Because as you have shown time and again, latter day CB’s reserve growth is most unwise. So, the US is betting that their foolishness has no upper boundary.

BTW, your colleage Benn Steil seems to think that the old economics is alive and well and will eventually assert itself. I dissent though on the euro’s fitness to take over.

http://www.cfr.org/publication/16094/how_the_rise_of_the_euro_threatens_americas_dominance.html

That sounds strange — no Paul volcker policies, yet a rise in the willingness of the official sector to hold dollars — but it seems to fit the facts …

Foreign (CB or private) financing of the US’ (or any country’s) current account deficit can in principle be considered "good" for the financed country: it is exchanging real stuff for printed paper, or promises to give more printed paper in the future. It’s even better if the financing is provided in the indebted country’s money as is the US case: all depreciation risks are assumed by the lender.

In the long run, however, if that financing is used for further developement of a living arrangement that has no future (suburban housing), the US would have been better off if no financing had been given to them. Same case as an addict: if he uses all money given to him to buy drugs, he’d be better if he got no money.

"The US would like to maintain the dollar’s global status – and not run up ever larger debts to the People’s Bank of China and the Saudi Monetary Agency."

The only way to not run up ever larger debts to foreigners (whoever they be) is to cut the current account deficit, which can be achieved thru either of the following possible Fed monetary paths:

a. Volcker’s style, causing a deep US recession, in turn causing US imports to drop drastically due to demand failure

b. Ben’s style, causing a (further) plunge in the dollar value, in turn causing US imports to drop drastically due to foreign goods becoming prohibitive to Americans.

Unless foreign holders of dollars and dollar-denominated debt do not care in the least about maintaining the value of their investments, path b. should lead to a the US dollar losing its status as international trade and reserve currency.

"Right now, though, the dollar’s global status hinges in no small part on their willingness to hold dollars."

The global status of ANY currency (fiat or even metal) has and will always hinge SOLELY on the willingness of global players to accept and hold it. See what happened to silver relative to gold after central banks worldwide decided to demonetize it in the 1870’s. And the main factors that prompt those players to do that are the perceived intrinsic usefulness and scarcity of the currency.

Yes, but, the Chinese worker took your job, because the Chinese government forces him to accept 7 times less pay, so you can’t pay him back.

FG: I am saving to buy my first home. Will I have to pay more because of Chinese policies? What does it imply in terms of economic distortions? Is that good or bad?

For awhile you will get lower house prices, with higher interest rates, and more money down. So you might have to save longer. And you will need very good credit.

Rather than having sustained growth, we are having more frequent boom and bust cycles. Do you like roller coaster rides? We are going to see continued inflation until slower growth finally takes hold in China and India.

Because the US is fighting a major war and the wealth needed to fund that war has to come from somewhere. Since it’s politically bad to take the money from obvious places, the wealth comes from non-obvious places.

One other factor in the case of China is that China needs to save massively in order to face the demographic crunch that is going to happen shortly.

FG: I am saving to buy my first home. Will I have to pay more because of Chinese policies? What does it imply in terms of economic distortions? Is that good or bad?

Actually, you are going to end up paying a lot less. As far as economic distortion, I really don’t like that concept because it assumes that there is some "undistorted" situation when there isn’t. As far as good or bad. Good or bad for whom? Overall what is happening is that there is some Chinese worker that is saving for retirement that is giving you your money for your house with the expectation that you are going to pay the money back to him when he gets old.

… but being dependent on future inflows is not a good thing, especially if these flows are decided by a Saudi King and the Chinese communist party.

Twofish: The only other currency out there that could possibly be a major reserve currency is the Euro.

You’re missing 1 logical step: why does this reserve accumulation need to happen at such rates as described above?

I am saving to buy my first home. Will I have to pay more because of Chinese policies? What does it imply in terms of economic distortions? Is that good or bad?

I wonder – the real (inflation-adjusted) return to yen-denominated assets has not been that bad.

I think Michael Dooley and T. Boone Pickens are right.

What happens to the share of the dollars in reserve assets after adjusting for exchange rate changes? For example, what would your graphs look if the euro had stayed constant at $1.20?

An analogy I like – the U.S. is being force-fed foreign lending, like you stuff a goose to make pate de foie gras. It won’t end well, and short-sighted (enabling) fed policies will only make things worse.

Large growing dollar reserve holdings are not good for the world economic system. It’s a sign of imbalance. These very large dollar currency reserve holdings (and US treasury purchases) by many nations are just a by-product of an effective effort to de-value each nations currency against the dollar. Currency de-valuation provides many nations (in particular, China and India) with an unfair competitive advantage, and is the root cause of US economic woes and the rise of inflation. This is because currency devaluation actually discourages truly efficient per capita production practices. The problem this causes for the US is that the currency pegs make investment in the US less attractive and keeps US export prices relatively high. This keeps sending the US into economic slowdowns due to low domestic investment. The result is the fed steps on the accelerator to stop the economic slowdown, increasing liquidity in the US, but also increasing the capital out flow of the US searching for better investments. The dollar flows out of the US but can’t get back in sufficiently via US exports due to foreign government’s efforts to keep the dollar strong by growing big pools of dollars to keep their currency relatively weak. This eventually sends the US into another economic slowdown as the fed let’s off the accelerator and raises interest rates. The actions that governments take to maintain these pegs short circuit the self correcting nature of the economic system via currency. The increasing frequency of US boom and bust cycles is just one symptom. The easy credit condition resulting in the US housing boom and bust is another. The irony is the US encouraged this situation via the “strong dollar policy” during the Clinton administration.

"…The result is an inevitable series of market accidents and policy mistakes … The solution is not simply a U.S. solution. Other consumers around the globe need to step up to the plate, in particular in China and India. We need to see a handoff from what is tiring U.S. consumers who are subject to headwinds to consumers in emerging countries who are empowered by a growth in the middle class, higher income, larger wealth, and legitimate aspirations. But as these countries get richer and consume more, they also put pressure on commodities, so it’s a very complicated world we live in right now…" http://www.businessweek.com/magazine/content/08_20/b4084063533815.htm