The U.S. trade deficit grew from about 1 percent of gross domestic product in 2001 to more than 5 percent from 2005 to 2008, and this should have created a shortage of demand for U.S. goods and services and a recession. However, China took the dollars it obtained by suppressing the value of the yuan and purchased U.S. securities. U.S. consumers borrowed those dollars, against their homes and on credit cards and kept the U.S. economy going. Finally, the credit bubble burst and an even bigger recession resulted. Huge federal borrowing is now required to finance massive U.S. stimulus spending, bail out banks and otherwise rescue the U.S. economy.
All this borrowing floods capital markets with Treasury securities and pushes down exchange rates for the dollar against every major currency except the Chinese yuan. This reduces the value of the dollars, as expressed in euro and yen, held by China, Russia, Saudi Arabia and others.
Now China and others would like to see the dollar replaced by a basket of currencies. But instituting a global currency would pose enormous diplomatic and technical challenges. Without one, private merchants and financiers would still seek a central national currency to facilitate trade and denominate private, cross-border contracts and debts.
Even with a global currency, China could still buy dollars with yuan to keep its value suppressed against the dollar and boost exports into the United States. The United States would still have to run large federal deficits to avoid economic meltdown. And China would still be stuck holding dollars that fall in value against other currencies.
If China and others want that problem fixed, they need to abandon currency manipulation and let their populations purchase more U.S. goods and services. The U.S. economy would grow robustly, federal borrowing would subside, and the threat of too many dollars would vanish.
Peter Morici, a professor at the University of Maryland's Robert H. Smith School of Business, is the former chief economist at the U.S. International Trade Commission. His e-mail is pmorici@rhsmith.umd.edu.
