The U.S. dollar seems invincible because each time there is economic turmoil, the rest of the world is forced to beat a path to America’s safe haven currency – a circumstance unlikely to change soon, according to Eswar Prasad, an economist and professor of trade policy at Cornell University.
In an interview with Steve Forbes for Forbes magazine
, Prasad noted the U.S. government has printed trillions of dollars since 2008 to keep the economy going, yet the huge paradox is that the dollar has not been debased.
Prasad said in fact many nations – especially in emerging markets – want to keep healthy levels of foreign exchange reserves, but there are few stable options for them.
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Europe is probably not going to put its money in China or Japan. And China, aware of ongoing weakness in Euro and the pan-European economy, is unlikely to turn to Europe. On top of that, global finance reform has made holding foreign reserves more important than ever in many countries.
“So, who’s left? The United States. And the U.S. is doing its bit for the world by prodigiously providing large amounts of safe assets. That is U.S. government securities,” he said.
Foreign confidence in the dollar was tested during the debt-ceiling crisis in October 2013, when the possibility of a technical U.S. default arose and it might have been logical for global investors to flee U.S. Treasury securities and the dollar.
“Instead, because there was no other place to go, people came to the U.S. to hide from the turmoil,” Prasad told Forbes.
“And just given the sheer amount of the U.S. Treasury securities and other dollar assets that the rest of the world holds, the rest of the world doesn’t want the dollar to plunge in value. Because if it did, then they would get hurt, in some ways even more than the U.S.”
Prasad noted many U.S. assets are denominated in foreign currencies. “And in fact, the U.S. is doing quite well, in terms of the returns it gets on those assets. So, even though the U.S. is a net debtor to the rest of the world, to the tune of $4.5 trillion, it’s actually making money on its net position.”
China, by contrast, is a net creditor to the rest of the world by about $1.7 trillion, but it is losing money because it’s mostly put a lot of its investments in the U.S. Treasury securities, and other very low-yield securities, Prasad said.
China places controls on its currency to keep its exchange rate low, unlike other developed nations that usually prefer to have their currencies float according to market demand.
Radio Free Asia
(RFA) reported that although China is expected to take over leadership from the U.S. as the world’s largest economy in 2014, the Chinese leadership is not celebrating.
Nicholas Lardy, an expert on the Chinese economy at the Peterson Institute for International Finance, said Chinese leaders fear that flaunting the country's wealth will result in greater pressure on Beijing to meet international and domestic expectations.
"I think the leadership is worried that saying that they are number one without taking into account that they have 1.3 billion people creates expectations that they cannot fulfill," Lardy told RFA.
If it became widely known inside China that it is the world's largest economy, there would be strong domestic demand for better health care and education, pollution control, a stronger pension system, and other benefits, Lardy predicted.
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