It appears it is necessary to clear up some significant misperceptions about our present payments and financial regime, with our topic today (and in a likely future post or two) being the petrodollar myth: the claim the the pricing of in dollars is foundational to the dollar’s reserve currency.
Even though the dollar is set to lose its dominant position due to the US no longer being the top economic dog (and the US giving other countries ample incentive to move away via our abuse of the power of controlling the dollar payments system), monetary regime changes take a very long time to play out. It took forty years, including two world wars and a global depression, to dethrone pound sterling. And now we have more significant frictions to changing monetary regimes in the form of the amount of computer coding behind current systems, and the depth and complexity of dollar financial instruments and investment vehicles.
Financialization winds up institutionalizing a lot of rentier activities, but it also, not surprisingly, makes for a very attractive place to do financial business. And this represents a big conundrum for Russia and China, which currently operate on what Michael Hudson would depict as an industrial capitalist model, disfavoring a big financial sector as creating unnecessary overheads and a parasitic power center.1
Today we’ll discuss why pricing oil is dollars is inconsequential save as an indicator of America’s historical importance in oil markets. In a future post (or posts) we will turn to the very large misconceptions, if not misrepresentations, about US and Saudi dealing during the 1970s oil crisis.
We’ll turn the mike over to Dean Baker, who has been having to ring the changes on his explanation of why pricing oil in dollars is inconsequential to the dollar’s reserve currency status. From a 2009 article in Foreign Policy:
For at least the last decade, a persistent, recurring conspiracy theory has held that major oil exporters will stop pricing oil in dollars, which will then lead to a collapse in the U.S. economy as the dollar becomes worthless….
It is true that oil is priced in dollars and that most oil is traded in dollars, but these facts make relatively little difference for the status of the dollar as an international currency or the economic well-being of the United States.
With the United States’ ascendancy as the pre-eminent economic power after World War II, the dollar became the world’s reserve currency: Most countries held dollars in reserve in the event that they suddenly needed an asset other than their own currency to pay for imports, or to support their own currency. Much international trade, including trade not involving the United States, was carried through in dollars. In addition, most internationally traded commodities became priced in dollars on exchanges. However, the dollar was never universally used to carry through trade (even trade in oil), and the pricing of commodities in dollars is primarily just a convention….
Suppose that prices in the oil market were quoted in yen or bushels of wheat. Currently, oil is priced at about $70 a barrel. A dollar today is worth about 90 yen. A bushel of wheat sells for about $3.50. If oil were priced in yen, then the current price of a barrel of oil in yen would 6,300 yen. If oil were priced in wheat, then the price of a barrel of oil would be 20 bushels. If oil were priced in either yen or wheat it would have no direct consequence for the dollar. If the dollar were still the preferred asset among oil sellers, then they would ask for the dollar equivalents of the yen or wheat price of oil. The calculation would take a billionth of a second on modern computers, and business would proceed exactly as it does today.
It does matter slightly that the trade typically takes place in dollars. This means that those wishing to buy oil must acquire dollars to buy the oil, which increases the demand for dollars in world financial markets. However, the impact of the oil trade is likely to be a very small factor affecting the value of the dollar. Even today, not all oil is sold for dollars. Oil producers are free to construct whatever terms they wish for selling their oil, and many often agree to payment in other currencies. There is absolutely nothing to prevent Saudi Arabia, Venezuela, or any other oil producer — whether a member of OPEC or not — from signing contracts selling their oil for whatever currency is convenient for them to acquire.
Baker has found it necessary to keep returning to this topic, for instance, in 2019, in It Doesn’t Matter At All That Oil is Priced in Dollars #43,656.
Let’s try a worked example. Let us say, contrary to the record2 that the Saudis considered requiring oil to be priced Saudi riyals at the time of the 1973 oil embargo. What would the process have been to buyers from the Kingdom, where the Saudis would presumably also have required payment to be made in riyals (recall Baker stressed setting the price in a particular currency didn’t mean you had to tender that currency in payment; the buyer and seller would set those terms).
Recall also that there are not a lot of riyals circulating outside Saudi Arabia, so you’d have to go to the Saudi central bank or an institution that dealt with the central bank and could obtain the needed riyals.
So what would the result look like? Gee, oil for riyals looks just like gas for roubles!
