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21. Perspectives on Balance Sheet and Credit Policies: A Tribute to Marvin Goodfriend

Author:
Esther L. George
Publication Date:
10-2020
Content Type:
Journal Article
Journal:
The Cato Journal
Institution:
The Cato Institute
Abstract:
Iappreciate this opportunity to pay tribute to Marvin Goodfriend and his many contributions to the theory and practice of monetary policy. At the Kansas City Fed, we knew Marvin as a scholar and a good Federal Reserve colleague. Marvin also was a participant in a number of our Jackson Hole Economic Symposiums. As a Research Officer at the Richmond Fed, he attended the first symposium that we held in Jackson Hole, Wyoming, in 1982, where his work on “Discount Window Borrowing, Monetary Control, and the Post‐​October 6, 1979 Federal Reserve Operating Procedure” was widely cited.1 Thirty‐​four years later in 2016, as a professor at Carnegie Mellon, he presented a paper making the case for deeply negative interest rates as a policy tool that could breach the zero lower bound on nominal rates. He argued that “the zero interest bound encumbrance on monetary policy should be removed so that movements in the intertemporal terms of trade can be reflected fully in interest rate policy to sustain price stability and full employment with a minimum of inefficient and costly alternative policies” (Goodfriend 2016; 128; emphasis added).
Topic:
Monetary Policy, Finance, Interest Rates, and Credit
Political Geography:
Global Focus and United States of America

22. Assessing President Trump’s Trade Priorities

Author:
Daniel Griswold
Publication Date:
01-2019
Content Type:
Journal Article
Journal:
The Cato Journal
Institution:
The Cato Institute
Abstract:
President Trump has delivered on his promise to shake up Washington, arguably nowhere more so than in the policy space of international trade. President Trump’s trade agenda has challenged more than seven decades of bipartisan policy commitment to seeking lower trade barriers at home and abroad through negotiated agreements. While President Trump pays lip service to pursuing free trade and eliminating tariffs, his trade policies so far have been marked by higher U.S. duties on a range of products, from washing machines to steel. Under Section 301 of the Trade Act of 1974, the administration has imposed duties on $250 billion of imports from China, with those duties set to escalate in 2019 absent an agreement with China. And under Section 232 of the Trade Expansion Act of 1962, the president is threatening to impose a 25 percent duty on imported automobiles in the name of national security. The Trump administration has renegotiated existing trade agreements with Canada, Mexico, and South Korea, but its modifications are as likely to restrict trade as expand it. One of the president’s first actions after assuming office was to withdraw the United States from the pending Trans-Pacific Partnership, which would have eliminated almost all duties with 11 trading partners around the Pacific Rim, including Japan.
Topic:
Economy, Tariffs, Trade, and Donald Trump
Political Geography:
North America and United States of America

23. U.S.-China Relations: The Way Forward

Author:
P. H. Yu
Publication Date:
01-2019
Content Type:
Journal Article
Journal:
The Cato Journal
Institution:
The Cato Institute
Abstract:
As confrontation looms over Washington and Beijing, it is critical to identify the true nature of this challenge from an international relations perspective before any attempt to devise a counter measure. Wrong presumptions or prejudicial interpretations may lead to dire consequences of unforeseeable magnitude. One past example would be the U.S. government’s belief that Iraq was developing weapons of mass destruction (WMDs) before the American invasion in 2003. A more current example would be the American nuclear anxiety on North Korea and how President Trump bypassed conventional American strategic thinking and circumvented hawkish threats of preemptive nuclear annihilation to resolve a “draconian crisis” via “smart diplomacy.” These examples may shed light on a pathway to resolution for the current U.S.-China trade conflict. The United States and China have ample experience of weathering a crisis on the brink of war, whether it was on the Korean Peninsula or in Indochina. China today remains on the U.S. sanctions list for certain high-tech products and military equipment. Both the Trump administration and Congress continue to criticize China regularly, ranging from human rights to religious rights, from the rule of law to the autocratic political system, from the state-owned banks to restrictive market access to foreign corporations, and from currency manipulation to unfair trade practices.
Topic:
International Relations, Bilateral Relations, Trade Wars, and Trade
Political Geography:
China, Asia, North America, and United States of America

