The International Dollar Standard and the Sustainability of the U.S. Current Account Deficit

FOR MORE THAN twenty years the world's richest, most mature industrial economy has drawn heavily on the world's limited pool of saving to support high consumption--in the 1980s by the federal government, and in the 1990s by households. Over the past decade, personal saving has fallen more than government saving (as manifested in the recent budget surpluses) has increased. The huge deficit in the current account of the U.S. balance of payments, equivalent to about 4.4 percent of gross national product (GNP) in 2000, reflects this saving gap. In order to support a normal level of gross domestic investment (historically about 16 to 17 percent of GNP) as well as this increased consumption, America has had to draw heavily on the saving of the rest of the world. On a flow basis, the United States now attracts more capital, net, than all developing countries combined. The international balance sheet of the United States has declined in corresponding fashion. From being a net creditor to the rest of the world at the beginning of the 1980s, the United States transformed itself into the world's largest net debtor--to the tune of an incredible $2 trillion or more--by 2000. The cumulative effect of this private foreign borrowing over the last ten years is now reflected in the balance sheets of both American firms and American households. The indebtedness of the personal sector is now a record 1.03 times disposable income; firms in the aggregate also show a very high indebtedness relative to cash flow. Should Americans worry about this anomalous situation? After all, the dollar remains strong, and the United States is unique in having a virtually unlimited line of credit with the rest of the world, which is largely denominated in its own currency. American banks and other financial institutions are relatively immune to currency risk because both their assets, which are largely claims on the domestic economy, and their (deposit) liabilities, of which a substantial fraction is owed to foreigners, are denominated in dollars. Other debtor countries must learn to live with currency mismatches when their banking and other corporate international liabilities are dollar denominated but their assets are denominated in the domestic currency. Indeed, this kind of mismatch was the genesis of the great Asian currency crisis of 1997-98. Because Indonesia, Korea, Malaysia, the Philippines, and Thailand had large outstanding, short-term dollar liabilities, they became extremely vulnerable to a currency attack, and the resulting devaluations bankrupted their domestic financial institutions. In contrast, no matter how precarious and overleveraged the financing of American borrowers--including American banks, which intermediate such borrowing internationally--might be, they are invulnerable to dollar devaluation. Does this invulnerability to currency crises simply reflect the greater strength of the American capital markets and the greater wisdom of American regulatory authorities, compared with other industrial countries? No. The fact that the United States is the preferred and highly favored international borrower is pure serendipity. How did this accident of history come about? The International Dollar Standard In the immediate aftermath of World War II, confidence in the currencies and financial systems of all the other industrial countries in the world had evaporated. To prevent capital flight mainly to the United States, the European countries as well as Japan imposed tight exchange controls. The relatively stable U.S. dollar was the only major currency in which international exchange could freely take place. In the late 1940s, under the Bretton Woods monetary order, other nations declared official exchange rate parities against the dollar, making it the central numeraire for the system. This official monetary order did not create asymmetry among currencies; it simply recognized it.(1) Thus was the dollar enthroned as "international money. …