Really?

The Wall Street Journal’s oped page writes that:

“the dollar plunge as translated into a net transfer in wealth from the US to the rest of the world”

I am not sure the rest of the world sees it that way.

A fall in the dollar reduces the wealth -- when measured in their own currency -- of all those in the rest of the world who have invested in the US. It thus arguably leads to a net transfer of wealth to the US.

The loans the US has taken out to finance its deficit are generally denominated in dollars. The fall in the dollar’s international value translates into a fall in their global purchasing power of America’s creditors. They will get paid back in depreciated dollars -- reducing their wealth.

Wall Street firms have been keen to book falls in the market value of their debt as a rise in their net worth. The US, in theory, could do the same. The value of US external debt, denominated in say euros, as fallen – to the benefit of the debtor and detriment of the creditor.

The US would be in much different position if its external debts had been denominated in a foreign currency, say the euro. Then the dollar’s fall would have increased the real value of US external debt (in US terms), making the US – not its creditors – worse off.

Put a bit differently, the dollar’s fall (and euro’s rise) has increased the value of American investments in Europe, and reduced the value of Europe’s investments in the US. Mechanically, the capital gains on US investment abroad have offset much of the rise in total external US debt held abroad, limiting the deterioration in the United States net international investment position (see this spreadsheet, especially the columns marked price and exchange rates changes; a positive number is good for the US).

The dollar’s big fall in 2007 – together with relatively poor performance of US equity markets (in 07) – will combine to keep the US net international investment position from deteriorating when the US releases the relevant data later this month. The rise in value of US assets abroad, expressed in dollars, will exceed the rise in the value of US debts held abroad. Or, from the perspective of an external creditor of the US, the fall in the euro (or another currency) value of US debt offset the rise in the stock of debt ….

Why does this matter? Well, as Joanna Slater of the Wall Street Journal’s news section notes, the dollar’s fall against the euro may be over. But the dollar has further to fall against the emerging world. And it is the emerging world that is financing the US deficit.

When China stops intervening, the RMB will rise. And the value of China’s dollar holdings, expressed in RMB, will fall. I suspect China would consider this a fall in its wealth …

And the longer China intervenes in the market to resist natural pressure for appreciation, the bigger its stockpile of dollars and the bigger its losses. China would be far better off, financially, if had stopped intervening in say late 2004, when it had $600 billion in foreign assets and maybe $400 billion in dollars. Now it has around two trillion in foreign assets (counting the CIC and the external assets of the state banks), and over $1.3 trillion (I would guess) in dollar assets ...