Guest Post: The Growing Risks To The Dollar

Tyler Durden's picture

Authored by Martin Feldstein, originally posted at Project Syndicate,

Two Dollar Fallacies

The United States’ current fiscal and monetary policies are unsustainable. The US government’s net debt as a share of GDP has doubled in the past five years, and the ratio is projected to be higher a decade from now, even if the economy has fully recovered and interest rates are in a normal range. An aging US population will cause social benefits to rise rapidly, pushing the debt to more than 100% of GDP and accelerating its rate of increase. Although the Federal Reserve and foreign creditors like China are now financing the increase, their willingness to do so is not unlimited.

Likewise, the Fed’s policy of large-scale asset purchases has increased commercial banks’ excess reserves to unprecedented levels (approaching $2 trillion), and has driven the real interest rate on ten-year Treasury bonds to an unprecedented negative level. As the Fed acknowledges, this will have to stop and be reversed.

While the future evolution of these imbalances remains unclear, the result could eventually be a sharp rise in long-term interest rates and a substantial fall in the dollar’s value, driven mainly by foreign investors’ reluctance to continue expanding their holdings of US debt. American investors, fearing an unwinding of the fiscal and monetary positions, might contribute to these changes by seeking to shift their portfolios to assets of other countries.

While I share these concerns, others frequently rely on two key arguments to dismiss the fear of a run on the dollar: the dollar is a reserve currency, and it carries fewer risks than other currencies. Neither argument is persuasive.

Consider first the claim that the dollar’s status as a reserve currency protects it, because governments around the world need to hold dollars as foreign exchange reserves. The problem is that foreign holdings of dollar securities are no longer primarily “foreign exchange reserves” in the traditional sense.

In earlier decades, countries held dollars because they needed to have a highly liquid and widely accepted currency to bridge the financing gap if their imports exceeded their exports. The obvious candidate for this reserve fund was US Treasury bills.

But, since the late 1990’s, countries like South Korea, Taiwan, and Singapore have accumulated very large volumes of foreign reserves, reflecting both export-driven growth strategies and a desire to avoid a repeat of the speculative currency attacks that triggered the 1997-1998 Asian financial crisis. With each of these countries holding more than $200 billion in foreign-exchange holdings – and China holding more than $3 trillion – these are no longer funds intended to bridge trade-balance shortfalls. They are major national assets that must be invested with attention to yield and risk.

So, although dollar bonds and, increasingly, dollar equities are a large part of these countries’ sovereign wealth accounts, most of the dollar securities that they hold are not needed to finance trade imbalances. Even if these countries want to continue to hold a minimum core of their portfolios in a form that can be used in the traditional foreign-exchange role, most of their portfolios will respond to their perception of different currencies’ risks.

In short, the US no longer has what Valéry Giscard d’Estaing, as France’s finance minister in the 1960’s, accurately called the “exorbitant privilege” that stemmed from having a reserve currency as its legal tender.

But some argue that, even if the dollar is not protected by being a reserve currency, it is still safer than other currencies. If investors don’t want to hold euros, pounds, or yen, where else can they go?

That argument is also false. Large portfolio investors don’t put all of their funds in a single currency. They diversify their funds among different currencies and different types of financial assets. If they perceive that the dollar and dollar bonds have become riskier, they will want to change the distribution of assets in their portfolios. So, even if the dollar is still regarded as the safest of assets, the demand for dollars will decline if its relative safety is seen to have declined.

When that happens, exchange rates and interest rates can change without assets being sold and new assets bought. If foreign holders of dollar bonds become concerned that the unsustainability of America’s situation will lead to higher interest rates and a weaker dollar, they will want to sell dollar bonds. If that feeling is widespread, the value of the dollar and the price of dollar bonds can both decline without any net change in the holding of these assets.

The dollar’s real trade-weighted value already is more than 25% lower than it was a decade ago, notwithstanding the problems in Europe and in other countries. And, despite a more competitive exchange rate, the US continues to run a large current-account deficit. If progress is not made in reducing the projected fiscal imbalances and limiting the growth of bank reserves, reduced demand for dollar assets could cause the dollar to fall more rapidly and the interest rate on dollar securities to rise.

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DJ Happy Ending's picture

This is all true but the USD is currently the least worst of all the world's fiat.

Zap Powerz's picture

And it will remain that way right up until it isnt.

francis_sawyer's picture

My last fart was the least stinky out of my last 10... Shall I bottle up & sell it to you as perfume?...

chumbawamba's picture

Are articles from 2009 merely being recycled by lazy authors who need to fill column space?

