Our Debt, Our Problem
Ken Rogoff's new book argues the U.S. dollar has nothing to fear but U.S. debt itself.
Talk about perfect timing. Ken Rogoff’s new book, “Our Dollar, Your Problem,” came out as President Trump’s tariff announcements sparked fears that the days of the US dollar as leading global currency might be numbered.
Before I tell you why this is an excellent book and why you should read it, a disclosure: Rogoff was one of my PhD thesis advisors at Princeton. He’s a Chess Grandmaster, in my view one of the sharpest minds in our profession, and has a deep grasp of real world policy issues from his experience at the Federal Reserve Board of Governors and as IMF Chief Economist.
This time is always different
Rogoff begins by listing the most egregious instances where we have naively assumed that “This is time is different”, leading to dire economic consequences: the belief that inflation and interest rates would remain low forever; that China’s real estate sector could never run into trouble; and that government debt had become a free lunch.
The book warns we are once again set to pay the price for our lack of common sense:
There are ample reasons to believe that over the coming decade, the world will experience higher interest rates and inflation than policymakers have gotten used to and that the dollar’s unique borrowing privilege might be considerably less amid a considerably more fragmented global financial system.
Rogoff then recaps past failed threats to the dollar’s dominance: first the Russian ruble (yes, really), then the Japanese yen, then the euro and most recently the renminbi. It’s useful to take the long-term perspective, see how fundamentals asserted themselves and over what horizons, and remind ourselves that the common wisdom at the time was quite different from our current twenty/twenty hindsight.
Europe, China, and Crypto
While the dollar has maintained its global dominance, Rogoff recognizes that both the euro and the renminbi still have the potential to erode it at the margin.
For the euro, this hinges on Europe making major strides towards fiscal, political and military union. Many of my European friends feel bullish about the prospect; I remain skeptical.
For China, it might be enough to allow more flexibility in its exchange rate. China’s trading partners need to watch their exchange rate vs the renminbi. So far this required no more than looking at their own dollar exchange rate and keeping reserves in US currency, since the renminbi has been predictably linked to the dollar. Should this change, they will need to build more reserves in renminbi.
What about cryptocurrencies? Rogoff acknowledges that cryptocurrencies are not just a speculative play. They’re becoming the preferred coin of the realm for the underground economy, estimated at about 20% of GDP for advanced economies and 30% for emerging markets. That’s a powerful use case, and the book provides an interesting discussion on the future of crypto and Central Bank Digital Currencies. On whether they threaten the dollar, Rogoff is more skeptical. He notes,
…the long history of money shows that each time a new private sector innovation or refinement comes along, the government will eventually either steal it or regulate into submission.
Governments are not about to relinquish their monopoly over legal tender. Rather than dreaming of government-free money, I would worry about the possibility of CBDCs becoming a powerful surveillance and enforcement mechanism: imagine a government with the digital power of preventing you from buying more than X gallons of gas at the pump, or purchasing a non-CDC approved remedy for the next nasty flu…
The curse of the free lunch
The most serious threat to the dollar’s future is domestic, and comes from loose fiscal policy and rising debt. The book could have been titled, Our Debt, Our Problem. Rogoff traces this threat to the economic misconceptions that have taken root over the past couple of decades:
The idea that inflation would never again be a problem;
The “Secular Stagnation” theory that structural forces would keep interest rates low forever;
Modern Monetary Theory’s claim that a government issuing its own currency faces no budget constraint;
A dangerous faith in governments’ ability to manage the economic cycle through activist fiscal policy.
The first two were behind the ill-timed and ill-fated 2020 revision of the Fed’s monetary policy framework. Supposed to be a response to secular trends, it proved counterproductively outdated just six months after launch, when inflation surged. The Fed has quietly retired it this week with Chairman Powell’s Jackson Hole speech.