24. Flawed Plan to Keep Out Welfare‐​Using Immigrants

Author:
David Bier
Publication Date:
01-2019
Content Type:
Journal Article
Journal:
The Cato Journal
Institution:
The Cato Institute
Abstract:
The Trump administration has proposed a new regulation that would greatly expand an old rule banning legal residence to immigrants deemed “likely to become a public charge”—that is, someone who the government has the responsibility to care for (USCIS 2018). The rule does not, nor could it, change eligibility for welfare programs for noncitizens in the United States. Instead, it requires applicants to prove that they are not likely, in the future, to become so dependent on welfare that they become a “public charge.” Therefore, the question regarding this regulation is not whether it is appropriate for noncitizens to become dependent on welfare, but whether the government will accurately predict their likelihood of doing so.
Topic:
Immigration, Welfare, and Donald Trump
Political Geography:
North America and United States of America

25. American Constitutional Theory and History: Implications for European Constitutionalism

Author:
Roger Pilon
Publication Date:
10-2018
Content Type:
Journal Article
Journal:
The Cato Journal
Institution:
The Cato Institute
Abstract:
It is perhaps not impertinent to suggest that American constitutional theory and history, owing to the longevity of the document that is their subject, hold lessons for constitutionalism everywhere, but especially for European constitutionalism—the more recent and ever evolving treaties that serve as a “Constitutional Charter” for the European Union. An American constitutionalist looking east today, seeing everything from Brexit to Grexit plus the reactions in European capitals, must be struck by the tension in the EU between exclusion and inclusion in its many forms, including individualism and collectivism. Those themes underpin my discussion here. The issues surrounding them are universal. They are at the heart of the human condition.
Topic:
Markets, History, European Union, and Constitution
Political Geography:
Europe, North America, and United States of America

26. Rethinking the International Monetary System

Author:
John B. Taylor
Publication Date:
06-2016
Content Type:
Journal Article
Journal:
The Cato Journal
Institution:
The Cato Institute
Abstract:
In previous articles in the annual monetary issue of the Cato Journal, I drew on historical facts and economic theory to explain the benefits of rules-based monetary policy and why legislation could help the United States reap those benefits (Taylor 2011, 2013a). In this article, I discuss the international aspects of monetary policy, a subject often glossed over in modern debates about rules-based policy, at least compared with discussions about the classic rulesbased gold standard.
Topic:
Economics, International Cooperation, and Monetary Policy
Political Geography:
North America, Global Focus, and United States of America

27. Subnational Economic Freedom and Performance in the United States and Canada

Author:
Daniel L. Bennett
Publication Date:
01-2016
Content Type:
Journal Article
Journal:
The Cato Journal
Institution:
The Cato Institute
Abstract:
During his illustrious career spanning more than half a century, Richard Vedder has tirelessly advocated for limited government and free enterprise. Much of his scholarship has focused on examining how fiscal and labor market policies consistent with the principles of economic freedom are associated with economic and social benefits such as stronger economic performance (Vedder 1981, 1990), lower unemployment (Vedder and Gallaway 1996, 1997), and poverty alleviation (Vedder and Gallaway 2002). Vedder has also examined the impact of government policy on income inequality (Vedder 2006; Vedder and Gallaway 1986, 1999; Vedder, Gallaway, and Sollars 1988), an area that he and I have collaborated to study (Bennett and Vedder 2013, 2015). Thus, Vedder’s scholarship has contributed to our understanding of the impact that economic freedom exerts on economic outcomes.
Topic:
Government, Income Inequality, Economy, and Free Trade
Political Geography:
Canada, North America, and United States of America

