Wednesday, January 9, 2013

Fiscal Cliff, Platinum Coin, and Reign of the Dollar

Almost two years ago, Barry Eichengreen published an op-ed called "Why the Dollar's Reign is Near and End." The article condenses many of the arguments of his book Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System. He writes (my emphasis added):
Finally, there is the danger that the dollar's safe-haven status will be lost. Foreign investors—private and official alike—hold dollars not simply because they are liquid but because they are secure. The U.S. government has a history of honoring its obligations, and it has always had the fiscal capacity to do so. 
But now, mainly as a result of the financial crisis, federal debt is approaching 75% of U.S. gross domestic product. Trillion-dollar deficits stretch as far as the eye can see. And as the burden of debt service grows heavier, questions will be asked about whether the U.S. intends to maintain the value of its debts or might resort to inflating them away. Foreign investors will be reluctant to put all their eggs in the dollar basket. 
The recent fiscal cliff fiasco and the current debt ceiling and platinum coin issues make me wonder if Eichengreen's prophesy is coming closer to fruition. So I started by looking at the exchange rate of the dollar against some other currencies from 2011 onwards. I chose the Canadian Dollar (blue line) and the Australian Dollar (green line), since the IMF recently declared them official reserve currencies, and since they are not as contaminated by recent events as the Euro and the yen. Look at the very far right of the graph, and you see both series drop down. That means that the dollar lost value relative to those currencies. One U.S. dollar can buy less Canadian or Australian dollars than before. In other words, the U.S. dollar got weaker.

Let's zoom in and have some fun with Google. I looked at Google trends data for the term "fiscal cliff." Google Trends gives you a measure of search volume for a particular term over time. The thick green line is the search volume for "fiscal cliff" and the dashed line marks its maximum. Notice how, when concern about the fiscal cliff got really high, the dollar got weaker. After President Obama signed the bill on January 2, the dollar continued to weaken, though not as drastically (the flatter downward slope). This is just a "playing around" finding and obviously not econometrically rigorous, but lends some anecdotal evidence to Eichengreen's predictions. Severe fiscal problems are chipping away at the dollar's "exorbitant privilege." If you want to have some fun, try out making a similar graph with the search term "platinum coin."


  1. Hey Carola, I enjoy reading your insights on economics. Regarding the first graph of this post, I can't seem to make heads or tails of any pattern. It seems there's so much variance that there may not even be a statistically significant trend. Regarding the apparently drastic drop in exchange rates occurring on January 2nd (when considered relative to the previous several days), did the President sign the bill early enough in the day for the numbers to be affected by that day's trading? Any such effect probably takes two days to manifest when considering the time zone difference between us and Australia as well.

    I think it shouldn't be hard for the world to envision a day in which America defaults on its debt at this rate. To anyone carrying entirely USD in their portfolio at that time, I would say they would have been blinded by the relatively short-term history of the infallible security of the USD. What do you think would happen to the world financial situation if the US did default on debt?

  2. Be interesting to look at similar for "debt ceiling" in July 2011. How did you overlay those graphs? Just plugged all the numbers into something?

  3. I overlaid the graphs by downloading the Google trends and FRED as csv files, import those into Stata, merging them, declare it a time series and use tsline to graph.

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