Vc Forex

Forex: Reserve-center Financing

The opportunity to have the rest of the world gladly accepts one's bank deposits and to hold them is more available to reserve-center countries such as the United States than to any others.

If the national currency is a key currency in international transactions, even in transactions not involving this nation, then the growth of the world economy is likely to lead to growth in the demand for this currency in international payment.

Throughout the postwar period, at least until the early 70s, foreign demand for dollar bank balances grew and was only partly met by growth of the Eurodollar market. The intensification of foreign demand for the dollar as a key currency gave the United States the opportunity to run 'deficits without tears'. Surplus-country critics, particularly in France, charged that the United States was helping itself to a free lunch by having the rest of the world hold the dollar bank deposits supplied by U.S. payments deficits. With the rest of the world willing to hold increasing amounts of its money liabilities, the U.S. could go on buying more foreign goods and services, and firms that it earned through its own sales.

The 'deficits without tears' charge is broadly correct to the extent that it describes the effects of the deficits on the United States despite considerable official hand-wringing, the United States refrained from severe adjustment, such as deflation of the whole U.S. economy, that would have been necessary to eliminate the deficits in a context of fixed exchange rates without exchange controls.

The United States was thus given extraordinary leeway to 'finance' its deficits.

On the other hand, the rest of the world did get something for its holding of dollar balances; it got the implicit services of the most widely recognized and accepted international money. By the 1970s, its private demands had become essentially satiated, and the United States could only accumulate dollar liabilities to those foreign governments, such as Japan, which were still trying to prop up the dollar to keep their currencies down and their goods competitive.

The time had come when the United States, like other countries before it, had to contemplate options for adjustment instead of being able to continue financing deficits with growing money liabilities. Any individual nation with a payments balance faces a five-way choice. It can finance the imbalance, float its exchange rate, impose exchange controls, adjust its economy to the fixed rate, or follow the rules of the adjustable peg system.