I am Chumbawamba.

francis_sawyer's picture

I thought it WAS 2009... Because I see "green shoots" everywhere... Obama has his 'Economic Dream Team' poised & ready 2 go... I saw it on TV so it must be true...

Stackers's picture

Its the same with the IRS. You basically have to be destitute and homeless for them to even think about discharging unpayable back taxes.

Tijuana Donkey Show's picture

It can be done, you just have to work the system a bit. Did you look at a OIC? 

Radical Marijuana's picture

Is history itself being merely recycled from the collapse of 2008? It looks like it to me. We are stuck in the same rut, wearing the bottom out, until we finally collapse through the worn out bottom of that rut ... Until then, there is nothing to do but repeat the same old stuff, as we are still going around and around in the same old rut.

Relatively speaking, most of us are still sitting on the warm, sunny beach, watching the storm clouds of a hurricane approach on the satellites. We worry about what that beach will be like when that hurricane finally comes, and so, articles like this recycle those worries, as we wonder about the precise, but unpredictable path that hurricane will take.

I agree that, in the last few years, I have read hundreds of articles which were similar to this one. Most of those attempts at long range finanical weather forecasts keep on repeating similar ideas to what this article did. I do not think that means the author is "lazy" so much as that is our current collective situation.

Everything we understand about the economy is done through abstract numbers, which can only be imagined in intellectual ways, on the basis of dubious and probably biased information. But nevertheless, the consequences of being hit by social storms, or hurricanes, the size of what this article speculates about, continues to command attention back to those issues.

Chupacabra-322's picture

From the article:

"An aging US population will cause social benefits to rise rapidly, pushing the debt to more than 100% of GDP and accelerating its rate of increase. "

Please correct if I am wrong but, aren't we presently at 104% of GDP already?

socalbeach's picture

Depends how you measure it.  He's probably not counting the intragovernmental "debt" (non marketable debt in the social security trust fund for example) of $4.8 trillion.  For cash accounting he's correct.

Furthermore, I would also subtract off Fed total money printing of about $3 trillion since that represents free (ignoring IOER payments of 0.25%) money to the government, and the Fed effectively retires debt when it buys it.  My guess is that he's probably counting that though, since it could conceivably be undone. Also, not all debt the Fed purchased is Treasury debt, but if the Fed buys MBS from a bank it frees up money for the banks in question to buy Treasuries.

SeattleBruce's picture

Martin Feldstein, Professor of Economics at Harvard University and President Emeritus of the National Bureau of Economic Research, chaired President Ronald Reagan’s Council of Economic Advisers fro…

What's not to love about Haaavaaaad...

socalbeach's picture

What makes you think it was written in 2009?  The article date on the Project Syndicate website says Feb 28, 2013.

clara-to-market's picture

I don't see the dollar in crisis.

I see deflation.

Especially when Europe shits the bed.

But what do I know?

akak's picture

I don't see the dollar magically rising in value.


I see deflationary flat-earthers who ignore all the evidence of fiat currency depreciation in front of their faces.

But what do I know (aside from the fact that Bernanke's 'low inflation' is a lie)?

Colonel Klink's picture

Yeah it gets old with people tagging their lame blogs.  Pretty funny akak.

Clara-to-market usually post some inane comment and a link.  Frankly it's a horrible blog.

Charles Nelson Reilly's picture

Uhhhh, you think Bernank would let deflation happen on his watch? The game is pretty simple to predict going forward, everyone debases. First it was the Yen, then the Sterling, next the Euro and eventually when everyone is done then its the Feds turn to really, and I mean really print money. If you're not long gold when that happens, like Faber said, you'll be in great danger.

SeattleBruce's picture

"I see deflation."