28. Global Imbalances: A Source of Strength or Weakness?

Author:
Kristin J. Forbes
Publication Date:
07-2007
Content Type:
Journal Article
Journal:
The Cato Journal
Institution:
The Cato Institute
Abstract:
Gross capital flows into the United States totaled $1.8 trillion in 2006. When combined with the $1.0 trillion the United States sent abroad, these net capital inflows funded the U.S. current account deficit of about $800 billion.1 The source of a large proportion of these capital inflows was developing economies—especially China and major oil exporters. Why are foreigners willing to invest such massive amounts of money in the U.S. economy? And perhaps even more surprising—why are countries with low levels of investment willing to send this relatively scarce resource to a capital-abundant economy instead of investing in their own countries? Understanding the motivation behind the millions of individual decisions that drive these capital inflows is critically important to understanding if this massive net transfer of capital into the United States reflects a strength or weakness of the global economy.
Topic:
Economy, Investment, and Capital
Political Geography:
Global Focus and United States of America

29. The Role of Monetary Policy in the Face of Crises

Author:
Anna J. Schwartz
Publication Date:
07-2007
Content Type:
Journal Article
Journal:
The Cato Journal
Institution:
The Cato Institute
Abstract:
In this article I first review the Greenspan Fed’s record of providing liquidity in response to its perception of shocks the economy is facing. It assumed that the shocks were likely to generate financial crises. No financial crises, however, have occurred. Yet the Fed was dilatory in draining the market of unneeded liquidity. Failure to do so meant that monetary policy remained accommodative. I next discuss whether there is a connection between the Fed’s accommodative policy and the depreciation since 2002 of the exchange value of the dollar as well as the twin deficits and growing global imbalances. In that discussion I refer to the need to raise the national saving rate, in part by eliminating the budget deficit as well as projected deficits from the unfunded liabilities of Social Security and Medicare. Monetary policy, however, must be independent of fiscal policy. I conclude with some observations on the advisability of adoption by the Fed of inflation targeting.
Topic:
Monetary Policy, Federal Reserve, and Economy
Political Geography:
North America and United States of America

30. The Columbian Exchange and the Reversal of Fortune

Author:
Thomas Grennes
Publication Date:
01-2007
Content Type:
Journal Article
Journal:
The Cato Journal
Institution:
The Cato Institute
Abstract:
It is difficult to think about modern American food without including hamburgers and hotdogs. It is also difficult to think about popular American history without cowboys mounted on horseback tending herds of cattle. However, before the arrival of Columbus in 1492 there were no cattle or pigs in America to provide beef and pork for hamburgers and hotdogs. There was no wheat to make hamburger and hotdog buns. There were no horses for cowboys or Indians to ride. The European settlers brought with them cattle, pigs, horses, wheat, and many other plants and animals that became the foundation for modern food and agriculture in the Western Hemisphere. It is also difficult to think about modern Mexican food without including rice, tacos filled with meat, refried beans in animal fat, cheese in enchiladas, and sugar, cinnamon, and milk in chocolate. However, Mexico in 1492 had none of these ingredients. The massive transplantation of plants and animals across the Atlantic Ocean in both directions has been called the Columbian Exchange (Crosby 1972). It has been described as the “greatest human intervention in nature since the invention of agriculture (Fernandez-Armesto 2002: 165), and it has had an enormous effect on the Americas and the entire world. The Columbian Exchange altered the kind of food Americans and Mexicans eat, the kind of agricultural products produced in both countries, and the entire pattern of world economic growth. This article will concentrate on the effects of the Columbian Exchange, but the exchange of plants and animals was part of a broader process of trade, migration, investment, colonization, and exchange of ideas that followed the voyages of discovery by Columbus and others. The same Old World plants and animals were introduced to the two regions that would become the United States and Mexico, but the effects in the two countries were substantially different.1 The United States was the poorer neighbor in 1492, but it became relatively richer. The purpose of this article is to show how differences in institutional development affected responses to the same opportunities. I shall concentrate on developments in the United States and Mexico, but the Canadian experience was similar to the U.S. response, and the response in the rest of Latin America was similar to the Mexican response (Cole et al. 2005).
Topic:
Migration, History, Food, Investment, Trade, and Columbian Exchange
Political Geography:
North America, Mexico, and United States of America

