The Almighty Greenback

BOOK REVIEW

Name:    THE DOLLAR TRAP

Author:   Eswar S. Prasad

Publisher:  PORTFOLIO Penguin, 2014.

The Almighty Greenback

The highly accomplished author of this meditation upon the US dollar early on makes the point that the dollar is the world’s reserve currency and ‘store of value’, even in these economically troubled times, and likely to stay preeminent going forward.

And that though the dollar is going to continue to depreciate against other currencies, particularly of countries that grow their economies more rapidly, it is trusted enough by nations around the globe to hold more than $5.6 trillion of the US Sovereign Debt.  

The second largest economy after the US, namely China, holds the highest amount of  US Debt, about $ 750 billion. The amount of notes the US prints continuously to provide liquidity to its economy at near zero per cent interest rates, does fuel domestic and global inflation. But post the financial crisis of 2008, other economies, those of Europe and other developed countries, are considered shakier than America’s, even with its $16.8 trillion gross federal debt growing apace.

But the ‘dynamics’ of public debt in advanced economies is expected to inexorably rise to $41 trillion by 2017, double the levels of 2007, before the US housing bubble burst, and brought on the global economic crisis in the first place. This represents an 81 per cent debt to GDP relationship, up from an already high 48 per cent to GDP in 2007.

The emerging markets, such as India, have a happier scenario, but FDI capital tends to flow out from poorer countries to richer ones. This Prasad calls ‘The Paradox of Uphill Capital Flows’. Reasons include untrained and unproductive labour in emerging countries, political instability, shallow capital markets, etc. There are other paradoxes too. Americans, much fewer in overall numbers, are ‘on average about eight times richer than the Chinese. Yet, it is the US that has been running a massive current account deficit’. Some advanced countries, led by the US, tend to be ‘net importers of capital’ to finance both their consumption and investment. And there are many individuals, institutions and governments, keen to lend to the Americans.

In the emerging markets, India and Turkey also import foreign capital in significant quantity. China, rather uniquely, is not only consistently ‘current account surplus’, but exports its capital extensively, accounting for 16 per cent of the total global capital exported, about $2.2 trillion in the period 2000-2012.

The economic performance gap between the debt-laden West and the more efficient emerging nations is widening, and Prasad suggests there will be a day of reckoning perhaps, in the relatively distant future.  For now, the statistics reveal quite a lot. The debt to GDP ratio in emerging markets was 29 per cent in 2007, but there is a projected decline to about 23 per cent of GDP in 2017. So emerging markets will do steadily better than advanced economies as the 21^st century progresses, signalling a ‘transformative shift in the balance of economic power’.

In 2007, the emerging markets accounted for 25 per cent of global GDP and 17 per cent of global debt, writes Prasad. In 2017, these same countries are expected to produce 40 per cent of global GDP and account for just 16 per cent of global debt.

And yet, the world feels ‘safe’ keeping its surpluses, or even its foreign exchange reserves, in US Treasury Bonds. This is because the entire developed world is closely tied to the US overseas economy, and there is effectively no other reserve currency of choice that derives succour from other sources worth the mention.

The Chinese Renminbi is not as yet even a theoretical alternative reserve currency, because the US has democratic institutions and a legal framework that the world sees as transparent and effective, versus the opacity of the Chinese system, run by a Communist Party without checks and balances.    

So, despite America being financially the most profligate nation of all, consuming far more than it produces, it is bolstered by the faith of the whole world fearing an economic holocaust should the current order collapse.

Perhaps, some Utopians have suggested, the world should have a single global currency so that currency volatility is no longer a problem, and cross border transactional costs are eliminated. But the Eurozone has already demonstrated its downside, where the weakest links have to be bailed out by the strongest for the zone’s mutual survival, whatever be the reasons. Also, an independent monetary policy becomes impossible, and who should run this global currency after all?

The United Nations, for example, meant to have been created as an equitable institution for all the nations of the world, is in reality mostly financed, housed and dominated by the United States. Similarly, the US dollar is most prized, over $ 750 billion of it in hard currency is held by people around the world, because it represents abiding value to them.

(803 words)

June 5^th, 2014

Gautam Mukherjee