Buyer goes to Saudi bank [GazpromBank] and tenders dollars [euros]
Saudi bank [GazpromBank] exchanges dollars for riyals [roubles]
Saudi bank [GazpromBank] ends up holding dollars [euros]
The big difference is not that the seller winds up holding foreign currency. It’s the one that the countries outside the Collective West have become sensitized too: where the foreign currency winds up being held. If the seller demands the payment be tendered in a currency that isn’t easy to get in world markets, the buyer will have to make payment through a bank that can round up the currency. That means the central bank or a major bank that has that central bank as its primary regulator/lender of the last resort.
The other approach, of paying in dollars, when the dollar is traded around the world, means any substantial international bank can handle the payment and wind up as the repository of the dollar balance (leaving default risk aside, which is why buying Treasuries would make sense as the initial place to park large balances). In the halcyon days of the 1970s, the US financial was regarded as both super sound and very well regulated, so foreign players did not have reservations about having large banks and securities holdings in US institutions.
Let’s now give a teeny example of how people looking at the question of moving away from the dollar can get many details right yet miss overarching issues. I don’t mean to seem to beat up on this Twitter poster but he starts with a very big claim:
Dollar hegemony rests atop a financial transaction network called SWIFT.
But what exactly is the SWIFT network and why is there now discussion of alternatives? 🧵
— professional hog groomer (@bidetmarxman) November 8, 2022
Then if you go through his tweetstorm, he has a good history of SWIFT. But what he fails to understand is that SWIFT is a messaging system. It does NOT process payments. There is a massive architecture that sits behind the messaging system. Dollar payments systems participants either need to have a US banking license (commonly but not always a New York state licensed branch) or deal with a correspondent bank that has said license. Those banks in turn have to meet certain standards to get that license, which among other things nearly always means having a parent bank in a home country that the US trusts to make sure the bank is adequately capitalized, keeps proper books, and otherwise behaves.
The banks in SWIFT do not in fact exchange all these payments each by each. They keep running totals during the day with each other (as in they run potentially massive unsettled intra-day balances), then square up at the end of the day. The reason they can roll this way is the system is backstopped by the dollar central banker and lender of the last resort, the Fed.
So here is where the tweetstorm goes off the rails:
Since 2014, the share of total transactions made using SPFS has rapidly expanded within Russia, even directly integrating with consumer bank accounts via its Mir card, which by 2022 have been adopted by the vast majority of people in Russia.
— professional hog groomer (@bidetmarxman) November 8, 2022
While not currently a direct competitor to SWIFT, functioning more as a direct transaction network, CIPS has grown to integrate over 1,280 financial institutions in 103 countries. Today, there is little constraining CIPS from expanding further. pic.twitter.com/lUfLwHacAz
— professional hog groomer (@bidetmarxman) November 8, 2022
Since at least 2014, China and Russia have been in talks about the potential for merging their two systems. But earlier this year, plans took on new urgency as it became more clear that the US means to increasingly wield SWIFT as a draconian financial weapon. pic.twitter.com/Ml9vDyEXHr
— professional hog groomer (@bidetmarxman) November 8, 2022
This all sounds as if things are moving along with alacrity until you step back.
To use the Russian system SPFS, you need to be a Russian institution that the central bank will bail out or otherwise resolve if it gets overextended. Otherwise no prudent financial institution would be willing to run large open intraday balances with it. And the alternative, of settling every transaction during the day and updating capital accounts on a real time basis would be computationally overwhelming and would tax oversight. The tweetstorm sort of acknowledges that by admitting the SPFS is used only within Russia.
But what about CIPS? Again, those non-Chinese institutions would still have to be licensed in China or have a correspondent account with a Chinese bank. If it’s just a correspondent account, it’s misleading to imply that using CIPS with the foreign bank using a Chinese bank is actually integral to the transaction.
But the critical part here is (like our riyal example), there’s not enough renminbi outside China for the renminbi to serve readily as a settlement currency. To get enough currency outside your country to do that, you have to run sustained trade deficits. China is not willing to do that because running sustained trade deficits is tantamount to exporting jobs.
An even bigger logic gap is the breezy way it mentions “potential for merging” the Russian and Chinese systems. Operating across two different currencies and more important, two different banks systems with different central banks as the guarantors? This is why Russia and China have not gotten much of anywhere since 2014.
Mind you, I am not saying trade between countries outside the dollar payment system will not continue to grow. But bilateral trade is messy and leaves the net exporter holding a lot of other people’s currency. Russia no doubt derives a great deal of geopolitical value from being willing to settle some transactions with Turkiye in Turkiye lira. But the currency balances are likely to depreciate. They are a dead weight to Russia unless Russia can buy Turkiye assets or figure out how to buy more stuff from Turkiye. Multiply this problem by every weak currency counterpart.