31. Remuneration vs. Reelection: A Senatorial Balancing Act

Author:
Jim F. Couch, Brett A. King, and Taylor P. Stevenson
Publication Date:
01-2007
Content Type:
Journal Article
Journal:
The Cato Journal
Institution:
The Cato Institute
Abstract:
Unique events often give rise to other unique events. Such was the case of Hurricane Katrina—the costliest and most destructive natural disaster in U.S. history. The resulting casualties and staggering damage estimates from the savage storm in late August 2005, led the U.S. Senate to vote overwhelmingly (92 to 6) against a Senate pay raise. Most senators apparently felt that voters would not look kindly on a Senate pay raise given the devastation caused by Katrina. The Senate vote was largely symbolic because the House of Representatives was not going to take a vote on rescinding a pay raise for members of Congress. Thus, senators voting against the raise knew their votes would resonate well with voters but have no impact on the annual congressional pay raise sanctioned by law. Of the six senators who did vote for the pay raise, five—James Jeffords (I-Vt.), Daniel Inouye (D-Hawaii), Jeff Bingaman (D-N.M.), Richard Lugar (RInd.), and Kit Bond (R-Mo.)—were long-time incumbents whose seats were not threatened, and one—Paul Sarbanes (D-Md.)—was about to retire. Typically, votes cast by members of Congress are relatively easy to predict. The empirical analysis of congressional voting patterns suggests that measures of ideology and party affiliation play a decisive role in explaining overall voting behavior. A vote on congressional pay, however, is not typical. It creates a dilemma for lawmakers by pitting two margins of self-interest against each other: pecuniary gains and reelection. Senators are clearly made better off by not opposing annual pay raises—salaries have increased from $98,400 in 1990 to $165,200 in 2006. Yet, those increases are likely to irritate voters and could harm a senator’s chances for reelection. In this article, we examine those conflicts of interest and how they affect voting behavior in the case of senatorial pay raises. It is often reported that cooperation among politicians, or bipartisanship, is a thing of the past. However, our results suggest that at least in the case of the Senate, when it comes to an issue as controversial as a pay increase, senators are fully capable of cooperating. More vulnerable senators (in terms of their probability of reelection) are allowed to vote against a pay raise, knowing that those in a more secure position can vote for the increase. The more vulnerable senators likely compensate senators who take the unpopular position of voting in favor of the pay increase with favorable votes on future legislation.
Topic:
Elections, Domestic Politics, Ideology, and Voting Behavior
Political Geography:
North America and United States of America

32. Global Imbalances: Do They Matter?

Author:
Miranda Xafa
Publication Date:
01-2007
Content Type:
Journal Article
Journal:
The Cato Journal
Institution:
The Cato Institute
Abstract:
This article reviews the recent literature on global imbalances and discusses the policy implications of the various theories that have been advanced to explain their unprecedented increase. Most of these theories fit the stylized facts, namely, the steady increase in the U.S. current account deficit, the shift to a surplus position of the developing countries, and the low nominal and real interest rates globally. The “low U.S. savings” theory—reflecting the increase in the fiscal deficit and in housing wealth—views the current account deficit as the result of fiscal and monetary policy decisions in the United States that need to be urgently reversed to prevent a crash landing. Other theories however, focusing on developments outside the United States, portfolio balance effects, or previously neglected benign factors, do not yield such a doomsday scenario. It is relevant to note that there is no historical precedent of disorderly exchange rate adjustment in industrial countries that keep inflation under control (Croke, Kamin, and Leduc 2005). Concerns over a disorderly unwinding of global imbalances therefore appear exaggerated. This view, prevalent among market participants and several prominent academics, has not been widely embraced by policymakers.
Topic:
Monetary Policy, Economy, Wealth, and Savings
Political Geography:
Global Focus and United States of America