Economics research bears its share of responsibility. As Rogoff puts it, “there is a lot of inertia in academic economic research.” Much like policymakers, academic economists are always fighting — or rather studying — the last battle. This has damaging policy implications:
The notion that government debt is a proverbial free lunch has so thoroughly pervaded the Washington establishment…
These illusions have put US fiscal policy on an unsustainable path and led the US Treasury to recklessly shorten the duration of government debt when rates were historically low. As Rogoff notes, this was like insisting on a variable rate mortgage when you could have locked in favorable long-term borrowing rates.
The “structural” forces supposed to ensure low interest rates forever are short-lived when seen in a long-term perspective. The long-term component of US interest rates, Rogoff shows, has been rising for the past hundred years. What Summers and others have seen as a secular decline was the short-term unwinding of the “Volcker shock”, when Fed Chair Paul Volcker jacked up interest rates in the 1980s to defeat inflation.
The book sounds a loud warning that we should recognize the limits of fiscal policy, and that rising US debt raises not just a threat to the dollar’s dominance, but also global risks of higher inflation, higher interest rates, greater financial instability and growing financial repression. Policymakers should take heed. So should economists.
A highly recommended read for this tail end of summer.
If I were Dante Alighieri and Adam Smith (or Ricardo or Keynes) were Virgil guiding me through the concentric circles of economic theory hell, I would place Ken Rogoff in the 1st circle --Unoriginality instead of Dante's Limbo -- and Larry Summers in the 5th circle -- Vainglory instead of Dante's Wrath.
(I would reserve the 9th and innermost circle -- Odium for Dante's Treachery -- for the likes of Harald Uhlig and John Cochrane and others of their ilk.)
I was a guest at the NBER Macroeconomics Annual in Cambridge, Mass., on April 15 2016 and Summers was delivering the keynote address. Unsurprisingly, given the date, the subject of his talk was Crises in Economic Thought, Secular Stagnation and Future Economic Research, a title so pompous and self-invoking that it would invite scorn if it came from anyone other than Summers, but because that is precisely what we have come to expect from him it was probably not challenged by the organizers.
I am not sure if Ben Bernanke was at that dinner but Rogoff and Robert Gordon were. Rogoff sounds smarmy now as he writes this work of popular economics (which you have reviewed and praised here) about the threats to the primacy of the US dollar and relates it to our recent inflationary episode and places the blame squarely on our fiscal mess. Yet, he was a prime proponent for a hyperactive monetary policy (along with Willem Buiter, who might also have been there that evening) throughout the 2010s – QE, aggressive forward guidance, and negative nominal policy rates (NIRP).
Let us remind ourselves what NIRP was supposed to do and Rogoff, even more than Buiter, called for a steady escalation of pressure on inert savings balances through ever more negative rates, which he saw as the problem then. By making future money balances lose value against present money stocks, while prices of goods and services remained the same, we were mobilizing inflation expectations implicitly. The possibility that this might become self-defeating and could perversely make the liquidity trap worse because when the cost of money becomes negative households target the quantity of saving for future spending, and rather than inciting current spending they increase precautionary savings -- a quasi-Fisherian explanation --and so depress effective demand, seems not to have occurred to him.
Now many years later, Rogoff is being artful in his rewriting of history, using both selection and confirmation biases to make his latest case. While all along calling for engendering inflation through reckless use of monetary policy, he has conveniently changed the subject and put fiscal activism in his sights, while also proclaiming piously to be concerned about the dollar’s paramount reserve currency status. There was not a chirp from him throughout those years about the hundred-year trend of rising “long term component of US government interest rates”.
As for his observation that “there is a lot of inertia in academic economic research.”, well we we have a prime example of that in the man himself. As far as I am concerned, he will remain in the First Circle of Hell for his unoriginal thinking.
A great and persuasive summary. During this past year I have often been stunned how differently Marco and I see things, specifically wrt Trump’s policies, so it was a real pleasure to read this and rediscover how much we agree on. I’ll be heading right down to the book store (yep, the physical one!) to get my copy.