There will be bouts of deflation in the midst of the inflation.  Clearly housing has been deflationary (not as much recently).  But look at all this Barnank-inflation:

As some others have commented recently, what will happen to inflation when NIRP starts up as the FED too begins to charge to hold money, and forces lots of that "bank" reserve money out into the economy?

tony bonn's picture

what this author fails to note is that many many nations have established bilateral trade/barter agreements which are settled with native currencies - see jim willie for all of the gory details and the rise of the yuan.....the corrollary to this is that the petrodollar trade is on its last legs....the usa accelerated this process with its economic attacks on iran....the world has coalesced around a non-dollar protocol....the usa is fucked beyond words...swift will swiftly disappear within 1-5 years.....anyone stuck holding dollars is a fool.....

btw - the reason the usa attacked iran is not because of its nuclear program but because it was accepting payments for oil outside of dollars....for the usa to accuse iran of being a nuclear danger when it blew up its own wtc with nuclear weapons is goddamned horseshit...and the invasion of mali has nothing to do with physical security except for the criminal central and bullion banksters who are desparately trying to find enough gold for understanding is that several of these assholes have death warrants and are using tax payer money to steal gold from defenseless nations.

we can thank the rockefeller axis of evil for the engineered destruction of the  usd.

Pareto's picture

+1 on reference to Jim Willie, because he has been talking about this stuff (bilateral trade in non US denominated currencies) for years, back before 911 even.  Actually, nobody has done as much on this as he has, or, at least what I have researched.  He's a little long winded, but, i think that is because he is so pissed off.  But, he's educated (Ph.d) I think.  And his discussions on currency debasement and thelogical implications....totally worth the read.  Forces you to think.

spinone's picture

When you talk about the WTC being destroyed by nukes you look crazy man

lolmao500's picture

China needs US$6.6 trillion for a stimulus program...they might sell some of those toxic US dollars to do it...

Premarket, there were sources reported that China plans major bond market reform to raise the money the duling Communist Party needs for a CNY 40trl urbanisation programme to buoy economic growth and close a chasm between urban rich and rural pool

- Sources said that central and local governments, as well as bank roans, will fund the costs.

CNY 40trl = US$6.6 trillion

Zap Powerz's picture

"If investors don’t want to hold euros, pounds, or yen, where else can they go?"

Oh, maybe gold and sliver?

India and China are buying tons of the stuff.  Maybe because they see the writing on the wall and that writhing says:


lolmao500's picture

Oh, maybe gold and sliver?

Yeah like the big US banks are gonna buy trillion in $$ of gold and silver. Please... that would screw the US dollar.

akak's picture

And that is why the big US banks WILL go down with the US dollar.

Laser Shark's picture

The US dollar goes down, they all go down though.  Everything is so connected and inter-dependent in this globalized world. 

The world-wide financial and monetary system will just completely collapse and cease to function in any recognizable way at some point.  Some of the currencies of oil producing nations or other real/raw resources nations might survive, but no major currencies will.  The social devastation will be uncontainable.

I really can't imagine interest rates being allowed to rise significantly.  That would render the US government insolvent and send the country into a Greek-like debt spiral.  The system is just being propped up until it implodes on its own.  Time is being bought.

McMolotov's picture

"The US dollar goes down, they all go down..." It'll be anarchy!

Kirk2NCC1701's picture

Of course!  Transitions with steep gradients in complex systems are inherently chaotic.  We can only hope that when the mono-culture of the GMO-currency knows as the USD dies, that the monetary ecosystem recovers nicely for the indigenous currencies.

In other words, IF or when the USD stops being the GRC, the world will get more interesting and diverse.

tickhound's picture



Yeah, yeah, yeah we know... 

"If they perceive that dollar and dollar bonds have become riskier...." blah blah all hell breaks loose.

Forget what IS, bitchez.  Its the perceiving that's the hook.  CONfidence.  And since perception is REALITY....

Paint me a picture, Ben.  Make it purty.  LIE TO ME.  Like every other narcissistic HERO we reward.


Mark123's picture

I don't expect the Romans saw the end coming until it was too late.


Bread and circuses baby.  Food stamps and TV.

Sophist Economicus's picture

Interest rates aren't going up. The FED will buy all that will be sold, period.

Radical Marijuana's picture

INTERNATIONAL BANKERS effectively took control of the government of the USA, bit by bit, more and more, for more than a Century, and then they ran the USA to primarily benefit those international bankers. Since those bankers, and their buddies, already have effectively bought up control of practically everything related to the government of the USA, including the two main political parties, and mass media, as well as most of the education institutions, etc., any benefits that Americans received were the secondary, indirect results of the primary goals implemented through the agenda of the international bankers. The status of the American dollar, and all other aspects of the American economy, are actually dependent upon the values of international bankers, who are now practically TRANSNATIONAL BANKERS.

