The U.S. Isn't Greece, and That's a Problem

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The dollar's domination of the world's monetary system has tremendous consequences for the U.S. economy and fiscal policy. Yet leading officials and commentators in Washington repeatedly overlook this effect when grappling with economic news. "Deficit fears don't appear to bother the bond market," was the headline on the front page of the Washington Post in June. The article implied that our creditors are naive for accepting low returns on Treasury bonds because America is running the risk of being hit with a debt crisis similar to what happened in Greece, whose government came close to defaulting on its obligations last spring.

Meanwhile, Federal Reserve Chairman Ben Bernanke is happy to take credit for what he sees as low inflationary expectations. "The spread between nominal and inflation index bonds remains quite low, suggesting just 2 percent inflation over the next 10 years," he told the House Budget Committee earlier this summer. Bloomberg BusinessWeek magazine declared that Bernanke "tamed the bond vigilantes."

How can the U.S. government's debt be selling so briskly when its finances are in such bad shape? In short, how come we haven't become Greece? The dollar's role as the world's major reserve currency makes this paradoxical situation possible. Foreign central banks' insatiable demand for dollar reserves, mostly in the form of interest-bearing Treasury bonds, has allowed the government to continuously deficit-spend at a discount to what other nations must pay to do it. Year after year the world has been there to finance Washington's self-indulgence because it uses our debt as a reserve asset and instrument for finalizing international payments. The arrangement of the global monetary system encourages a massive issuance of U.S. government debt, which Congress uses to pay for its budget deficits.

In theory, Washington could issue enough debt to push up its borrowing costs. Or the Fed could inflate it away and produce the same effect, which is what happened in the 1970s when interest rates ran into the double-digits. In fact, experience has shown that the reserve currency weakens over time against competitor nations' currencies as the world's demand for available liquidity outstrips any effort to maintain the dollar's value.

But the Greek scenario doesn't hold for America; unlike Greece, the U.S. has foreign governments ready and willing to buy up more of our dollar-denominated debt, which has the effect of financing our deficit spending. Furthermore, economic crises around the world typically stoke demand for our debt as foreign central banks and private investors rush to the relative safety of Treasury notes and dollars. What is happening now mirrors what happened on a more acute level during the financial crisis, when in the fall of 2008 the 10-year Treasury yield sank below 3 percent in a worldwide "flight to quality."

The dollar's role as the reserve currency is a comparative advantage only if you believe that awarding a seemingly unlimited credit line to Congress is a good thing for the United States. What we've seen from the results of living beyond our means is that excessive government spending fails to help the economy and leaves a trail of bad policy decisions in its wake. The reserve currency arrangement paves the way for big government and pressure for higher taxes.

As unpopular as the growth of government may be, the notion that deficit spending is incompatible with America's financing capabilities is incorrect. As long as the status quo exists, there will be a steady demand around the world for our debt, whether or not we ultimately have to pay higher interest rates on it. The key to curtailing the growth of government is to replace the dollar with something else as the world's major reserve unit, something that isn't one particular country's liability. Before the dollar emerged in its current form in the years leading up to the Great Depression, gold fulfilled this role. It continues to be the commodity most identifiable with money. Unlike paper currency, gold retains its value over time and its supply grows at a predictably steady rate.

Chairman Bernanke had a hard time seeing all this in his testimony before the House Budget Committee. When ranking Republican member Paul Ryan pointed out that most people interpret the rising gold price as a sign of dwindling confidence in the dollar, all Bernanke had to offer was, "The signal that gold is sending is in some ways very different from what other asset prices are sending," such as Treasury bonds.

If the Fed chairman fully grasped the effects of the dollar's global role he would understand how these two seemingly contradictory signals are occurring simultaneously. The worldwide demand for U.S. government debt means it can increase in value even as the gold price surges and indicates higher long-run inflationary expectations.

For Bernanke's Republican critics in Congress, this paradox should alert them to the reality that America will never be able to escape big government when financing it comes easily. Instead of looking exclusively at spending and the deficit, they should examine the reserve currency arrangement that enables this excess.

Until that happens, Republicans will be stuck sounding the alarm against a bloated fiscal policy while the monetary system continues to prop it up. The U.S. isn't Greece, and that comes with its own set of consequences.

Rich Danker is project director for economics at the American Principles Project, a Washington, D.C. advocacy organization

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