JD Vance is right

Reserve currency status is a resource curse

I get confused with Ohio Senator J.D. Vance enough as it is, given our similar face shapes, immaculate beards, and shared interest in conservative family policy. So it doesn’t help that we also seem to have surprisingly congruent views on geoeconomics.

At last month’s hearing with Jerome Powell, Senator Vance asked the Fed Chairman whether the dollar’s status as the global reserve currency might have some downsides. Vance drew parallels to the classic “resource curse,” suggesting the dollar’s global role contributed to financialization at the expense of investment in the real economy:

One of the things you hear a lot when you study the regional history of Appalachia is it’s often described as possessing a “resource curse,” right?

There’s a lot of coal in central Appalachia that enables a certain amount of consumption, obviously, consumption is good, people need food and medicine, and other things. There’s also a pretty good argument that for a host of reasons, it causes malinvestment in the region and consequently, you have lower productivity growth, lower innovation, and an economy that is much less diversified and much less dynamic.

I am wondering when I hear about the history, what I think about and read about the history of Appalachia and the resource curse, I am struck by the idea that you can make a similar argument about the reserve currency status of the United States dollar.

Vance expanded on the argument at a recent American Moment event, video below:

I think Vance is exactly right. As I argued in a 2020 report on economic development policy:

…unbalanced economic development creates unbalanced politics. Developing countries provide many examples of this dynamic that the United States can learn from. Left to their own devices, market forces can lead an emerging economy to overspecialize in its abundant factor, be it natural resources or low-wage labor. The former gives rise to petro states and the Dutch disease, whereby currency appreciation suppresses the development of productive export sectors, and turns politics into a zero-sum conflict over resource rents. The latter gives rise to the so-called "middle-income trap," whereby a country specialized in labor-intensive production underinvests in the capital, technology, and education necessary to transition to a high-wage equilibrium, and so enters a developmental cul-de-sac.^[41]

Both the Dutch disease and the middle-income trap stem from the failure of an economy to properly diversify, and in many ways the contemporary U.S. economy exhibits symptoms of each. Following the collapse of the Soviet Union, the U.S. adopted an explicit strong-dollar policy, only rather than export oil, we exported the safety and stability of dollar-denominated assets like Treasury securities. The U.S. dollar now denominates two-thirds of international foreign currency reserves, 90 percent of foreign-exchange trades, and trillions of dollars in private assets held abroad.^[42] This makes the U.S. the most attractive economy in the world to park one’s excess savings, which we absorb in the form of our ever greater public and household debt.^[43] Where a petro state might invest in pipelines and refineries, the U.S. invested in Wall Street — the de facto pipes of global finance. In the mid-1990s, the U.S. corporate sector thus transitioned from being a net borrower to being a net lender, while aggregate investment in tangible assets like structures and equipment withered on the vine.^[44]

And while the U.S. is no doubt a high-income country, our specialization in a particular kind of college-educated knowledge production — buttressed by financialization and the growth of intangible assets like intellectual property — puts us at risk of walking down a developmental cul-de-sac of our own.^[45] We therefore reject the misleading distinction between developing and developed countries, as if the United States has reached some kind of end-state. On the contrary, economic development is a process that never ends, and without proactive diversification, even frontier economies can fall short of their full growth potential.

It’s great to see a sitting US Senator making very similar points. After all, if you get the diagnosis wrong it’s easy to end up chasing red herrings.

One major red-herring is the popular theory that “shareholder primacy” drove corporations to forgo long-term investments for short-run returns. Corporate governance matters, but as I wrote in a 2019 piece for the American Conservative, its explanatory role pales in comparison to these global macroeconomic forces:

Interpreting the last 40 years of economic history is all the more challenging due to how many major events occurred around the same time. The 1980s shareholder revolution, for example, took off in the years following the hugely consequential demise of Bretton Woods. The sudden adoption of free-floating exchange rates allowed countries around the world to liberalize their capital accounts while maintaining independent monetary policies. The resulting wave of globalization led to the U.S. dollar’s privileged role as the global reserve currency, denominating two thirds of all foreign reserves and nearly 90 percent of foreign exchange trades. As banker to the world, it’s thus not surprising that the United States became host to the world’s financial services industry.

Being the global reserve currency comes with significant benefits, like the ability to unilaterally impose financial sanctions. It also means deficits and the cost of capital matter a lot less than under standard economic models. Foreign countries and multinationals depend on U.S. treasuries as safe and highly liquid assets. With an aging population and a growing global middle class, savings have come to dramatically outstrip investment, pushing down global interest rates and encouraging excess leverage.

To take full advantage of the bottomless demand for U.S. sovereign debt, we could have financed massive public investments in infrastructure and R&D. Instead, the Clinton administration passed budget surpluses and, in 1995, adopted an explicit strong dollar policy. As peripheral countries pursued export-led development growth through currency depreciation, U.S. multinationals shifted from domestic investment to international arbitrage, offshoring much of America’s manufacturing sector. For the “tangible” production that remained, capital goods were often cheaper to import from China. As Brad Stetser notes, “the China shock for capital goods lasted until at least 2012.” Rising industry concentration followed, not because of lax antitrust enforcement, but because smaller, less productive firms struggled to compete on a global stage.

Stable inflation during the “Great Moderation” compounded financialization. Shielded from inflation risk, creditors—including the business sector—increased lending like never before. With the Treasury and Federal Reserve keeping a lid on the supply of U.S. dollars, global savings shifted into mortgages and financial derivatives, engineered to appear as safe as sovereign debt.

The American model of corporate governance no doubt played a role in all this. Nonetheless, the massive structural changes brought on by financial globalization and tight U.S. monetary policy do a far better job of explaining the facts. Multinationals shifting production to China may have been focused on maximizing shareholder value, for instance, but that doesn’t explain why those returns were so preternaturally high in the first place.

Trends that can't go on forever won't, and a global rebalancing is now already well underway. Sanction regimes, export controls and other forms of neo-protectionism have amplified the partial deglobalization triggered by the pandemic. China tensions are driving a race to reshore, and Congress can't decide whether to ban TikTok or build an internet firewall of our own.

These are the sort of trends that give rise to new monetary regimes, and Senator Vance seems to be thinking in those same terms. He's right to.