In other words, this is far from a trivial transition. And oversimplifying out of a (well deserved) antipathy for how the US has been abusing its privileges doesn’t solve problems.
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1 Japan in its heyday had very large and only thinly profitable financial institutions, and that was part of its economic model: finance was a handmaiden of industry. a bank making too much money was seen as a bad thing. But one reason Japan could get away with that was that it had a highly regulated banking system. When the US forced rapid deregulation on Japan in 1980s, it was like telling a drayage company it was really in the transportation business and giving it a 747 to fly. The results were predictable.
2 I will turn to that but in a later post.
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A discussion of the dollar without Bretton Wood is a little odd.
The U.S. has been the buyer of last resort since we lost our oil dominance in the 1970s. Because this is particularly convenient for other countries pushing the export model of growth, there is a lot of US$ sloshing around the world. Thus it is a very convenient currency to do business in. How are you going to get the Yaun/Renminbi to buy oil? Rubles? Russia is particularly vulnerable to the “Dutch Disease” where commodity exports drive up currency value until your other potential exports become unaffordable. Very much another reason to use dollars and manipulate your currency to keep it from appreciating against the US$.
At this point, you also have the Fed acting as the lender of last resort to just about everyone: including the Chinese the last go around. Other countries don’t want to take this on for various reasons, so they have by default left the US in an even stronger currency position.
I said I was not addressing this all at once and made clear the historical discussion comes later.
The big point here is you do not have to know squat about Bretton Woods or the 1970s oil crisis to show that the pricing of oil in dollars is a historical artifact and unimportant to the dollar’s dominance.
And oil was priced in dollars before the Nixon Shock.
Agree with your point here. The critical point I think not widely understood within the Twitterverse (the parts I see anyway) is that reserve status requires deficits. That’s misunderstood by different people for different reasons. Once that’s internalized it’s easier to see that things like the currency for pricing oil is off the mark. The point on daylight overdrafts is very helpful for looking at bilateral trade schemes.
I think it would be interesting to do a comparison with the Gold standard heyday on this blog. There was no one entity controlling gold nor was there gold sloshing around everywhere or being printed on massive quantities. Yet trade was healthy and fairly workable. There is no reason one currency hehemon is needed for world trade.
Sometimes it is hard to see alternatives without willing to question all aspects of the current system.
The gold standard was deflationary and lowered growth. For instance, the US suffered what was called the Long Depression for much of later 1860s through the mid 1890s. You will also see inflation levels whipsawed, often going from levels like the low teens to negative inflation the next year. That level of variability in prevailing price levels also increases business failure and deters investment.
The gold standard being deflationary is some sort of a myth. A standard backed by a commodity like gold prevents you from messing with the currency, i.e. ‘QE’. If you want to pump more fiat into the economy you need to back it up with an additional equivalent amount of gold. If you do not you are unfettering inflationary forces and depreciation of your currency. There are enough historical examples to back that argument. Just for that reason any commodity backed standard is considered deflationary particularly during and after periods of recession.
With regard to the US$ as the modern reserve currency there is no way of making that argument without the ‘petro dollar’. No matter how you slice it, a stable currency needs to be backed by something other than fiat and this is oil since the original petro dollar deal of Nixon. Regardless of how much currency you get out of the country – which of course is a technical and formal necessity to form the reserve currency – without that money commodity being backed by something like oil it will quickly devalue and with the currency stability gone the recession cycle is kicked off
Every big discovery of gold induced a price shock[see oil], the nature of bimetallism is not unlike crypto in like resource inputs to seek a big payday for a lucky few.
Your perspective might be better advance if all the gold in the world was extracted and then market dynamics about new supply could be negated. Albeit I do understand that fiat still suffers the same political dynamics and ponder what Banco could have been if some did not want to be dominate one way or another …
So the chink in the armor is not, contrary to popular myth, China dumping T-Bills and the Saudis demanding settlement for oil sales in Riyals, it’s the abuse of power borne of exceptionalism and hubris. In that case I think the threat to the USD reserve currency status is even more dire given the current wrecking ball approach to diplomacy the US is employing to “contain the rise” of its imagined adversaries. Weaponising the dollar’s reserve currency status for geopolitical reasons, and the subsequent loss of trust, is ultimately what will wipe the shine off the “safe haven” mirage once and for all.
