Economist's View: Kenneth Rogoff: Why Hasn't the Dollar Crashed Yet?
Mark Thoma watches as Ken Rogoff wonders why the dollar hasn't collapsed yet:
Economist's View: Kenneth Rogoff: Why Hasn't the Dollar Crashed Yet?: Many people have been asking why the dollar hasn't crashed yet. Will the United States ever face a bill for the string of massive trade deficits...?... [S]taggeringly, US borrowing now soaks up more than two-thirds of the combined excess savings of all the surplus countries in the world.... Foreigners are hardly reaping great returns on investing in the US. On the contrary, they typically get significantly lower returns than Americans get on their investments abroad. ...
[T]he central banks of Japan and China are holding almost two trillion dollars worth of low-interest... US treasury bonds and mortgages. This enormous subsidy to American taxpayers is, in many ways, the world's largest foreign aid program....
Most sober analysts have long been projecting a steady trend decline in the dollar.... So why hasn't more adjustment taken place already? The first answer, of course, is that the trade-weighted dollar has fallen--by more than 15% in real terms since its peak in early 2002. Yet the US deficits have persisted, and even risen, since then.
The real driving force has been two-fold. First and foremost, America's government and consumers have been engaged in a never-ending consumption binge. On the consumer side, this is quite understandable.... 25 years of stunning prosperity punctuated by only two mild recessions... Americans feel pretty confident about their economic situation.... People have enjoyed such huge capital gains over the past decade that most feel like gamblers on a long winning streak. By now, they see themselves as playing with the house's (or their houses') money.
It is less easy to rationalise... the US government.... When a... government launches a war, it typically cuts back... and raises taxes. The Bush administration did the opposite... good politics, for a time....
In order for the US economy to run deficits with the world, other countries must be willing to... supply... savings.... [T]here is global investment shortfall... due to... medium-term institutional roadblocks to investment in many developing countries, where long-term returns now seem to be by far the highest. The net result is that money is being parked temporarily in low-yield investments in the US, although this cannot be the long-run trend.
What then is future of the dollar? As long as the status quo persists... the US can continue to borrow... without immediate consequence.... Nevertheless, it is not hard to imagine... dollar collapses. Nuclear terrorism, a slowdown in China, or a sharp escalation of violence in the Middle East could all blow the lid off the current economic dynamic....
[T]he fact that the US trade balance has defied gravity for so many years has made it possible for the dollar to do so, too. But some day, the US may well have to pay the bill... [and] pray that their creditors will be as happy to accept dollars as they are now.