A relatively sudden collapse of the value of the dollar, by perhaps as much as 50%, is a plausible thing, especially because the hardships that would cause many millions of mainstream Americans is NOT something that the real government of the USA actually cares about.  Most Americans have been reduced, gradually, through more than a Century, from competent citizens to consumers of bullshit. From an objective point of view, the triumphs of the international bankers, (now transnational bankers) by taking control of the government, and thereby being able to legalize the lies that they wanted, have created a system wherein 99% of Americans act like political idiots, or Zombie Sheeple.

Of course, the slow motion train wreck history of legalized financial fraud, backed by the force of government, was the history of dishonesty, backed by violence, gradually getting worse and worse, while entangling Americans into adapting to survive within that system of debt slavery. But nevertheless, from an objective point of view, the result is almost all Americans act like political idiots, because an overview of the established systems of privatized, fiat "money," made out of nothing, as debts, demonstrates that the vast majority of the people get screwed by that system, while a tiny minority benefit tremendously from the achievement of that privatized form of legalized counterfeiting. 

What this article worries about should be worried about !!!!!

"The future evolution of these imbalances remains unclear."


AllWorkedUp's picture

and the thing is I don't see anyway of stopping the banksters. They have free reign and as you said gov't police and military protection, along with a corrupt judicial system.

and add insult to injury they beat the shit out of gold and silver all day, every day while every piece of shit stock on the planet goes up.


Sparkey's picture

Excellent thinking Radical! Where can I get some of the stuff `You` Smoke?

besnook's picture

total usa centric bullshit. the contrived 1997-8 asian currency crisis did compel the exporting nations to accumulate a diversified portfolio of foreign reserves as defense but it should not be forgotten that they can be used for offense. china, specifically has enough dollars to sink the dollar and now has enough gold to hedge the loses from that trade. it could baht the dollar over the center field fence in fenway park.

the world is telling the dollar(the usa) that they are sick of their shit and are actively trying to rid themselves of dollar dependence. the 1997 crisis was the last straw. that is why the only defense of the petrodollar is force and not trade based diplomacy.

Atomizer's picture

Rethinking potential output: Embedding information about the financial cycle


This paper argues that incorporating information about the financial cycle is important to improve measures of potential output and output gaps. Conceptually, identifying potential output with non-inflationary output is too restrictive. Potential output is seen as sustainable; yet experience indicates that output may be on an unsustainable path even if inflation is low and stable whenever financial imbalances are building up. More generally, as long as potential output is identified with the non-cyclical component of output fluctuations and financial factors play a key role in explaining the cyclical part, ignoring these factors leaves out valuable information. Within a simple and transparent framework, we show that including information about the financial cycle can yield measures of potential output and output gaps that are not only estimated more precisely, but also much more robust in real time. In the context of policy applications, such "finance-neutral" output gaps are shown to yield more reliable estimates of cyclically adjusted budget balances and to serve as complementary guides for monetary policy. 

Analysis: Grab the nearest broom and quietly sweep the bullshit under a rug.

Kreditanstalt's picture

Only one problem.  It isn't "investors" who buy US debt - it's other central banks.

essence's picture

Got to admit, these article contributors that just sort of nibble about the edges are 'nothing muffins'.

Man .... either call a spade a spade/shit or get off the pot ...whatever metaphor one chooses, but at least contribute something definitive or just STFU.

Oh yeah, you feel inhibited about calling a top/bottom... or calling out the Feds  ('cause they're uncle gorilla and will sick the drones/minions on you).

Then why even post if you're such a chicken shit.


Get out of Dodge fer christ sakes. Hell, a simple traceroute of zerohedge shows their servers aren't  based in the fascist USA. So why are you?
Oh wait ... just looked you up ---associated with HARVARD. That explains it.  Captured.

Get out .... free yourself.  JUST SAY NO!



spinone's picture

As long as dollars buy oil, everything will be fine

hairball48's picture

So fucking what if the US$ goes down the shitter and drags all the rest of the fiats with it?

My gold and silver(and yours as well) will then  RULE!

Gold and Silver bitchez! You better own physical soon if you don't already.

laosuwan's picture

more likely the price of your gold will rise to the level of value it has now in dollar terms. that is to say, it will be worth the same, buy as much stuff. which means you have to sell it, in which case you dont have it anymore.

laosuwan's picture

nations that export goods to the usa have no choice but to accept dollars. the fate of the dollar depends on the fate of usa imports.


pricing of oil and gold in dollars is not going to change that.

ArmyofOne's picture

Time for plan B.  Print more money.  I read the Yen has to rise to 125 to the $ just to get to 2% inflation.  Thats a lot of paper.