Not a financial person here (and I have a bank account to prove it) but I think that I heard that the international use of the US Dollar has the side effect of exporting inflation from the US to the rest of the world. But if there was a gradual and slow decrease in countries using the US Dollar to settle accounts, would that not mean that there would be as a consequence a slow increase in inflation in the US as a result?
Not unless the US trade deficit also decreases over time? That’s my guess.
But since almost everyone is trying to run a trade surplus…
Thanks for the Dean Baker. He has always been one of my favorite conventional wisdom bashers and also likes to beat the press in his blog called, appropriately enough, Beat the Press.
http://www.cepr.net/index.php/blogs/beat-the-press/
Among other ideas he favors bringing in foreign professionals such as physicians to provide competition to our somewhat rigged medical economy and dialing back copyright laws to reduce the rent seeking there. So he like Hudson says it’s all about the rents.
Carolinian
What I love about Baker is how clearly he explains what happened – the story has been told many times here, but unfortunately our media is a tightly controlled propaganda organ for the oligarchy.
https://www.cepr.net/the-case-for-the-trumpers-anger/
At this point, a large majority of non-college educated whites (especially white men) are willing to follow Donald Trump off any cliff. They have open contempt for more educated people (a.k.a. the “elites”) and their institutions, such as universities, mainstream media outlets, and science.
….
We know the data on what has happened to income distribution over the last four decades. To take a simple point of reference, in debates on the minimum wage we often talk about how if it had kept pace with inflation since its peak real value in 1968, the national minimum wage would be over $12 an hour at present, compared to its current $7.25.
However, in the three decades prior to 1968 the minimum wage did not just keep pace with inflation, it rose in step with productivity. That meant that the lowest paid workers shared in the gains of economic growth. If the minimum wage had continued to keep pace with productivity growth, it would be almost $26 an hour in 2022.
That’s worth thinking about for a minute. Imagine the lowest paid workers, the people cleaning toilets in office buildings or bussing dishes in restaurants, earned $52,000 a year if they worked a full-time job for the whole year. A two minimum wage earner couple would be pulling down $104,000 a year. That’s a very different world than the one we have.
….
Given this reality, suppose that the poor prospects for non-college educated workers was the result of deliberate policies pushed by the people who control debates on economic policy, as in people with college and advanced degrees. The people who are best positioned to steer economic policy consciously structured it in ways to benefit people like themselves and to screw workers with less education. Would that give the losers in this picture reason to be angry?
Now, suppose also that the people who rigged the system to favor themselves at the expense of the less-educated also lied about the fact they rigged it, and ridiculed the less-educated for not being able to compete in the modern economy. Furthermore, since the winners staff all the major media outlets, they insisted that only the false story, of losers being unable to compete, ever got mentioned in discussions of economic policy.
…
This is basically the story of US politics in the era of Trump. The economic losers hate the winners and distrust the institutions they populate: the media, universities, government agencies. There is a rational basis for distrust. The winners really did screw them and they have concocted nonsense stories to conceal that fact….
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Later in the article Baker explains how this is done. But the important point is that this is not some inevitable law of nature – it is rules that men make, and the rules men make in this country are to help the wealthy and hinder the less wealthy. And the whole edifice that hides that fact…
There is no power in equality.
Except against an outside enemy. But internally within the state, you are correct.
Greaber and Wengrow’s “The Dawn of Everything” is great on this point in its treatment of Teotihuacan.
After it overthrew its hierarchical state and embarked on a vast equal housing program that lasted centuries, it’s atlatl wielding warriors were feared throughout the balance of Central America. They were so feared, imposters playing up their bogus Teotihuacan credentials at the courts of other states insinuated themselves into power.
Such was the prestige of the egalitarian societies war fighting capabilities that its defeated enemies learned to pose as expatriates to bask in the glow.
Thank you!
Indeed, he hits the core truth that what one transacts in is not as important as what one saves in. Some caveats apply … if you can restrict transactions for something necessary to one currency .. e.g. USD.. then sanctions have more bite, which is another tool of control. But what is saved in is still the key.
The real petrodollar has always been the initial agreement for Saudi to recycle its surpluses into American financial assets, not that oil was priced in dollars.
This post’s explanation seems like it doesn’t address all the benefits to the US I’ve heard of for selling oil in dollars. If oil is sold only for dollars, and a country requires dollars to buy it, then can the US not surveil and potentially block that purchase? Are such dollar transactions not cleared in the US? If this US does have this power over dollar-based oil sales, that’s significant, and made it seem plausible that the petrodollar story was true separate from Swift.
