US will flood world with liquidity for years to come

From Dr. Desmond Lachman

Sir, There are many reasons to be concerned about the long-run global economic outlook and about the prospects for the long-run maintenance of an open international trading system. However, a shortage of global liquidity would not appear to be one of them, notwithstanding Barry Eichengreen’s assertion to the contrary (“The dollar’s days as a reserve currency are numbered”, October 9).

Prof Eichengreen’s main concern is that a relative decline in the US economy will undermine its ability to supply the world with an adequate amount of safe and liquid assets. Yet that concern is hardly supported by the experience of the past few years.

Since 2008, in the context of the weakest US economic recovery in the postwar period, the US has contributed to an unprecedented increase in global liquidity. Over that period, the US Federal Reserve has expanded its balance sheet from about $800bn to about $2.5tr while the US Treasury has issued short-term debt at a record rate. And all of this was done without in any way destabilising the US dollar or kindling US inflation.

With the Federal Reserve now embarked on QE3 without a terminal date and with the US government deficit likely to remain high, there is every prospect that the US will continue to flood the global economy with too much rather than with too little liquidity for many years to come.

There is also every prospect that this increase in global liquidity will occur within the setting of a stable US dollar as the euro, the US dollar’s main competitor for international reserve currency status, continues its process of gradually unravelling. And there is also every prospect that US inflation will be contained by the persistence of very large output and labour market gaps.

If this does occur, Prof Eichengreen might take comfort in the fact that he will not have been the first to cry wolf about the US dollar’s imminent demise as the world’s reserve currency.

Desmond Lachman, American Enterprise Institute, Washington, DC, US

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About the Author

 

Desmond
Lachman
  • Desmond Lachman joined AEI after serving as a managing director and chief emerging market economic strategist at Salomon Smith Barney. He previously served as deputy director in the International Monetary Fund's (IMF) Policy Development and Review Department and was active in staff formulation of IMF policies. Mr. Lachman has written extensively on the global economic crisis, the U.S. housing market bust, the U.S. dollar, and the strains in the euro area. At AEI, Mr. Lachman is focused on the global macroeconomy, global currency issues, and the multilateral lending agencies.
  • Phone: 202-862-5844
    Email: dlachman@aei.org
  • Assistant Info

    Name: Emma Bennett
    Phone: 202.862.5862
    Email: emma.bennett@aei.org

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