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Repatriation

Mises Daily: Monday, November 23, 1998 by

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Here is a news piece from Investor's Business Daily (Nov. 23, 1998) dealing squarely with one of the most interesting monetary issues of the day. The author quotes some well-known Austrian economists to help sort it all out.


Are the vast amounts of U.S. currency held overseas a threat to the U.S. economy?

Whether for spending or saving, most Russians prefer the dollar to their own rocky currency. Some 40 billion U.S. dollars are now held there.

And who can blame them? With inflation spinning out of control over the last few years, Russians have seen their ruble-priced wealth vanish.

The dollar is the preferred cash all over the world. People in Russia, Latin America and Asia stuff dollars - not local currencies - into their mattresses.

The Federal Reserve has a pretty good track record of managing the money supply. The Fed has tended to keep inflation low.

That's in contrast to most Third World countries. Even Western Europe, which is far from Third World status, has a long history of monetary mischief.

Further, the U.S. probably is No. 1 when it comes to political stability. And the two oceans that lie on each side of the North American continent are a buffer from hostility. The picture - and history - in Europe is quite the opposite.

''In many ways, the international economy now operates on a dollar standard,'' said David Blitzer, chief economist at Standard & Poor's.

What's wrong with that? As long as those dollars stay in foreign hands, not much. But if those dollars start coming back to the U.S., the result could be a severe case of inflation here.

The government says that more than half of all U.S. currency is held overseas.

That helps explain one of the big economic mysteries of the '90s: Why is U.S. inflation so low despite big growth in the money supply?

The money supply is now growing faster than the economy, and has been for some time. That's a recipe for inflation, according to monetarist models. When money grows faster than output, there are too many dollars chasing too few goods. That's when prices soar.

''Those models seemed to work for a long time,'' said Stephen Slifer, chief U.S. economist at Lehman Brothers. ''But in the '80s they broke down.''

No one doubts that at some point too much money will drive up prices, but economists don't know exactly where that point is.

''Monetarism assumed the demand for money is fairly constant,'' said Ian Shepherdson, chief U.S. economist at High Frequency Economics. ''But we now know that demand isn't constant.''

Demand for dollars climbed in the '80s and '90s. Much of that demand came from overseas, where people can hold foreign currencies for the first time.

Cash held by foreigners isn't chasing U.S. goods, and it isn't funding U.S. firms. So the prices of houses, cars and pencils shouldn't be affected, this argument goes.

''The Fed should basically just ignore those dollars when making monetary policy,'' said Bruce Bartlett, a senior fellow at the National Center for Policy Analysis.

If we subtract that foreign-held cash from monetary statistics, Bartlett says, it's clear that the money supply isn't growing as fast as Fed numbers seem to show.

If the money supply is too tight, it can cause deflation because there's too little money chasing too many goods.

In that event, the Fed should open the spigot a little more and create enough dollars to meet both foreign and domestic demand, say many economists.

Yet not all experts accept that advice.

''It's dangerous for the U.S. to count on foreign demand to support monetary expansion,'' said Joseph Salerno, an economist at Pace University. ''That demand is sensitive, and could change quickly.''

Some think the euro might take a bite out of dollar demand.

''The European Monetary Union is explicitly trying to get some of the dollar's market,'' said Jeffrey Herbener, an economist at Grove City College in Grove City, Pa.

''They are printing 500-euro notes, larger than the $100 bills popular on the black market,'' Herbener said. ''The idea is that these larger notes will be more attractive than the $100 bill because it will take fewer of them for large transactions.''

Problems in the U.S. economy could also cause foreigners to cough up their dollars.

They could spend those dollars on other currencies or use them to buy goods from abroad. As those dollars start moving across borders, they would eventually find their way back to the U.S. And if they return here to buy goods, that would spark inflation.

That's happened before. In the '70s, inflation and devaluation robbed the dollar of value, and foreigners rushed to get rid of their greenbacks.

Most economists don't think foreigners will lose their hunger for dollars, and even if they do, the Fed has the tools to deal with it.

''But the Fed would deal with that inflation by tightening the money supply, by raising interest rates,'' Salerno said.

And that might cause a recession. Yet slowing the growth of the money supply now would also likely plunge the economy into a recession. It would be foolish to wreak such havoc to prevent price inflation that might never come, say most economists.

That view is short-sighted, Salerno says.

''It would be wiser to tighten now. If we wait, the money supply will just grow more, and cause more distortions and bring an even worse recession when the Fed does act,'' Salerno said.

(C) Copyright 1998 Investors Business Daily, Inc.