In addition, if dollars are required to buy, sanctions become harsher, as a buyer would need to transact with a bank with dollars before purchasing. If the US could convince all banks not to participate, the purchase gets much harder. I’m sure there are many other power dynamics at play as well.
And I hear that not all oil is sold in dollars. However, I believe all Saudi oil is sold for dollars – is that not true? That’s the petrodollar story as I understand it; a special relationship between Saudi Arabia and the US. And back when the Saudis were major swing producers and the US a dominant supplier (in the 70s around US peak conventional oil production) this was a bigger deal than today. This post seems a little lightweight, as if there were no politics behind the pricing of things – of course if prices were calculated in Wheat the computers could do the math, or if the seller demanded their own currency an intermediate bank could do it. But it seems like other dynamics are at play too, and if that’s not true I’d like to hear that acknowledged and debunked.
It would help to outline the common petrodollar myth and reasons it has explanatory power before debunking it to ensure everyone’s on the same page.
Thanks for this post series; I’m very interested. I especially look forward to the historical piece.
Here are the salient facts I drew from this post:
a. If you are a net exporter, you will end up holding someone else’s currency
b. If that “someone else’s currency” is not stable, or easily obtainable, and easily exchanged for another currency, your trade has created risk for you, the exporter
c. The US dollar (USD) is stable, easily obtainable, and easily exchanged for almost any other currency. That’s why it’s the “reserve” currency.
From other reading, I know that the US has lately been making it more risky to use USD. Reserves have been confiscated, U.S.-licensed banks have impeded trades – those banks are one key mechanism to enforce sanctions
So the world would like to use USD as a trading currency, but would like to avoid US interference, and to do that, it needs to avoid U.S. or U.S.-controlled institutions.
I think the question to resolve is “how to use the USD as trade currency while avoiding the U.S. institutions ?”
Hopefully, the next few posts on this subject will help me answer that question; the answer will help me understand how fast trade flows among non-Western players will expand.
Wait a minute. I think we’re talking about two different meanings of the “metro-dollar.”
In balance-of-payments terms, the impact of Saudi petrodollars went far beyond just pricing oil in dollars. Yves is quite right about how that pricing was not so novel. After all, most raw materials have been priced in dollars.
What was key — and I was part of discussions in the White House in 1974 — was WHAT Saudi Arabia DID with the dollars it obtained for its oil when prices quadrupled. The State Department and Treasury said that it would be an act of war if they did not RECYCLE THESE DOLLARS into the U.S. economy.
So there was a great capital inflow into the US — not to buy major U.S. companies (it was forbidden to do that), but to buy U.S. stocks and bonds, including U.S. Treasury bonds. It bought Citibank stock in particular, I remember (and didn’t do very well in this). The key was that oil-exporting countries recycle their dollar export earnings into the U.S. economy. THAT is what supported the dollar’s value.
It also flooded into U.S. banks, which relent much of this inflow to Third World countries, setting the stage for the post-1982 debt crash when Mexico said that it could not pay its tessobonos.
Dr Hudson:
Does that mean that the current friction between major materials exporters like SA and China (finished goods) and the U.S. is (partly) because of _what_ they’re doing with their dollar holdings?
And if that is the case, what are these exporters doing with their dollars instead of buying US debt or US-based assets?
First, there are people all over the Innertubes and the mainstream media, who are making the argument about the pricing in dollars being key to US power. That is why Baker has to keep debunking it every two years or so. So to many people, this is central to the petrodollar thesis.
Second, re your act of war claim, that is not what State Department archives say and they are declassified. Some pretty amazing conversations are recounted in detail, . The White House may have fumed that privately.
The US was worried about the massive economic of the Saudis and other OPEC members (the Saudi were not the only ones running surpluses)And the Saudis were investing about half non-dollar currencies). And you seem to forget that as of the 1970s, capital markets ex the US were thin and not very appealing. European stocks had vastly inferior and less frequent financial disclosure (only every 6 months, not quarterly). So the US was the natural big destination.
There was no euro, so each European currency represented a lot more risk. Even the DM market was so thin that many investors as of the early 1980s, a full decade later, would buy synthetic DM government bonds (Treasuries and then a DM currency swap) rather than the real deal. There were also fewer European corporate bonds due to so much more lending being done by banks than via the bond market in Europe. Again the Eurobond market was only becoming meaningful as of the later 1970s/early 1980s. Japan as a capital exporter also dominated by banks, with a weak currency as of then, and lacking the strong investor protections of the US again was a less than ideal place to park a lot of dough.
