Matt Yglesias writes more than a post per day about how he doesn’t understand why the Fed isn’t being more aggressive at easing to further reduce unemployment, or why we can’t simply devalue our currency against the renminbi, or why we don’t set a higher inflation target, or other topics related to monetary and exchange rate policy.
I understand where Matt’s coming from, and I don’t want to discount the possibility, which he raises frequently, that this is all a matter of class interests. But on the admittedly idealistic assumption that everyone involved is actually trying to look out for the national interest, here’s one reason why we might be acting more cautiously than he would like.
The dollar remains the predominant world reserve currency. As such, the U.S. government benefits from the ability to issue debt at a lower interest rate than would otherwise be the case, and the rest of the U.S. economy benefits in turn from this subsidy.
It will not always remain so. The United States’ percentage of the global economy will inevitably shrink over the next generation, as the mega-nations of China and India, along with Brazil and perhaps other nations (Russia? Turkey? Iran? Vietnam?) begin to realize their considerable upside economic potential. Regardless of whether Europe and Japan stagnate, and whether the United States regains the growth trend it was on prior to the recent crisis, at a certain point it is no longer going to be tenable for much of the world to transact in dollars or to subsidize American borrowing.
What will replace the dollar is a real question; most likely it will be no single other currency but a basket thereof, or a supra-national construct pegged to such a basket. But regardless of what replaces the dollar and how, eventually Americans are going to lose the benefits of being issuers of the global reserve currency.
But many factors will affect the timing of this shift, and one of them is the perception in foreign capitals of how serious America is about protecting the value of its currency. I don’t happen to think that markets are so skittish that an announcement of a 4% inflation target, say, would result in a run on the dollar. But I do think it would be a sufficiently significant departure from past practice as to raise real questions about the long-term prospects for dollar debt holdings. Which, in turn, would lead to an acceleration of the process of unwinding the dollar as global reserve currency.
Again: this is inevitable. It’s going to happen one day either way. But when it happens, it’ll cost us something in terms of diminished growth. So we rationally want to delay the inevitable.
A more aggressive effort to raise the rate of inflation in America, or to devalue the dollar against, particularly, the yen and renminbi, could indeed result in higher nominal growth in the United States, and hence lower unemployment. But it could also result in a more rapid move away from the dollar as a reserve currency, with a resulting rise in borrowing costs over and above the expected effect from higher expected inflation, and a cost in terms of lower long-term growth for the U.S. economy.
Which policy is optimal? That’s a judgment call; even in retrospect, we probably won’t agree on the answer. But the policy mix we’ve got now – a big spike in government debt and short rates at zero, but not actually maxing out the credit card and trying to end extraordinary monetary actions like quantitative easing as early as possible – doesn’t strike me as a crazy one. The distribution effects of the policy should be disturbing to someone with Matt’s political commitments – but that might be something we need to tackle some other way than by throwing caution to the winds on monetary policy.
Ultimately, I think the debate about whether the inflation target or the exchange rate should be here or there is somewhat off the most important point. The important point is that a shift away from the dollar is inevitable, and we should be preparing for a day in which it is relatively more expensive to borrow abroad than it is today, and where we have to generate more capital at home.
Does that mean we need to borrow less today? Not at all. You borrow when rates are low. Rates are now low.
What it does mean is that we need to be much more attentive to how we invest the money that we’re currently borrowing.
Both the United States and China spent a lot of money on economic stimulus during the recession. But the character of that spending was and is very different. The American stimulus was composed of things like tax cuts to boost consumer spending at the margin, assistance to the unemployed and poor for similar purpose (and to alleviate acute suffering), aid to the states to forestall layoffs of government workers, and so forth. China’s stimulus focused on rolling out to the interior provinces and second-tier cities the kind of infrastructure development they’ve already executed in the higher-income coastal regions. America borrowed from the future to keep people afloat today – which is good, because it is much more expensive to climb out of a hole than to avoid falling in. But China is investing in the future, their internal market. As the coast gets wealthier, it will move up the value chain, producing more and more valuable products for export; as the interior develops, low-wage manufacturing will move inland, exporting not only abroad but to the coastal regions, and importing higher-value products from the coastal regions rather than predominantly from abroad.
The United States can’t do what China is doing. We don’t have a deeply impoverished hinterland to develop, Mississippi and West Virginia notwithstanding. But there is still plenty we could do – in terms of changes to our tax code, to public investment priorities, to regulatory regimes, to to our immigration policy, to our education and health delivery systems – to prepare for a more competitive world, a world in which we will have to generate roughly the same amount of capital we deploy, rather than importing it from abroad.
I don’t get the sense that, in general, this is where the Obama Administration’s heart is, though the Administration definitely has some ideas. That said, it’s abundantly clear that the Republic Party as an institution is incapable of even thinking coherently about this kind of question. There are some smart guys out there writing papers and things, but the political leadership is completely incapable of even asking coherent questions about America’s future, much less answering them. Rather, the party is committed to a strategy of incoherent populist rage coupled with interest-group logrolling. It is hard for me to recall a time when I saw less to like about the G.O.P., and yes, I include the Bush years in that assessment. The Democrats seem wrong to me about a whole bunch of things. The Republicans are not even wrong.
Assuming I can keep focused, I’ll try to frame my own thinking on some of the areas I mention above in a series of posts. Consider them notes towards a policy platform for a party that does not currently exist.