Losing the Exorbitant Privilege

I don't think there's any prospect of any big shift in portfolio preferences of foreign investors right now. Ben Bernanke

The bank stress tests are beginning to create a perception problem, but not – as you might think – for banks. Rather the issue is top level Administration officials’ own optics (spin jargon for how we think about our rulers).

At one level, the government’s approach to banks – delay doing anything until the economy stabilizes – is working out nicely. This is the counterpart of the macroeconomic Summers Strategy and in principle it is brilliant. “Don’t just do something, stand there,” is great advice in any crisis – eventually everything bottoms out and you can take the credit, justified or not (unless an election catches up with you first; check with Herbert Hoover.) Simon Johnson

Harry Truman, who famously wished for a one-handed economist, would, I suspect, be quite pleased with Mr. Bernanke and Mr. Summers, both of whom, according to the passages above, are singularly concerned with restoring US citizen's faith in finance.

Summers and Bernanke seem to have forgotten the wisdom of Machiavelli; For a prince should have two fears: one, internal concerning his subjects; the other, external, concerning foreign powers. These princes of finance apparently have no fear of external powers.

The America Economy is, I believe, a wondrous thing, a powerful engine of production. Despite what I believe to have been a lack of need, the US added a turbo-charger to the economic engine- the, in the words of Valery Giscard D’Estaing, exorbitant privilege of issuing debt to foreigners in our own currency. The exorbitant privilege will not be retained by restoring US citizens' faith in finance, but rather by restoring the faith of external powers.

Without the exorbitant privilege the US would already be deep in the throes of a currency crisis familiar to many banana republics. Without the exorbitant privilege big finance would have no bargaining chip with the state and as President Obama is reported to have said, My administration is the only thing between you and the pitchforks.

While it might be fear of the pitchfork wielding public that drove Summers and Bernanke to one-handed-ness I suspect a bigger factor is residual self-image from the heady End of History days. Summers' Don’t just do something, stand there policy implicitly accepts what Bernanke explicitly stated, no prospect of shifts in foreign investors' portfolio preferences. I can almost imagine these two advising the Pope during Martin Luther's time- "there's no prospect of a shift in sinners' desires to buy indulgences from us."

The genius of Paul Volcker, informed by current problems, becomes clearer by the day. Mr. Volcker didn't just break the back of inflation, at great risk of angering the pitchfork wielding public, he maintained the exorbitant privilege. He understood that one needs to compete to stay at the top. With Russia (in 1979) flexing its muscles and Iran breaking free of US control, US$ dominance wasn't assured, as Volcker learned during an IMF meeting in Belgrade that year. US policy needed to ensure the $ was a solid store of value.

Sadly, the Obama administration seems to be listening to Mr. Summers rather than Mr. Volcker. The most recent G20 meeting was, in my view, another Belgrade- a warning that US$ dominance is not a given.

I think we, and even his backers in big finance, will greatly regret this summer with Summers. The recovery for which he waits might be driven by China, and the pitchforks his backers fear might yet be brandished- made in China and purchased with RMB.