Fiat Currencies vs. Trade

In his Wall Street Journal op-ed Sean Rushton makes a very important point about our trade deficit:

The U.S. dollar’s status as the global reserve currency is at least as responsible as any free-trade agreement or unfair practices. High demand for dollars has tilted the playing field against American exporters and workers.

but I’m skeptical of the solutions that he proposes:

First, to guide monetary policy, Federal Reserve appointees should commit to targeting the real-time prices of an index of commodities, plus foreign currencies and bonds. Such an approach would have prevented the Fed’s biggest recent errors. Easy money in the 1970s and 2000s led to large increases in world dollar holdings, price bubbles and crashes.

Second, the U.S. should invite other major currencies—starting with the second-largest, the euro—to stay steady with the dollar. A dollar-euro stability pact, later including Japan and other democracies, would stabilize demand for dollars. A recent International Monetary Fund communiqué expressed positive sentiments on this front: “We recognize that excessive volatility or disorderly movements in exchange rates can have adverse implications for economic and financial stability. We will refrain from competitive devaluations, and will not target our exchange rates for competitive purposes.”

Third and most controversial, the U.S. and other leading economies should establish a new international currency for pricing global commodities and settling trade accounts. Nations would keep their own currencies for domestic use, exchanging them for the international currency at fixed rates.

most importantly because the Congress considers their ability to spend more than we’re willing to pay for via the willingness of other countries to hold our bonds a feature rather than a bug. They would be very reluctant to relinquish the power it gives them.

My specific observations about the piece are:

1. I wish he presented much more quantitative evidence than he does. I’m a quantitative kind of guy.
2. He fails to note that Japan, South Korea, and China are all holding dollar reserves much higher than those determined by the IMF and higher than they’ve agreed to. If they don’t follow the international accords to which they are signatory now, why will they if his reforms are adopted?
3. It’s high time the Fed and other central banks started using more modern tools. Spoiler alert: they will be reluctant because it will reduce their governors’ power.
4. The gotcha in his third proposal are two words: fixed rates. What process would be used to set them and for how long? It sounds to me as though the arbitrage would vitiate the effectiveness of his reform.

but most importantly he fails to consider other alternatives. We don’t need Germany, Japan, or China’s permission to make their policy of running a permanent trade deficit with us impossible.

However, the critical point is that he teeters on the brink of an important realization but fails to embrace it fully. International trade really needs to be reconsidered in the context of a fiat currency. Many of the assumptions made about trade don’t really hold when everybody has their own fiat currencies.