33. Why the U.S. External Imbalance Matters

Author:
William R Cline
Publication Date:
01-2007
Content Type:
Journal Article
Journal:
The Cato Journal
Institution:
The Cato Institute
Abstract:
Last year the U.S. current account deficit (mainly on trade but including capital income and transfers) reached almost 7 percent of GDP, or about twice as large a share as in 1987, the peak of the previous episode of large external imbalances and dollar overvaluation. A major reason is that from 1995 to 2002 the dollar rose by 28 percent against other currencies, after taking account of inflation and weighting by trade. A strong dollar made U.S. exports expensive and imports cheap, driving up the trade deficit after about a two-year reaction time. With large and persistent external deficits, the United States has swung from being the world’s largest creditor nation to its largest debtor, with net foreign liabilities now at about one-fourth of GDP. The dollar has corrected somewhat and is now about 13 percent lower on a trade-weighted basis than its average in 2002, based on the Federal Reserve’s broad real exchange rate index. Without that partial correction the trade deficit would now be even larger. It will likely require a decline of an additional 15 to 20 percent in the dollar to cut the current account deficit back to about 3 percent of GDP. That rate would be consistent with limiting net foreign liabilities to 50 percent of GDP in the long term. Exceeding that ceiling would seem imprudent for both the U.S. and global economies. It will be crucial that China, Japan, and much of the rest of Asia participate in realignment of their currencies against the dollar, because the decline of the dollar so far has been heavily concentrated against the euro and other industrial country currencies except for the Japanese yen. Dollar correction will also need to be accompanied by fiscal adjustment. Otherwise much of the competitive effect of the dollar adjustment would be offset by higher inflation and a dollar rebound from higher interest rates. Fundamentally the external deficit is the excess of resources used over resources produced, and with U.S. household saving near zero, the government cannot be a large net borrower without keeping the nation in large external deficit.
Topic:
Government, Finance, Economy, Currency, and Deficit
Political Geography:
North America and United States of America

34. Stockholders and Stakeholders: The Battle for Control of the Corporation

Author:
Donna Card Charron
Publication Date:
01-2007
Content Type:
Journal Article
Journal:
The Cato Journal
Institution:
The Cato Institute
Abstract:
The American corporation is in trouble not only because of various immoral executives, but also because it is a target of sustained attacks. For several decades, corporate revisionists have toiled to transform the corporation from private to public property. Were they to succeed, the tragedy of the commons would slowly sap the corporation of its vitality. My objective in exposing the battle for corporate control is to urge and encourage those committed to the preservation of this highly performing institution to place the issue more prominently on their agenda. To this end, I detail the evolution of the battle and assess the present state of affairs. In so doing, I describe and critique “stakeholder theory,” the revisionist’s chosen weapon for gaining control of the corporation. Stakeholder theory currently dominates textbooks and syllabi of courses in business management, human resource management, marketing, and public policy. It colors the decisions of many corporate executives. And it controls the thinking in the majority of business ethics centers. Aware of its reach, I adumbrate a strategy for reversing the destructive inroads of stakeholder theory.
Topic:
Business, Management, Corporations, and Stakeholders
Political Geography:
North America and United States of America

35. Independent Central Banks: New and Old

Author:
John H. Wood
Publication Date:
10-2006
Content Type:
Journal Article
Journal:
The Cato Journal
Institution:
The Cato Institute
Abstract:
In the 1990s, several governments gave their central banks operational independence to pursue low inflation, and steps were taken to make the new monetary policy more credible by making it more transparent (Bernanke et al. 1999). The governor of the Reserve Bank of New Zealand is subject to dismissal if inflation is outside the assigned range. In the United Kingdom, if inflation misses the target by more than 1 percentage point, the governor must explain publicly why the divergence occurred and what steps the Bank of England is taking to deal with it. The new transparency “facilitates public understanding of monetary policy and increases the incentives for the central bank to pursue the announced goals of monetary policy” (Svensson 1999: 631–32). Accountability is increased, indeed made possible, by the choice of a unique objective, which implies “a stronger commitment to a systematic and rational optimizing monetary policy than other monetary policy regimes” (p. 608).
Topic:
Monetary Policy, Inflation, and Central Bank
Political Geography:
England and United States of America

