Why dollar as reserve currency is America's Achilles heel

By Robert D. Atkinson

Here's a thought experiment. The government can wave a magic wand and automatically reduce the price of exports by 15 percent and increase the price of imports by the same.

We all know the result: Exports would increase and imports fall, increasing the competitive position of domestic exporting firms. Their sales would increase, enabling them to invest more in R&D and new production equipment.

For many countries, including Korea, this thought experiment is real and is playing out in real time. Over the last 18 months the value of the won has fallen 17 percent against the U.S. dollar. Likewise, the Euro has fallen around 15 percent against the dollar, and the Japanese yen more than 20 percent.

For Korean tourists hoping to visit the United States this is bad news: Their vacation now costs them 17 percent more. But for Korean companies exporting to the United States this is great news.

International economics 101 teaches that a country's currency valuation should fluctuate based on the economy's current account balance.

If the country is running a deficit, the value of its currency should fall to make imports more expensive and exports cheaper. Conversely if a country is running a trade surplus, the currency should rise in value. This is how markets are supposed to work.

Unfortunately they do not. The U.S. has run a current account deficit pretty much every year since 1982, and in the first quarter of 2022 it reached a record $291 billion. And yet, the U.S. currency has strengthened against foreign currencies. These levels of imbalances are fundamentally destructive and not sustainable.

What's going on? What is going on is that what McKinsey Global Institute calls financial globalization is driving the train. Capital is seeking safety and higher returns and flocks to the least worse place: the United States, driving up the value of the dollar, even as the United States runs record trade deficits.

This all made worse by the fact that the "Washington Consensus" has long held that a strong dollar and the dollar as the global reserve currency is good for America. In 2008, in the face of growing trade deficits, President Bush made it clear: "We're strong dollar people in this administration, and have always been for a strong dollar."

President Obama's Treasury secretary, Timothy Geithner, proclaimed that "we will never weaken our currency"? Under President Trump, U.S. Treasury Secretary Steven Mnuchin said "I support a stable dollar" by which he meant he opposed trying to reduce the value of the dollar.

Current Treasury Secretary Janet Yellen has maintained this stance, saying that the United States would not intervene to help raise the value of the yen and lower the value of the dollar.

In the rare instance where a Washington official did not support the Washington strong dollar consensus, the pressure was on.

As former Bush administration Treasury Secretary Paul O'Neill stated, "When I was Secretary of the Treasury I was not supposed to say anything but 'strong dollar, strong dollar.' I argued then and would argue now that the idea of a strong dollar policy is a vacuous notion." For these and other heretical views, O'Neill was replaced by someone who knew the right tune.

There are several reasons for this inflexible position. First, with mid-term elections coming up in November the Biden administration is concerned first and foremost with the short-term impacts of inflation, not the longer-term impact of a hollowing out of U.S. industrial competitiveness. By making imports cheaper a strong dollar reduces inflationary pressures.

Second, monetary policy in the United States is largely controlled by or influenced by the financial sector. Wall Street benefits from a strong dollar because it increases the value of their assets.

Finally, holding the globe's reserve currency provides the U.S. government with a valuable weapon that can be used to punish adversaries. Indeed, Australia's Lowy Institute uses this as one measure of their Asia Power Index. This is why many U.S. policymakers, especially those in foreign and defense policy, so strongly defend a strong dollar.

There are two critical problems with this stance. First, over the moderate to long-term a strong dollar and reserve currency are a result, not a cause of competitiveness and national strength. As U.S. competitiveness, especially in advanced industries, continues its long slide downward, it is only a matter of time before the dollar is dethroned.

Second, a strong advanced industrial base is much more important to U.S. national power than having the reserve currency. Wars are won or lost on kinetic weapons, not digital currency flows. And a strong dollar acts as acid that eats away at the foundation of U.S. industrial capacity.

The good news from Korea's perspective is that U.S. policymakers are unlikely anytime soon to prioritize industrial competitiveness over currency competitiveness. And that will mean more exports for Korean firms.

Robert D. Atkinson (@RobAtkinsonITIF) is the president of the Information Technology and Innovation Foundation (ITIF), an independent, nonpartisan research and educational institute focusing on the intersection of technological innovation and public policy.