The Mexican peso crisis was 1994, and the big actors there were not US banks but US brokerages, particularly Morgan Stanley and Merrill Lynch. Covered in considerable detail in the Frank Partnoy book, particularly the structure of the tesobonos and the specific chronicle of the developments that triggered the crisis and how the US Treasury Department rescued the peso to rescue the then investment banks.
Yves
I read before from Michael Pettis about the impossibility of having a reserve currency if the country does not run a trade deficit exporting its currency.
However, the US had reserve currency status after WWII and Bretton Woods and it was running trade surplus at that time, all the way up to the early 1970s if I’m not mistaken.. Contrary to what many think were not under a Gold Standard back then, we were in a fixed currency regime (actually currencies were allowed to float within bands). Exchanging dollar for Gold was simply an option for foreign central banks.
So how the US could enjoy reserve currency status and run a trade surplus?? Dollars were exported as investment (think Marshall Plan)??
Thank You
US had a post-war trade surplus because it was the last man/country standing?
I’qq as m just guessing the US wanted to be paid in dollars, and didn’t care if that affected the exchange rate or financial flows. As for the source of those dollars, aside from your suggestion of vendor financing, the US also had military stationed all around the world injecting dollars to Europe and Asia.
The US had a trade surplus for the next 30 years.
It looked like this.
Because of Marshall Plan spending and subsequent military spending by US bases in the nations of our trading partners, the US was pumping the world economy full of dollars.
If I understand Dr. Hudson’s argument, the excess of dollars spent on “imports” versus dollars earned on exports that caused the balance of payments deficit to surface in the early 70s was in fact an excess of dollars spent abroad directly by the military and by US military personnel stationed abroad spending dollars there for goods and services consumed there. It wasn’t an actual trade imbalance between goods in and goods out, but spending imbalance between dollars spent domestically and dollars spent abroad.
Although I agree with the conclusion of the article that swapping the US out as a reserve currency will be far harder than what many commentators suggest, there is one other consideration. The more belligerent and abusive the US gets with its control of world’s financial system, the more incentives the rest of the world will have to decrease their reliance on the system.
For a nation such as Russia, it is very easy to understand why a system of bilateral trade where the Russians hold many other currencies would be the lesser evil compared to their reliance on the US, which has frozen their currency. Other nations are at risk – the most obvious being of course China, which is playing a bigger and bigger role in the world’s economy. Yet there are even more nations that are in a sort of “grey zone” where they are not hostile to the US, but also do not wish to comply with Washington’s every demand.
If one thinks about what the freezing means, it could easily set the stage for a gradual change. It won’t happen overnight, but it will happen. I’ll say this much, the US once spoke very negatively about nations that would nationalize the assets of American corporations, arguing that private property was sacrosanct. Now though, it seems that the double standards are exposed for the world to see.
If the US doubles down on these practices towards other nations, I could see another messaging system as a competitor to SWIFT seeing adoption outside of the collective West.
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The fear of the dollar becoming worthless isn’t so much that it would become worthless as much as it is that it would lose a large part of its value. This is an issue because of two things.
First, the US manufacturing base is now gone. This means that the US would not have domestically manufactured goods and would suffer a large inflationary event, as imported goods and what raw materials or energy are imported for domestic production / consumption would cost a lot more. This in turn means a decline in the standard of living.
Second, is more related to our elites. In theory, a weak currency is a chance to re-shore manufacturing. As has been written elsewhere, our ruling class lacks the competence to execute an effective industrial policy. Our ruling class is also “short term greedy” and building up manufacturing requires many years of careful discipline, without the kind of profit margins that our elites want. Thinking long term is a big reason why the East Asian nations like China were so successful.
In other words, the US no longer has the capability to build up its own manufacturing and cannot capitalize on a weaker currency that losing reserve status could bring. Furthermore, the US does at times import foreign energy (oil and yes, LNG during cold snaps).
Altamain: a few points for you to consider:
U.S. mfg’g is way stronger than the current popular vibe says. See StLouisFed’s remarks. While you’re there, take a gander at the number of jobs in mfg’g necessary to deliver the goods. See how it changes over time.
