Executive master in e-Governance Better than an MBA-thanks to our Swiss reputation Economist. com oPINION Economics focus The dollar and the deficit Sep 12th 2002 From The Economist print edition Why the dollar still rules the world-and why the world should be grateful THE dollar is looking vulnerable. It is propped up not by the strength of America's exports, but by vast imports of capital. America, a country already rich in capital, has to borrow from abroad almost $2 billion net every working day to cover a current-account deficit forecast to reach almost $500 billion this year. To most economists, this deficit represents an unsustainable drain on world savings. If the capital inflows were to dry up, some reckon that the dollar could lose a quarter of its value. Only Paul ONeill, America's treasury secretary, appears unruffled. The current-account deficit, he declares, a"meaningless concept" which he talks about only because others insist on doing so The dollar is not just a matter for America, because the dollar is not just America's currency. Over half of all dollar bills in circulation are held outside america s borders and almost half of Americas Treasury bonds are held as reserves by foreign central banks. the euro cannot yet rival this global reach. International financiers borrow and lend in dollars and international traders use dollars even if Americans are at neither end of the deal. No asset since gold has enjoyed such widespread acceptance as a medium of exchange and store of value. In fact, some economists, such as Paul Davidson of the University of Tennessee and Ronald McKinnon of Stanford University, take the argument a step further (see references at end). They argue that the world is on a de facto dollar standard, akin to the 19th-century gold standard For roughly a century up to 1914, the world's main currencies were pegged to gold. You could buy an ounce for about four pounds or twenty dollars. the contemporary dollar standard"is a looser affair. In principle the world's currencies float in value against each other, but in reality few float freely. Countries fear losing competitiveness on world markets if their currency rises too much against the greenback they fear inflation if it falls too far. As long as American prices remain stable, the dollar therefore provides an anchor for world currencies and prices, ensuring that they do not become completely unmoored In the days of the gold standard, the volume of money and credit in circulation was tied to the amount of gold in a countrys vaults. Economies laboured under the tyranny"of the gold regime booming when gold was abundant deflating when it was scarce. The dollar standard is a more liberal system. Central banks retain the right to expand the volume of domestic credit to keep pace with the growth of the home economy. Eventually, however, growth in the world's economies translates into a growing demand for dollar assets. The more money central banks print the more dollars they like to hold in reserve to cover their transactions. If the greenback is the new gold, Alan Greenspan, the Federal Reserve o underpin their currency. The more business is done across borders, the more dollars traders needEconomics focus The dollar and the deficit Sep 12th 2002 From The Economist print edition Why the dollar still rules the world—and why the world should be grateful THE dollar is looking vulnerable. It is propped up not by the strength of America's exports, but by vast imports of capital. America, a country already rich in capital, has to borrow from abroad almost $2 billion net every working day to cover a current-account deficit forecast to reach almost $500 billion this year. To most economists, this deficit represents an unsustainable drain on world savings. If the capital inflows were to dry up, some reckon that the dollar could lose a quarter of its value. Only Paul O'Neill, America's treasury secretary, appears unruffled. The current-account deficit, he declares, is a “meaningless concept”, which he talks about only because others insist on doing so. The dollar is not just a matter for America, because the dollar is not just America's currency. Over half of all dollar bills in circulation are held outside America's borders, and almost half of America's Treasury bonds are held as reserves by foreign central banks. The euro cannot yet rival this global reach. International financiers borrow and lend in dollars, and international traders use dollars, even if Americans are at neither end of the deal. No asset since gold has enjoyed such widespread acceptance as a medium of exchange and store of value. In fact, some economists, such as Paul Davidson of the University of Tennessee and Ronald McKinnon of Stanford University, take the argument a step further (see references at end). They argue that the world is on a de facto dollar standard, akin to the 19th-century gold standard. For roughly a century up to 1914, the world's main currencies were pegged to gold. You could buy an ounce for about four pounds or twenty dollars. The contemporary “dollar standard” is a looser affair. In principle, the world's currencies float in value against each other, but in reality few float freely. Countries fear losing competitiveness on world markets if their currency rises too much against the greenback; they fear inflation if it falls too far. As long as American prices remain stable, the dollar therefore provides an anchor for world currencies and prices, ensuring that they do not become completely unmoored. In the days of the gold standard, the volume of money and credit in circulation was tied to the amount of gold in a country's vaults. Economies laboured under the “tyranny” of the gold regime, booming when gold was abundant, deflating when it was scarce. The dollar standard is a more liberal system. Central banks retain the right to expand the volume of domestic credit to keep pace with the growth of the home economy. Eventually, however, growth in the world's economies translates into a growing demand for dollar assets. The more money central banks print, the more dollars they like to hold in reserve to underpin their currency. The more business is done across borders, the more dollars traders need to cover their transactions. If the greenback is the new gold, Alan Greenspan, the Federal Reserve