36. Tobacco Control Programs and Tobacco Consumption

Author:
Michael L. Marlow
Publication Date:
10-2006
Content Type:
Journal Article
Journal:
The Cato Journal
Institution:
The Cato Institute
Abstract:
The Centers for Disease Control and Prevention (CDC) believe that adequate funding of tobacco control programs by all 50 states would reduce the number of adults who smoke by promoting quitting, preventing young people from ever starting, reducing exposure to secondhand smoke, and eliminating disparities in tobacco use among population groups. CDC has established guidelines for comprehensive tobacco control programs, including recommended funding levels, in Best Practices for Comprehensive Tobacco Control Programs (CDC 1999; hereafter called Best Practices). Recommendations are based on best practices in nine program elements: community programs to reduce tobacco use, chronic disease programs to reduce the burden of tobacco-related diseases, school programs, enforcement, statewide programs, countermarketing, cessation programs, surveillance and evaluation, and administration and management. CDC recommends annual funding per capita to range from $7 to $20 in smaller states (population less than 3 million), $6–$17 in medium-sized states (population 3–7 million), and $5–$16 in larger states (population more than 7 million).
Topic:
Tobacco, Public Health, and Public Spending
Political Geography:
North America and United States of America

37. Does “Starve the Beast” Work?

Author:
Jerry H. Tempelman
Publication Date:
10-2006
Content Type:
Journal Article
Journal:
The Cato Journal
Institution:
The Cato Institute
Abstract:
Starve-the-beast proponents believe that in order to tame the beast, one needs to starve it, with the beast being an obvious reference to Thomas Hobbes’s Leviathan depiction of an out-of-control state apparatus. The idea of tax reductions as a way to enforce discipline in government spending holds regardless of whether the nation is in the midst of an economic expansion or a recession. Following the recurrence of federal budget deficits that coincided with the enactment of federal tax cuts during 2001–2003, the starvethe-beast approach to fiscal policy that once was one of the underpinnings of the Reagan Revolution has become increasingly controversial. It is no longer mainly the political left that criticizes the starve-the-beast approach. Even some Republicans who once participated in the move to a smaller government during the Reagan presidency now criticize starve-the-beast thinking. Recently, William Niskanen (2005) has used statistical evidence to demonstrate that a decrease in taxes in a given year is followed by an increase in spending the next. Bruce Bartlett (2005) has proposed raising taxes, namely by introducing a value-added tax, presumably to prevent having to increase less efficient income taxes later.
Topic:
Budget, Economy, Tax Systems, and Fiscal Policy
Political Geography:
North America and United States of America

38. Limiting Government: The Failure of “Starve the Beast”

Author:
William A. Niskanen
Publication Date:
10-2006
Content Type:
Journal Article
Journal:
The Cato Journal
Institution:
The Cato Institute
Abstract:
For nearly 30 years, many Republicans have argued that the most effective way to control federal government spending is to “starve the beast” by reducing federal tax revenues. Moreover, two Nobel laureate economists, Milton Friedman and Gary Becker, have endorsed this argument. Friedman (2003) summarized this perspective as follows: How can we ever cut government down to size? I believe there is one and only one way: the way parents control spendthrift children, cutting their allowance. For governments, this means cutting taxes. Resulting deficits will be an effective—I would go so far as to say, the only effective—restraint on the spending propensities of the executive branch and the legislature. The public reaction will make that restraint effective. Becker and his colleagues Ed Lazear and Kevin Murphy (2003) described this effect as “the double benefit of tax cuts.” (Lazear is the recently appointed chairman of the Council of Economic Advisers.) This argument has been effective in unifying the Republican Party in favor of reducing federal taxes, but at the cost of undermining the more traditional Republican concern about fiscal responsibility.
Topic:
Government, Economy, Tax Systems, Fiscal Policy, and Public Spending
Political Geography:
North America and United States of America