Those of you that doubt me when I say “labor is being factored out of the production equation” should take a look at the “mfg’g jobs as pct of employment” graph, (StLouisFed link above) and note that across that graph-plot, mfg’g output has remained nearly constant. And look at the slope of that mfg’g jobs curve, too.
I’m not at all sure that “the US no longer has the capability to build up its own mfg’g”. We’d need policy (formal or informal, either will work), some technical schools or major investment in OJT, and a bunch of new manufacturing facilities.
Note that “new mfg’g facilities” would also equate to “most efficient in the world”, since you get to use the latest tech and method when you build new.
Lastly, on the subject of materials shortages. When I talk about materials re-use, most people think I’m being (entirely) a romantic tree-hugger.
Did you consider that, for those countries like UK, Germany, Japan, Taiwan, Viet Nam…and to a lesser degree the U.S….if you don’t have a bottomless pit of minerals at the ready, wouldn’t it make good sense to design manufactures for materials reclamation? Wouldn’t those products have a leg-up in global sales?
Yes, the U.S. may be the last to grasp this, but … since I am romantic, hope springs eternal. The other countries, which don’t have the kind of mineral resources the U.S. has will certainly figure this out.
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A weak currency would make it less expensive to buy the components / materials necessary to do more mfg’g here in U.S. …. Yes, that’s true to the degree we import materials…but it looks like the main materials we’re importing are steel, chemicals, plastic. Most of the rest of imports are finished mfg’d goods for both industry and consumer.
So, if we re-shore manufacturing, we’ll import more steel, chems and plastic for a while until the mfg’g capacity for those goods gets re-shored. We have the raw materials (iron ore and petroleum) to make steel and petrochems (the bulk of imported chems).
The manufactures imports will steadily fall as we either impose tariffs or become more competitive. See these imports by category, sorted by $ volume (a few tables down in the page). .
So, while we’re ridiculing the NeoCons for their greed and stupid, let’s not trash the industrial capitalists quite as much. If they got the financial capitalists off their back / out of the way, they can do the job.
And the American worker can do the job, too. That’s more a cultural issue (entertainment and advertising industries’ malware) than a native-capability issue.
Statistics lie. “It’s all robots, not because we outsourced anything, honest!”
Further, even if true, it wouldn’t change the fact that millions of people were made unemployed and whole regions of the country turned to rust.
Who do I believe, some economists who insist the industry still exists but just became more efficient, or my eyes that can see the abandoned factories and run down towns?
Aso it’s very, very conspicuous how much stuff has ‘Made in China/Mexico/Pakistan/India/Malaysia/etc’ printed on it. If huge amounts of stuff is still being made in the US…where is it? Because I have to go out of my way to find things made in USA to buy.
Sordemos:
I concur that we outsource a lot; look at the mfg’d items imports. They account for a lot, if not the majority of imports. But that mfg’g (of industrial and consumer items) what would come back if we made the policy decision to bring it back.
And after the War of Rent-Seeking ends, we’ll bring it back, or us and the 1% are going to be way poorer. I’m thinking they’ll choose half a loaf .vs. none.
And in the meantime, the Little People may well elect to conduct autarky, and start making things themselves. That’s a huge subject which we have only nicked the edge of.
I agree with all you said. My question to you is “what do the Little People do next”?
Tom – the issue is not whether or not ordinary Americans are up to the job. The issue is the ruling class controls society and we are in a plutocracy. If the ruling class were to decide to invest in technical schools and capital projects such as plants, then yes, it would be possible. But not with the current crop of (mis)leadership.
In regards to American manufacturing, the US seems to be increasing the dependency of imports from China.
https://asiatimes.com/2022/04/dependence-on-china-shrinks-the-us-economy-in-q1/
It’s been argued the US needs China more than the reverse.
https://www.industryweek.com/the-economy/article/22025438/us-needs-china-more-than-china-needs-the-us
If manufacturing kept up with real GDP, I’d ask the question, why has the imports from China been so big? Either the Federal Reserve’s methods are not correct in measuring this, or our consumption of manufactured goods has increased as a percentage of GDP, which would imply a loss of employment from trade deficits. In that case, re-shoring is a good idea.
The American worker can do the job, sure, but that requires the ruling class to commit to building manufacturing and paying workers well. That’s apparently too much for our ruling class.
Altemain: agree on all counts.
I’ll emphasize that the ruling class will likely be slow on the uptake. First they have to fight and lose the War of Rent-Seeking. That may take decades.
Recall the slope of the curve of jobs-to-mfg’g output. It’s _steep_. The little people _may not have decades to make the adjustment_.
