Does Making Sense of the Dollar still Make Sense?

Today is the third anniversary of the publication of my book, Making Sense of the Dollar:  Exposing Dangerous Myths about Trade and Foreign Exchange. The book presented big picture and long-term arguments about the future of the dollar and, more generally, the US commercial expansion strategy.

The thesis of the book is simply that the dollar and that expansion strategy is more durable than many–both friend and enemy–suspect.  I place it among the early responses to the current iteration of declinists, who believe the United States and the dollar are in an inexorable decline.

Whether or not the US is decline remains an open question.  The dollar itself is weaker.  On the Federal Reserve’s real (inflation adjusted) broad (inclusive of major and emerging markets) trade-weighted index declined a little more than 10% in the first two years after the book came out and appreciated by about 7% in third year.

However, my argument was not based on near or intermediate term price action.  Instead of price, my argument focused on role or function of the dollar in the global economy.  And here as a reserve asset there has been no such decline.  As the numeraire, the dollar’s role has not waned.  It is still the global benchmark.  Commodities are still priced and traded in dollars.  There are, of course, exceptions, but they are minor and do not detract from the generalization.

It is still the early days, though and much can still happen.  Three years ago and even more recently, many still saw the euro as the most likely successor of the dollar as the key international asset.   My book tried to address those arguments head-on.  It understood EMU as a work in progress, with a serious birth defect of not having a political union to compliment, reinforce and balance the monetary union.    Now the disintegration of the EMU seems to be more likely than the euro supplanting the greenback.

Chinese yuan appears to have replaced the euro as the currency of choice by the declininsts to be the next numeraire.  China has boosted the internationalization of the yuan through swap agreements with numerous foreign countries and has tried encouraging its trade to be invoiced in yuan.  The swap lines have lied mostly dormant and the percentage of trade invoiced in yuan seems quite marginal.  There has a few central banks that have sought for, and received permission, to buy Chinese bonds for reserve purposes.  However, it can hardly even be called a minor reserve currency yet.

The creation of an off-shore yuan market (Dim Sum) is though an important market development.  The yuan that trades there (CNH) has been embraced by many participants as a superior product to the non-deliverable forward market, which was previously the common way non-Chinese investors hedged or speculated on the yuan.  Yet the tightly controlled ability to bring the CNH into China (mainland itself) makes rather unique as Chinese officials try to square a circle.

The market for Dim Sum bonds is also quite narrow in terms of duration (3-years and less) and concentration (dominated by Chinese banks and real estate industry).  I suggested at the start of 2011 that perhaps what is going in is more the Sino-ification of Hong Kong more than the internationalization of the yuan.   While the possibility that the yuan replaces the dollar cannot and should not be dismissed,  all that can be fairly said at this juncture is, as Zhou Enlai reported said in the early 1970s, when asked about the political consequences of the French Revolution, ” It is too early to tell”.

It is also particularly difficult to evaluate the US commercial expansion strategy, which in the book, I argue, is based on foreign direct investment rather than export driven.  It is about meeting foreign demand by building and selling locally.  Given the global financial crisis, weak aggregate demand, oil shocks and other disruptions, both models have been challenged.

In the book I called the US strategy „evolutionary” as it responded to changes in the political economy environment.  I continue to believe it is a superior strategy and see evidence companies in Europe and Asia are adopting it.   Perhaps the two strategies are complimentary as well as competitive.

At the same time, however, with the financial fragmentation in Europe and the some signs of a return of the home bias elsewhere, and seeing what seems like the fragility of democratic institutions, my confidence of a liberal (in the classic sense of liberty–property rights, trade, tolerance) future,  which I articulated in the book, has been weakened.