America runs large trade and current-account deficits to issue the world’s reserve currency–Americans import more then they export, spending beyond their means. Contrary to intuition, paper dollars are not the world’s money–U.S. Treasury bills are, and Treasuries can only circulate abroad through large trade deficits. Economists call this the Triffin Dilemma: whichever nation issues the world’s money must damage its economy to do so.
The Euro is also a global currency and a serious contender to the dollar. Yet the Eurozone has balanced trade with the rest of the world. How is this possible? The solution to the Triffin Dilemma is multiple reserve currencies, one per economic bloc. The Chinese buy Euro bonds–creating a balance of payments deficit–but the Europeans cancel this out by buying American bonds–capital inflows and outflows balance out–the Europeans are loaning Chinese capital to America.
The United States lacks this option. If America purchases Euro bonds (to offset the Asian deficit), the Europeans will simply buy more American bonds to maintain their own balance. The only possible solution is greater liberalization of China’s capital account, whereby the United States and Europe can buy Chinese bonds to offset Asia’s dollar and euro purchases.
China has already begun reforms, but history shows this takes time; a sharp, sudden liberalization would be economic catastrophe, causing bubbles and economic collapse from massively overloading the Chinese economy with liquidity.
But while fast and quick cannot work, slow and steady can still win the battle. The recent opening of Hong Kong’s renminbi markets show that progress is being made.