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December 02, 2007

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Nato

Coalitions have stopped dollar declines before and could do so again, I'm sure. The counterpoint issue to Nathan's is that if they decide really aggressive action to be necessary, the cruder instruments that implies might prop up the dollar too much while making the underlying problem worse: overuse of the dollar as a reserve currency.

Nathan Smith

This dollar decline is a bit more dramatic than most in the past, however...

The knowing tone of one of Nato's remarks puzzles me. How can we know what would be "overuse of the dollar as a reserve currency?" How do we know the appropriate amount of dollars that should be used as reserves? And there's no reason to assume that dollars abroad are in use as a reserve currency. Money traditionally has three uses: (a) a store of value, (b) a medium of exchange, and (c) a unit of account. The dollar could and does serve all three purposes. I'm not aware of any theoretical reason why the entire world couldn't opt to use dollars as their main currency, in which case we could afford to export a lot more than we have so far.

Nato

Nathan, if they chose to use dollars as their currency, I don't think that would be a problem except that we'd have to adjust monetary policy dramatically to account for that. But that's not what banks holding dollars are doing - they hold foreign currencies that aren't officially negotiable in their home country. Some 65% of all the foreign reserves are in dollars, but only a quarter or so of the world economy is actually dollar denominated. This is essentially all excess risk. I don't think this is particularly controversial.

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