FINANCIAL CRISIS, FLIGHT-TO-QUALITY AND THE DOLLAR PROBLEM

AM | @MackinlayEuruni

. The Role of the Dollar as the key international reserve currency. Understanding the banking crisis: a (brief) look at the US dollar as the key international reserve currency. 1945-1973: Germany & Japan; 1978-2007: China. The stock of productive capital destroyed; authoritarian political culture. The solution: LOW COST OF LABOUR through a fixed (and undervalued) local currency against the dollar.

 . China’s economic development model. In order to avoid an exchange rate adjustment, China recycles its foreign-exchange reserves into the US credit market. [QUESTION: IMPACT ON THE US CREDIT MARKET??][CHART] [Annex to the Federal Reserve’s Weekly Balance Sheet]. Michael P. Dooley, David Folkerts-Landau & Peter Garber: “An Essay on the Revived Bretton Woods System”, NBER Working Paper 9971 (2003).

. Psychology & Markets: Attitudes toward risk. US credit markets flooded with cash! Jacques Rueff. Le péché monétaire de l’Occident. Paris: Plon, 1971:

The process works this way. When the U.S. has an unfavorable balance with another country (let us take as an example France), it settles up in dollars. The Frenchmen who receive these dollars sell them to the central bank, the Banque de France, taking their own national money, francs, in exchange. The Banque de France, in effect, creates these francs against the dollars. But then it turns around and invests the dollars back into the U.S. Thus the very same dollars expand the credit system of France, while still underpinning the credit system in the U.S. The country with a key currency is thus in the deceptively euphoric position of never having to pay off its international debts.

The money it pays to foreign creditors comes right back home, like a boomerang … The functioning of the international monetary system is thus reduced to a childish game in which, after each round, the winners return their marbles to the losers … The discovery of that secret [namely, that no adjustment takes place] has a profound impact on the psychology of nations (la psychologie des peuples) … This is the marvelous secret of the deficit without tears, which somehow gives some people the (false) impression that they can give without taking, lend without borrowing, and purchase without paying. This situation is the result of a collective error of historic proportions.
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