In my November 30th, 2007, column for the Pittsburgh Tribune-Review I did my best to calm the fears of those who worry that non-Americans who hold dollars and dollar-denominated assets will suddenly dump them and thereby inflict economic harm on Americans. You can read my column beneath the fold.
A dollar dump? Not likely
Should Americans worry that foreigners hold lots of dollars and dollar-denominated assets? Conventional wisdom says “yes.” The alleged reason for this concern is that if foreigners suddenly dump these assets, their prices will fall, interest rates will rise, and the American economy will be severely destabilized. The end result will be a depression.
But I don’t share this concern. It’s not that I doubt that economic woes would result if foreigners suddenly rid themselves of all of their dollar assets. Rather, I doubt that foreigners will go on a dollar-selling binge. More precisely, I doubt that foreigners will for no good reason go on a dollar-selling binge. If foreigners do start selling dollars and dollar assets in large quantities, they will do so because the underlying value of the dollar is falling.
In other words, any large sell-off of dollar assets would be much more the result of the dollar losing its value than the cause of the dollar losing its value.
The first fact to recognize is that foreigners are not unified. There are millions of them who hold dollar assets in one form or another. Some of these foreign holdings of dollars are done by foreign governments; other holdings are done by private firms; yet others are done by private individuals. Foreign holders of dollars no more act as a unified group than do American holders of dollars.
A second fact to recognize is that, with the possible exception of foreign governments that hold dollars, foreign holders of dollar assets hold these assets for economic reasons. They expect to be enriched by having dollar assets in their portfolios.
A third fact to keep in mind is that if any large holder of dollar assets (including foreign governments and central banks) dumps these assets simply for the sake of dumping them — or for the more sinister purpose of destabilizing the U.S. economy — a disproportionate share of the cost of such dollar dumping will fall on those that do the dumping.
If, for example, the Chinese government dumps its holdings of dollar assets, the worldwide prices of these assets — especially of U.S. Treasury securities and of the dollar itself — will likely noticeably fall. And while Americans would suffer, the Chinese government would suffer even more.
Imagine if Bill Gates suddenly dumps most of his holdings of Microsoft stock. Sure, other holders of that stock would suffer as its price falls, but none would suffer as badly as Mr. Gates. Only a holder of a significant portion of a particular kind of asset can push down the price of that asset by dumping it — but such a holder also, in order to dump its stash of the asset, must sell it at fire-sale prices.
Of course, governments often act foolishly or in ways that sacrifice economic benefits for political advantages. Might Beijing’s motive for acquiring large holdings of dollar assets be the sinister one of eventually dumping these assets simply to disrupt American economic growth? It’s possible. But if so, the American economy enjoyed huge benefits to offset any problems springing from the later disruption.
During the time that the government in Beijing was accumulating dollar assets — accumulating these assets by paying for them prices higher than they are really worth – Beijing transferred wealth to Americans.
To see why, suppose that an evil businessman seeks to disrupt the economic future of innocent Ms. Jones. This businessman reasons that if Ms. Jones unexpectedly is fired from her job, she will suffer. And she will suffer even more grievously if any new job that she finds pays her less than the job she lost. So Evil Businessman hires Ms. Jones at a salary well above her true market value. For several years Evil Businessman keeps paying Ms. Jones a salary much higher than she would command on a market not poisoned by the uneconomic motive of Evil Businessman.
And then one day, suddenly and unexpectedly, bam! Evil Businessman fires Ms. Jones, who then discovers that the best new job that she can get pays her an annual salary that is $100,000 less than she “earned” while employed by Evil Businessman.
Without doubting the disappointment and inconvenience Ms. Jones suffers when she is suddenly fired, we can nevertheless doubt that Evil Businessman really hurt Ms. Jones on net. During all the time that he employed her she earned more than she would otherwise have earned. And during this same time, Evil Businessman was paying the price for the later privilege of disrupting Ms. Jones’ economic life by firing her.
Rather than “Evil Businessman,” he really should be called “Stupid Businessman” — and the U.S., like Ms. Jones, should count its blessings if it’s really true that Beijing or any other wealthy entity consistently overpaid for American assets.
