In recent years, the current account deficits of the American economy have been growing tremendously, reaching 5% of GDP in 2002. Along with the deficit, there has also been a marked increase in the number of heterodox economists who believe that the American foreign debt (“the biggest of the world”) is getting unsustainable. These include some of followers of the Marxist tradition (Giovani Arrighi, Anwar Shaikh, Jayati Ghosh and several others), Post-Keynesians (Wynne Godley, Robert Blecker, Tom Pailley, James Galbraith, among others) and also some Latin American structuralists (Arturo O’Connell and Celso Furtado, to cite only the most notable)If the American external deficit is not substantially reduced, they argue, this will trigger a “speculative attack against the dollar” and consequently a serious crisis in the American (and the world) economy. With this crisis, the dollar would probably loose the central role that it plays in the world economy today.

In fact, what these heterodox critics do not seem to notice is that the American current account deficits and external liabilities are very different from those of a country like Brazil, and even from those of the other rich countries. This is due to the fact that the dollar is nowadays the international currency of the world economy. The world economy works in practice, at least since 1980, in what we have been calling the 'floating dollar standard'^[2], where the dollar has a very different role from all other currencies (including the convertible currencies of the other rich countries). This gives an extraordinary asymmetric power to the US economy, which simply does not have any kind of balance of payments constraint.

The position of the American dollar is different from all other currencies, for several reasons. First and most importantly, is that the dollar is the international means of payment. This means that, differently from the other countries, almost all the US imports are paid in dollars. This also implies that virtually the whole of the American external liabilities are also denominated in dollars. Since the dollar is issued by the FED (American Central Bank), it is impossible (since American imports are paid in dollar) for the US not to have enough resources (dollars) to pay their external accounts. Moreover, naturally, it is the FED that determines the dollar basic interest rate.^[3]Therefore, since the American foreign debt is denominated in dollars, the US is in the peculiar position of unilaterally determining the interest rate paid on their own foreign debt. Further, American public debt that pays interest rates set by the FED is the most liquid dollar financial asset and is also the most important reserve asset and store of value of the international financial system.

Another consequence of the fact that American external liabilities are denominated in dollars is that when the dollar depreciates relative to any other currency, it is the owners of the American foreign debt of that country who will suffer balance sheet losses instead of the US. Another advantage for the US due to the special position of the dollar is that exchange rate devaluations cause very little inflation in the US. This occurs because, in a large part of the international markets, including almost all commodity markets, prices are set directly in dollars and, as in the case of the oil price for instance, do not increase when the dollar is devalued. Recent econometric estimates show that on average less than 50% of the devaluations of the dollar are passed through as an increase in the internal prices of the imported products^[4]. It is clear that, under these special conditions, the US, unlike Brazil and all the other countries of the world, can have a regime of floating exchange rates and free short term capital flows without this creating any obstacle to its macroeconomic policies.

Let us see three recent examples of how things are really different for the dollar. Our first example is from 2001. In this year, the American recession had already started with the decrease of private investment, due to the excess of productive capacity that was rapidly installed in the high technology sectors of the "new economy" during the NASDAQ bubble, when the September 11 terrorist attack took place.

The American policy answer to the crisis was fast and drastic. The basic interest rate was reduced, there was an enormous coordinated injection of liquidity in the international financial system by the FED, together with the central banks of the rich countries. There was also a rise in public spending, tax cuts, government financial help for the especially jeopardized sectors as airlines and insurance companies, etc.

All these measures certainly avoided the deepening of the recession and the disorganization of the financial system. Just after the terrorist attack, there was naturally a tendency in the international financial markets for "flight to quality", due to the increased perception of risk and uncertainty. This was worsened by the initial fear that the "war against terrorism" would end up triggering greater supervision and control of international capital flows, with the aim of combating money laundering channels and locating the financial sources of the terrorists’ funds.

For our purposes here, what is important to notice is that this “flight to quality” of the market was a run for the dollar and not from the dollar, despite of the interest rate reduction, more than confirming the role of the dollar as a store of value currency of the capitalist world economy. It is to the dollar that the market runs to at moments of crisis, even when the crisis, as in this case, occurs in New York, at the financial centre of the US dollar.

Our second example is from 2002. The damage control and expansionary measures described above were already beginning to work in 2002. However, the scandal of ENRON and of the other big companies that were caught falsifying their balance sheets ended up bursting the stock market bubble. Until then, with the FED's help, the overall stock market bubble had survived not only the collapse of the NASDAQ bubble, but also the terrorist attack.

