• Trade imbalances would adjust to more accurately reflect import and export demand, and not be subject to appreciation whenever random people’s banana republic subsidizes its exports through exchange rate controls.
• A weaker dollar, other things equal, should lead to more expensive commodities for the U.S. Anyone who’s in favor of a gas tax could extol the long-term environmental and structural benefits of such a situation. Less reliance on rapacious oil sheikhs, more incentives to develop sustainable clean energy etc…
• Conversely, exports in general become more competitive.
• More punitive interest rates on debt might induce future administrations to think more strongly about committing umpteen-billions to liberating oil fields or digitizing health care records. Deficit hawks should love this feature.

However, insofar as rhetoric goes, the U.S. is claiming commitment to a strong dollar. If you read about it long enough, one sort of gets the impression that Geithner & Co are holding limp Chinese and Russian hands, chanting the foreign exchange equivalent of “why are you hitting yourself!? Stop hitting yourself! Why are you hitting yourself!?” Foreign governments and sovereign wealth funds are engaged in an equally ridiculous kabuki, threatening to sell their reserves while simultaneously buying more.

This FT article by Martin Wolf does an excellent job of making the case while simultaneously pointing out the problems of actually getting there. Since the U.S. is rich and unlikely to turn into a failed state, it makes sense that some people would want dollars if they have to store wealth. This leads to a paradox: the better of a job the U.S. does at cleaning up its fiscal house will reinforce the dollar’s reserve currency status, making it easier to engage in the reckless fiscal behavior that draws so much ire. Wolf writes:

In the 1960s, Robert Triffin, a Belgian-American economist, argued that a global monetary system based on the dollar had a flaw: the increased liquidity the world sought would require current account deficits in the US. But, sooner or later, the overhang of monetary liabilities would undermine confidence in the key currency. This view – known as the “Triffin dilemma” – proved prescient: the Bretton Woods system fell in 1971.

Strictly speaking, reserves could be created if the key-currency country merely borrowed short term and lent long term. But, in practice, the demand for reserves has generated current account deficits in the issuing country. In a floating exchange-rate regime reserve accumulations should also be unnecessary. But, after the financial crises of the 1990s, emerging countries decided they needed to pursue export-led growth and insure themselves against crises. As a direct result, three quarters of the world’s currency reserves have been accumulated just in this decade.

Yet this very search for stability risks creating long-run instability. Indeed, Chinese policymakers are worried about the risk to the value of their vast dollar holdings that, on Triffin’s logic, their own policy exacerbates. US policymakers may repeat the “strong dollar” mantra. But this is an aspiration without an instrument. Relevant policy is made by the Federal Reserve, which has no mandate to preserve the dollar’s external value. The only way China’s policymakers can preserve the domestic value of external holdings is to support the dollar without limit, which compromises China’s domestic monetary stability and will prove self-defeating in the end.

Of course, actually getting there could prove difficult. From naked capitalism:

… this view is implicitly based on the idea that the dollar will somehow find its “correct” level, more or less. But currencies are known for their propensity to overshoot and stay for long periods at levels not warranted by fundamentals. The yen is a prime example. Even with Japan’s lousy domestic economy, its large (until recently) trade surpluses would have argued for an appreciation of the yen. However, the currency stayed super cheap because the yen had become a funding vehicle. It was only when the carry trade unwound and domestic currency speculators exited their foreign bets that the yen rallied, and is now at levels that seem similarly unwarranted by the fundamentals. To his credit, Munchau does not see some welcome weakness of the dollar as a long-term solution; he highlights the need for structural reforms.

… Also if the Yuan appreciates my real income goes up. But that’s entirely ancillary to this line of reasoning.

At first glance, there doesn’t appear to be much of a relationship. If anything it’s Japan we need to be worried about, and the imminent threat Japan poses to America’s hegemony hasn’t been news for the last 20 years. Regardless, there are many variables other than relative currency strength that need to be considered when evaluating long term economic health. You could create a more coherent narrative that the USD Index appears to be inversely correlated with total debt issuance by the US government, but that also seems to ignore other variables causal variables – you have to create the debt before anyone can buy it. If the whole system is a myth in the making, it’s not the Chinese one needs to be worried about. They’ve bought in lock, stock and barrel.

Treasury holdings displayed in Billions USD. Data from US Treasury International Capital System.