There are really only two people in the world who understand how cash really works. The problem is, they disagree.
Cash is used to buy and sell goods. It is the commodity that we use as a storehouse of value rather than using barter. Cash used to have its own intrinsic value, such as gold coins. With the advent of paper cash, governments backed their currency with gold. Now, there is nowhere nearly enough gold to back currency, so it is essentially backed by creditworthiness of the country issuing it. The safest and most liquid currency is the U.S. dollar, so it is the de facto currency for the world.
Every country seems to have a clearly defined policy towards how they value their cash, except for the U.S. Countries do not want their currency to be a commodity that hedge fund traders can manipulate at will. I cannot say for sure what our policy is in valuing our currency against other countries’ currencies. If we have a policy, which I think we do, we never seem to say what it is. It appears that we want the dollar to be weak. A weak dollar makes imported goods more expensive and exported goods cheaper so in theory it encourages jobs in the United States. Since our balance of trade is constantly moving more and more negative there is some concern that a weak currency is not necessarily the cure for what ails us. In fact, what we know is true is that by making imported goods more expensive, we are increasing the cost of living for Americans.
We also know that a weaker currency makes it harder for U.S. entities to compete buying international assets, so it allows foreign companies a pricing advantage over U.S. companies. It allows foreign capital competitive advantage in buying U.S. companies and assets. It creates an incentive for US companies to keep their capital offshore, to avoid U.S. taxation and to allow for acquisitions offshore. There is $1.2 trillion in U.S. corporate accounts overseas, which the U.S. is trying to tax. Perhaps if the US tax regime was not so punitive to corporations and the U.S. dollar so consistently weak, we would not only repatriate corporate profits, but more corporations would domicile in our country to avoid the risks of being in more unstable countries. Would not such a policy result in more jobs in the United States than a weaker dollar policy? And, at the same time, free Americans from being paupers on the world stage?
Because many currencies are linked to the U.S. currency, which used to be a way to stabilize a country’s currency, no matter how weak the U.S. dollar gets, it is always still the same relative to those currencies. That is the case with China. China’s currency is in large measure linked to the U.S. currency. Hence, the U.S. is putting intense pressure on China to strengthen its currency. During the credit crunch, China realized how important it was to maintain demand for its goods, so it does not seem reasonable to expect that China has adequate incentive to strengthen its currency. If anything, China’s solution would be to establish another global currency other than the U.S. dollar so it is not so subject to the policies of the United States. Until then, countries that peg to the U.S. dollar such as China that unlike the United States are huge net exporters get to enjoy the fruits of the U.S. policy of a weaker dollar.
I often wonder why in this age we even need paper money anymore, or why we need currency backed by a particular country. It seems to me that value is value and that a system of credits and debits can be devised with barter that would not be dependent on a country’s fiscal house of cards to operate.
I question why the Federal Reserve is buying US Treasury bonds. Since the rates are very low, it does not appear to be a great investment. The Treasury is issuing the bonds so getting the Federal Reserve to buy the bonds seems to be moving cash from one pocket to another. I have often wondered how the Treasury decides when and how much currency to print. Where did the money for the bailout came from? How does the Federal Reserve know how much to lend to banks, and what price to lend it to banks? It seems that there is no cost to banks to borrow money now, so if I were a bank, I would borrow money and leverage it as much as I could by buying really safe investments that pay interest. How does this help our economy? I do understand how it helps the banks, unless what they buy that they thought was safe turns out not to be so safe.
Our country does have a policy of being the strongest country in the world, both militarily and financially. There is no way it will give up the dominant position that the U.S. dollar now enjoys in international trade. If that is the case, then we need to know what we don’t know and make sure that we are good stewards of the dollar to allow business to transact worldwide without the fear that the dollar is subject to manipulation and to intervention. We need to have an explicit policy on the dollar and treat the dollar as an international currency and not a vehicle for a domestic agenda.