One major reason the United States runs a trade deficit is because the U.S. dollar is a “reserve currency.” And what is a “reserve currency?”
Here are two examples: When an importer in Thailand buys goods from a manufacturer in India, does the bill get settled in Thai baht or Indian rupee? In many cases, neither; it gets settled in U.S. dollars. When an Argentinian firm issues bonds to finance its operations and sells them to a Brazilian mutual fund, are the bonds denominated in Brazilian real or Argentinian peso? Again, typically in neither; the bonds are represented in U.S. dollars.
Although only about 10 percent of world merchandise trade is between the USA and other countries, U.S. dollars are used in 40 percent of the world’s merchandise transactions. Around 60 percent of all bonds issued by foreign governments and corporations are denominated in U.S. dollars, a percentage that has risen in the last decade. This implies there is an almost insatiable demand outside the United States for U.S. dollars.
So how do foreigners get those dollars? They sell us more merchandise than they buy from us—and, voila, we run a trade deficit. Think about it: We print up dollars and foreigners give us goods. But foreigners never use the dollars to buy U.S. goods because they use them in transactions with other foreigners. This is a great export market for our nation to dominate!
However, there is a dark side to being a reserve currency, and it’s not so much about the trade deficit. The U.S. dollar’s status as a reserve currency allows the U.S. government to rack up debt in a way no other entity on the planet can. The near-insatiable demand for dollars lets the federal government borrow at super-low interest rates, because foreigners want dollars.
An analogy: Think of an Indiana household that magically holds a credit card with a $200K limit and no minimum payment. Interest charges just get rolled into the ongoing balance. The balance has been creeping up for years and is now at about $100K. That’s pretty much where the U.S. government is today.
So where does this go? If we are mature adults, we recognize and protect our privilege and do not run our card to the max. But that’s not how we’ve been behaving. In 1968, the federal debt was about 38 percent of current GDP. Today it’s about 106 percent.
Many think that, if our debt even approaches 200 percent of GDP, our currency will lose its reserve status or our super-low interest rate will rise.
Our government hasn’t been the mature adult protecting its privilege. That’s not good.•
Bohanon and Curott are professors of economics at Ball State University. Send comments to firstname.lastname@example.org.