Furthermore, even if mfg’g is brought back, it’s gonna come back to factories that are world-class efficient…meaning labor efficient. Probably not so much materials- or energy-efficient, but certainly labor efficient.
And so where’s all the employment to pay labor wages coming from in the future?
This is the major, huge, pivotal economic question. Major. Not addressed. Anywhere, left, right, 1% or 99%. Nobody. And it’s fundamental.
Even if that’s sorted out tomorrow, there remains the major, huge, pivotal environmental question of “can we run our economy so that it fixes our planet as we make our living?”
Not a lot of forward motion on that score, yet. It can be done, but it probably isn’t gonna come top-down, because, as I said, the elites are slow on the uptake. They have to lose the Environmental Degradation war before they’re going to do anything about it, and…that war has a lot of momentum.
Can’t just declare defeat and move on from the Environmental War. The consequences chase you around, and they’re very persistent and enormously powerful.
I don’t agree with Krugman on everything but his paper ‘The International Role of the Dollar: Theory and Prospect’ is the best thing that I have read on this topic:
https://www.nber.org/system/files/chapters/c6838/c6838.pdf
My understanding of that paper boils down to this:
Say you are a Swiss manufacturer that has customers in Colombia, Canada, and Peru and suppliers in Egypt and Indonesia. Are you going to want to conclude long term contracts with them in 5 different currencies or just one currency?
Similarly – are you going to want to disburse payments and receive payments using five different bank accounts or just have a single US dollar denominated account in addition to your Swiss account?
In the early 1990s, one of my indirect clients was Motorola. My immediate client was O’Connor & Associates, which then was the biggest FX options firm.
Motorola had that problem in spades: they might make a phone in Singapore but then not know if it would be shipped to Italy or Germany. They were losing fortunes trying to hedge that risk.
Perhaps I made this up, but I was thinking that Russia was demanding oil payment in rubles to protect itself from sanctions. I’m admittedly fuzzy on how this protection would work, but I imagined that to get the rubles to pay for oil, a western company would have to ask a Russian bank to make the currency exchange. At that point the Russian bank would issue the rubles only in exchange for deposit of western currency in a non-sanctioned account owned by that Russian bank.
OTOH, if dollar payment was allowed, a Russian oil company could accept dollar payment into its account in a western bank without ensuring that the account would be sanction free. Or something like that.
Otherwise, what is the point of pricing in rubles?
Mo – what you write is in line with my understanding.
That is what I said in the post and at the time there was much speculation about how the trade would work. The point was to have the transaction occur at a Russian bank (it turned out Gazrpom Bank) so that the foreign currency payment would be made to it and therefore be in its custody. As far as I can tell, this site was the only commentator early to puzzle out how the scheme had to work and why Russia was making that demand.
And it was gas for roubles, not oil for roubles. The US prohibited imports of Russian oil and petroleum products on March 8.
What happen when the EU will feel confident enough (probably when out of Russian gas dependency) to sanction Gazprombank with its foreign reserves piling up in the European banking system?
What I don’t understand is why China, Russia, and friends don’t build a “SPFS/CIPS” type system based on Eurodollars. As long as at least one of their allies are not under US sanctions that country would be able to convert those Eurodollars into real dollars – which in my mind would solve the problems that Yves has outlined.
I suppose one flaw to that plan is that such a country could steal the deposits it had been entrusted with to funnel into US banks.
You can’t run any payments system in dollars unless it is backstopped by the Fed. The Fed (or more accurately, Treasury which runs the anti-money-laundering and terrorist financing program, with Fed assistance) can kick you off any time, as they did by sanctioning most but not all Russian banks. There’s no point in having a messaging system unless you can process payments. And a dollar system allows for assets to be seized again.
Yves, thanks for this post. You must have noticed that I twice asked (in comment sections) for your views on the PD myth. Much appreciated that I can get my answers from you on such a high quality blog.
If you are still following these comments- I would like to make a statement about the PD, and hear your feedback on it.
“While the PD is a myth, myths can take on power if enough people believe in them. Just as a false provenance story behind an antiquity can drive its price up in an auction house, so can the myth of the PD drive up prices (of stocks, treasuries, etc) in certain markets. And when no one believes the false provenance story, or the myth of PD, resale prices will adjust accordingly. And prices and actual valuations will become more in line”.
Also, if the PD myth is supportive of the concept of dollar hegemony, do you discount dollar hegemony as well?
Thanks in advance.