiscaldeficititmustruntofundglobaltradeandsavingspoolsgrowslargerasashareofthedomesticeconomy.Therefore,astherestoftheworldgrows,theconsequencesforourownexportsectors—anovervalueddollarincentivizingimports—becomemoredifficulttobear,andthepaininflictedonthatportionoftheeconomyincreases.

Eventually(intheory),aTriffin“tippingpoint”isreachedatwhichsuchdeficitsgrowlargeenoughtoinducecreditriskinthereserveasset.Thereservecountrymaylosereservestatus,usheringinawaveofglobalinstability,

andthisisreferredtoastheTriffin“dilemma.”Indeed,theparadoxofbeingareservecurrencyisthatitleadstopermanenttwindeficits,whichinturnleadovertimetoanunsustainableaccumulationofpublicandforeigndebtthateventuallyunderminesthesafetyandreservecurrencystatusofsuchlargedebtoreconomy.

WhiletheUnitedStatesshareofglobalGDPhalvedfrom40percentofglobalGDPinthe1960sto21percentin2012,andhasrecoveredslightlytoitspresentlevelof26%,itisstillfarfromsuchatippingpoint,inpartbecausetherearenomeaningfulalternativestothedollarortheUST.Areservecurrencymustbeconvertibleintoothercurrencies,andareserveassetmustbeastablestoreofvaluegovernedbyreliableruleoflaw.WhileothernationslikeChinaaspiretoreservestatus,theysatisfyneitherofthesecriteria.AndwhileEuropemay,itsbondmarketsarefragmentedrelativetotheUSTmarket,anditsshareofglobalGDPhasshrunkevenmorethanAmerica’s.

ItisworthobservingthattheU.S.shareofglobalGDPtroughedaroundtheGFCandhasstabilizedorimprovedsincethen,coincidentwiththepatterninmanufacturingemployment.Inthistelling,ourshareofglobalGDPdrivesthesizeoftheTriffindistortionintradeequilibrium,whichinturndrivesthestateofthetradeablesector.

Thebackdropforthesecurrencydevelopmentshasbeenasystemoftariffratesdefiningtheinternationaltradingsystemthatare,broadlyspeaking,lockedintoaconfigurationdesignedforadifferenteconomicage.AccordingtotheWorldTradeOrganization,theUnitedStateseffectivetariffonimportsisthelowestanynationintheworldimposesatabout3%,whiletheEuropeanUnionimposesabout5%andChina10%.4Thesenumbersareaveragesacrossallimportsandnotreflectiveofbilateraltariffrates;bilateraldiscrepanciescanbemuchlarger,forinstancetheU.S.imposesonly2.5%tariffsonautoimportsfromtheE.U.,whileEuropeimposesa10%dutyonAmericanautoimports.5Manydevelopingnationsapplymuchhigherrates,andBangladeshhastheworld’shighesteffectiverateat155%.Thesetariffsare,inlargepart,legaciesofanerainwhichtheUnitedStateswantedtogenerouslyopenitsmarketstotherestoftheworldatadvantageoustermstoassistwithrebuildingafterWorldWarII,orincreatingalliancesduringtheColdWar.Moreover,tariffsin

Acriticalanalysisofthe“currentaccount”and“fiscal”versionsoftheTriffindilemmaisavailableinBordoandMcCauley(2017).Theirdismissalofthesetheoriesfocusesmoreonthelackofdilemma/crisisintheneartermandtheinabilitytoidentifyanysuchcrossingpoint,ratherthanonanabilitytodiscountthebasicmechanism.

https:/

/w

w

/english/res_e/booksp_e/world_tariff_profiles24_e.pdf

https://

/news/2023/01/19/joe-manchin-davos-inflation-reduction-act-europe-00078510

somecasesenormouslyunderstatetheunevennessoftheplayingfield,assomenationsemploymaterialnon-tariffbarriers,stealintellectualproperty,andmore.Intheory,priortariffratesmaynotaffecttradeiffloatingcurrenciesadjusttooffsetthem,buttheyhaveverysignificantconsequencesforrevenueandburdensharing(seethediscussionbelow).

Figure2U.S.shareofglobalGDP.Source:WorldBank

EconomicConsequences

WhilewearelikelyfarfromtheeconomiccrisesthatcomprisethetippingpointoftheTriffindilemma,wemustnonethelessreckonwiththeconsequencesoftheTriffinworld.Reservenationstatuscomeswiththreemajorconsequences:somewhatcheaperborrowing,moreexpensivecurrency,andtheabilitypursuesecuritygoalsviathefinancialsystem.

CheaperBorrowing

Becausethereisapersistentreserve-drivendemandforUSTsecurities,theUnitedStatesmaybeabletoborrowatloweryieldsthanwouldotherwisebethecase.Becauseeconomistshavelittlevariationtostudy(we’vebeenthesolereservecurrencyformanydecades),it’simpossibletohaveconfidenceabouthowbigthisbenefitis.

Someestimates,fictionalastheyare,haveitaslargeas50-60basispointsofborrowingyield(McKinsey,2009).

Inanycase,therearenumerouscountriesthatborrowsignificantlymorecheaplythantheUnitedStates.Atthetimeofwriting,allG7membersborrowmorecheaplythantheUnitedStatesexceptfortheUK,whichborrowsatenthofapercentmoreexpensive.OtherpeerslikeSwitzerlandandSwedenborrowmorecheaplytoo,Switzerlandbyalmost4percentagepoints.Meanwhile,anerstwhiletroubleddebtorlikeGreececanborrowoverapointmorecheaply.