39. U.S.-China Relations: The Case for Economic Liberalism

Author:
James A. Dorn
Publication Date:
10-2006
Content Type:
Journal Article
Journal:
The Cato Journal
Institution:
The Cato Institute
Abstract:
In its 2005 Report to Congress, the U.S.-China Economic and Security Review Commission—also known as the U.S.-China Commission (USCC)—recommended that China appreciate its currency, the renminbi (RMB), “by at least 25 percent against the U.S. dollar” or face “an immediate, across-the-board tariff on Chinese imports.” The commission argued that such an action could be justified under Article XXI of the World Trade Organization (WTO), “which allows members to take necessary actions to protect their national security.” The key idea behind the commission’s protectionist policy stance is that “China’s undervalued currency has contributed to a loss of U.S. manufacturing, which is a national security concern” (USCC 2005: 14).
Topic:
Bilateral Relations, Economy, Trade, and Liberalism
Political Geography:
China, Asia, North America, and United States of America

40. The U.S. Dollar and Prosperity: Accidents Waiting to Happen

Author:
Reuver Brenner
Publication Date:
07-2006
Content Type:
Journal Article
Journal:
The Cato Journal
Institution:
The Cato Institute
Abstract:
Development in the rest of the world depends on the United States because America continues to be the engine of the world economy and the U.S. dollar is the main reserve currency. In this article, I examine the prospects of America remaining an economic superpower and the dollar maintaining its status as a reserve currency. I also show that unless the United States succeeds financial markets and development around the world will suffer. During the last decade, the U.S. dollar has experienced wide fluctuations. The dollar’s real effective exchange rate relative to the seven major currencies varied from about 80 in 1995 to 120 in 2001, and back to 90 in 2005 (BIS 2005: 91). The dollar was up roughly 30 percent relative to commodity prices between 1997 and 2001. Then, between 2002 and the end of 2004, the dollar fell by about 30 percent relative to gold and commodities. During the first 10 months of 2005, all hard currencies (except the Canadian and Australian dollar) were down by another 15 percent relative to gold. Nevertheless, the bond market still expects a stable dollar over the long haul, as reflected in long-term interest rates. The relative stability of the long-term interest rates offers comfort because the world depends on a predictable value of the dollar. The havoc its demise as reserve currency would provoke is hardly imaginable. The significant upward movement in the U.S. dollar during the late 1990s brought financial, political, and social havoc in countries that either pegged their currencies to the dollar or had currency boards, Argentina’s case being the most prominent. Later, the decline in the dollar between 2002 and 2004 has brought about much antagonism in trade relations around the world and cries for protectionism. Even with the dollar’s volatility around a downward trend since 2002, the euro did not displace the U.S. dollar as the world’s main reserve currency—and will not do so unless drastic events happen, which I do not foresee.1 One such drastic event would be an utter mismanagement of the U.S. dollar. Another would be the European Central Bank (ECB) announcing that it was moving toward targeting the price of gold to manage the euro. The ECB would then become a supranational monetary institution independent of all political pressures. Anchoring the euro to the price of gold would reflect changes in global demands for euro liquidity, functioning as a reserve currency. The reason I do not expect the euro to replace the U.S. dollar as the main reserve currency, unless either of these two events happens, is that the euro is the very first paper currency not backed either by a strong government or by gold. It is a unique experiment. For the euro to become a reserve currency, the eurozone would have to run persistent trade deficits, allowing surplus countries to build up their euro reserves. To achieve that outcome, however, the eurozone countries would have to radically reform their fiscal and regulatory policies, to encourage far more domestic entrepreneurship and consumption than they presently do. This scenario does not seem to be in the cards. Indeed, as Europe’s population gets older, meaningful reform becomes less likely, and I do not see any chance for a strong European government to emerge and tackle the situation. Aging baby boomers, who dominate Europe’s voters, prefer the status quo. In sum, the chances of the euro becoming a serious alternative to the U.S. dollar as a reserve currency are slim, or nonexistent. The Federal Reserve would have to seriously mishandle monetary affairs for this to happen.
Topic:
Currency, Economic Development, and Dollar
Political Geography:
Global Focus and United States of America