Since the dollar was being kept appreciated mainly by the foreign demand for papers negotiated in the American stock market and the FED was already quickly reducing the American interest rate (by much more than the other rich countries), it is only natural that the dollar started to depreciate.

However, the result of this recent foreign capital outflow from the US and of the devaluation of the dollar, contrary to what many of the heterodox economists mentioned above had foreseen, has been the continuous reduction (instead of an increase) of American interest rates. These interest rate decreases have lowered the financial losses of the heavily dollar-indebted American firms and workers, and have also been helping to keep demand growing both in the markets for real estate and for durable consumption goods.

This shows that the US simply does not need those external capital flows to finance its external current account deficit. The American external deficit continues to be automatically financed at the moment in which transactions that generate this deficit are denominated and paid in the American national currency. Which other country that has a stock market crash and an outflow of external capital, answers these by reducing its interest rate?

Our third example is from 2003. Although the dollar is tending to devalue, some countries - especially in Asia, such as Japan and China among others - have been doing everything possible to avoid or contain the appreciation of their currencies relatively to the dollar. On the one hand, these countries do not want the increase in the dollar costs of their exports to generate either lower profitability or lower market share for their products in the international markets. Moreover, the appreciation of the currencies of these “surplus” countries that hold a great amount of financial assets in dollars would bring big balance sheet losses for the local companies and financial systems. Because of that, the central banks of these countries are letting their external reserves in dollars increase continually in the attempt to avoid the appreciation of their exchange rate rates. By now, Japan already holds more than US$ 500 billion dollars of reserves, while China already passed the US$ 300 billion mark, South Korea has more than US$ 100 billion, Taiwan province of China more than US$ 180 billion and even Indonesia has more than US$ 30 billion^[5].

Given this, if the heterodox critics cited above were correct, the American government should be commemorating the fact that although the private agents have “run away from the dollar” in recent times, the governments of the Asian countries are helping to minimize the devaluation of the dollar and finance the enormous American current account deficit, avoiding thus the “dollar crisis”.

But, what is occurring in reality is exactly the opposite of this. There has been an increasing and not very subtle American diplomatic offensive pressuring the Asian countries to let their currencies appreciate. The pressure on China to abandon the fixed exchange rate and to revalue the Yuan, in particular, has been very strong, and there is growing American official accusations that the Asian countries are “protectionist”, follow “mercantilist” policies and practice “unfair competition”. The reason for this pressure seems to be very simple: at the moment, the American priority is reviving its domestic economy. The devaluation of the dollar is in the American interest in order to increase exports and to reduce the American imports to help the domestic economic recovery. The Asians are seen as going against this plan when they avoid the appreciation of their currencies.

This last example shows how the American government is not even slightly worried about the depreciation of the dollar causing any problem, let alone a “crisis”. One reason for this is because (as recent official figures points out), about a third of the American current account deficit with “foreign residents” is in fact due to imports from branches of American multinationals abroad. The main reason, however, is simply that the American government knows very well that, given its current condition of being the world’s only superpower, so soon it will not have any difficulty in finding sellers in the international markets willing to accept dollars as payment for its imports.

References
SERRANO, Franklin L. P. (2003). From 'Static' Gold to the Floating Dollar. Contributions to Political Economy, 22, 87-102 (forthcoming).
BOMFIM, Antulio N. (2003). Monetary Policy and the Yield Curve. Federal Reserve Board, mimeo, New York
BEDDOES, Zanny M. (2003). Flying on One Engine - a survey of the world economy. The Economist, September, 20.
SAMUELSON, Robert (2003). A Crackup for World Trade. Newsweek, August, 25.

October 14, 2003.

# I would like to thank, but not implicate, Prof. Paul Davidson for his comments on an earlier version of this note.
* Associate Professor at the Instituto de Economia, UFRJ, Brazil.
[1] In fact, this view is so widespread nowadays that it is easier to mention the few exceptions such as Prabhat Patnaik and Paul Davidson (and curiously enough, Ronald Mckinnon in his new incarnation).
[2] See Serrano (2003).
[3] Besides directly determining the basic short run dollar interest rate, the FED has a lot of power to influence the determination of the longer dollar rates of interest set by the market. Because of arbitrage, these longer rates depend fundamentally on the market participants' expectations of the future course of the short rates set by the FED. See Bomfim (2003).
[4] See Beddoes (2003).
[5] See Samuelson (2003).