Moreprecisely,onecancreateasyntheticdollarborrowingratewithcurrencyriskhedgedout,i.e.examinedeviationsfromcoveredinterestparity,asinDu,ImandSchreger(2018).Suchdeviationsarecurrently(andusually)closetozero6fortheUnitedStatesrelativetootherG10borrowers;inotherwords,there’slittlespecialborrowingrateconferredontheU.S.relativetootherdevelopedcountries.G10vs.EM,however,stillcontainsubstantialresiduals,suggestingthatemergingmarketspayaborrowingpremiumrelativetodevelopedmarketstoborrow.

TheinferenceIdrawfromthisisthatwhile,allelseequal,beingareservecurrencymayreduceborrowingcosts,whateverbenefitisgainedislikelytobedwarfedbythingslikecentralbankpolicyoutlooks,growthandinflationforecasts,andequitymarketperformance.

However,theborrowingadvantagemaybeframeddifferently:ratherthanreducingthecostofborrowing,itmayreducethepricesensitivityofborrowing.Inotherwords,wedon’tnecessarilyborrowsubstantiallycheaper,butwecanborrowmorewithoutpushingyieldshigher.Thisisaconsequenceofthepriceinelasticityofdemandforreserveassets,andtheflipsidethatwerunlargeexternaldeficitstofinancethatreserveprovision.

RicherCurrency

Canada

-1.05

Japan

-3.38

UK

0.12

France

-1.19

Germany

-1.94

Italy

-0.66

Greece

-1.03

Switzerland

-3.93

Sweden

-2.20

Themoresignificantmacroeconomicconsequenceofservingastheworld’sreserveproduceristhatreservedemandforAmericanassetspushesupthedollar,leadingittolevelsfarinexcessofwhatwouldbalanceinternationaltradeoverthelongrun.AccordingtotheIMF,thereareabout$12trillionofglobalforeignexchangereservesinofficialhands,ofwhichroughly60%areallocatedindollars—inreality,reserveholdingsofthedollararemuchhigher,asquasi-andnon-officialentitiesholddollarassetsforreservepurposestoo.

Clearly,$7trillionofdemandisenoughtomovetheneedleinanymarket,evencurrencymarkets.Forreference,$7trillionisroughlyathirdofU.S.M2moneysupply;flowscreatingorunwindingtheseholdingswillobviouslyhavesignificantmarketconsequences.Iftrillionsofdollarsofsecuritiesbought

fortheFed’spolicyandnotinvestmentpurposesontheFed’sbalancesheethavehadanyeffectonfinancialmarkets,thentrillionsofdollarsboughtforforeigncentralbanks’policiesandnotinvestingpurposesshouldalsohavesomeeffectiftheyareonothernations’balancesheetsinsteadoftheFed’s.

Becausenationsaccumulatereservesinparttostemappreciation

Table1:10-yearborrowingspreadstoTreasurynotes.Negativenumbersmeantheothernationborrowsmore

cheaplythantheUnitedStates.Source:Bloomberg,HBCcalculations

pressuresintheirowncurrencies,thereisacontemporaneousnegativecorrelationbetweentheexchangevalueofthedollarandthelevelofglobalreserves.Reservestendtogoupwhenthedollarisgoingdown,asaccumulatorsbuydollarstosuppresstheircurrencies,andviceversawhenthedollarisgoingup.

Nevertheless,otherthantwoquartersin1991,theUnitedStateshasrunacurrentaccountdeficitsince1982.Thatthecurrentaccountcannotbalancebeyondanegligibleperiodoverhalfacenturytellsusthedollarisnotplayingitsroleofequilibratinginternationaltradeandincomeflows.

Theinterplaybetweenreservestatusandthelossofmanufacturingjobsissharpestduringeconomicdownturns.Becausethereserveassetis“safe,”thedollarappreciatesduringrecessions.Bycontrast,othernations’currenciestendtodepreciatewhentheygothroughaneconomicdownturn.Thatmeansthatwhenaggregatedemandsuffersadecline,paininexportsectorsgetcompoundedbyasharperosionofcompetitiveness.ThusemploymentinmanufacturingdeclinessteeplyduringarecessionintheUnitedStates,andthenfailstorecovermateriallyafterward.

/view/jschreger/CIP?authuser=0

CURRENTACCOUNT

Currentaccount(billionsof$)

Currentaccount(%GDP)

2% 300

1% 150

0% 0

-1% -150

-2% -300

-3% -450

-4% -600

-5% -750

-6% -900

-7% -1050

-8%

1961

1950

1960

1970

1980

1990

2000

2010

-1200

20202024

Figure3U.S.currentaccount.Source:BureauofEconomicAnalysis,HBCcalculations

ItmayseemoddtosupposethatreservedemandforTreasurysecuritiesplaysonlyasmallroleindeliveringfavorableborrowingterms,yetalargeroleincreatingcurrencyovervaluation.However,thatistheexplanationmostconsistentwithoutcomesinbothinterestratemarketsandthebalanceofpayments.Indeed,itisalsoconsistentwiththeideathatliquidityinjectionsultimatelyraiseinterestratesbecausetheystimulatestrongernominalgrowth.Othertheoreticalexplanationsforthiscombinationofoutcomescouldmakeinterestingresearch.

3)FinancialExtraterritoriality

Finally,ifthereserveassetisthelifebloodoftheglobaltradeandfinancialsystems,itmeansthatwhoevercontrolsthereserveassetandcurrencycanexertsomelevelofcontroltradeandfinancialtransactions.ThatallowsAmericatoexertitswillinforeigna