11/16/2009 11:30 am ET Updated May 25, 2011

Our Currency, Your Problem. Fair Deal?

You know the story: out of control domestic spending, massive balance of payment and trade deficits, and the mind-boggling expense of foreign war are pressuring the dollar and leading governments around the world to demand U.S. fiscal constraint. Except that the President isn't Barak Obama, but rather Richard Nixon. And he responds by unilaterally terminating the convertibility of dollars to gold, stopping the run on Fort Knox by countries like France, which were holding gigantic US dollar reserves and trying to make America fulfill its "promise to pay."

This set up the greatest financial Oracle-of-Delphi moment ever. Treasury Secretary John Connelly declared: "Its our currency, and your problem."

Profoundly true. We control the world's medium of exchange, and that gives us the ability to effectively export major portions of our economic ills. We do it very simply by printing more dollars. This reduces the value of the massive dollar reserves held by China, Japan, and many other foreign governments; effectively reduces the principle and interest we have to pay on our giant debt obligations; and makes our goods and services cheaper for foreigners to buy, so that ours will be the first developed economy to emerge from the Great Recession.

As in Nixon's day, foreign governments are screaming. But, like Lady Macbeth, they doth protest too much: they share the blame.

First, let's look at the country at the focal point of the debate. China is sitting on about 1.5 trillion of dollar reserves. So, when the dollar declines by, say, 15% (as it has against major currencies this year), China can claim that it's lost a couple of hundred billion of value, poor thing. But it has very consciously made this bed itself, by enforcing an absurdly low exchange rate for the yuan over many years. (Even today, amid all the crying, the yuan is pegged to the dollar, so that Chinese exports just keep getting cheaper for the rest of the world as the dollar falls.) So, we've been buying Chinese goods "too many" dollars all along. Now, as those excess dollars lose value, China is reaping what it has sowed.

The rest of the world is also experiencing some karma catch-up. The U.S. has effectively acted as the world's stabilizing military power for the last twenty years, and protected the free world from Russia for thirty years before that. None of our allies had to bear the incredible cost of maintaining the shield that has effectively protected them for sixty years. Not to mention, of course, that both Europe and Japan were rebuilt with US aid after WWII, and then had their economies incubated and strengthened by US consumer demand for decades thereafter. (In addition, during the 80s and 90s, Japan was playing an early version of China). A weaker dollar effectively is making all these countries pick up a portion of this multi-decade, mammoth tab.

What will happen from here? It looks like a certainty that we'll try to inflate our way out of our current problems: we don't have the discipline to cut spending or the political will to raise taxes. Meantime, there is still a huge debt hangover from the blowout consumer party of the past 20 years; moderate inflation will, for example, help the 20% of homeowners whose mortgages exceed the value of their homes. And, as noted, a cheaper dollar makes it easier to sell U.S. goods overseas... might as well take a page out of China's playbook, eh? To politicians of both parties, ratcheting up the dollar printing presses is an irresistible "Get Out of Jail Free" card.

Whether and how they can subsequently keep us out of the Weimar Republic-style hyperinflation that some fear is a different question. Nixon temporarily tamed this beast by imposing wage and price controls (rather shocking for a Republican president), but the problem wasn't solved until Paul Volker ran interest rates to the moon as Fed Chairman. Facing high unemployment for many years to come, that is an option that Bernanke and his successors are unlikely to have.

Meantime, from the rest of the world's perspective, the real question is whether the governments protesting the decline of the value of their reserves will get serious about sharing the obligations of world leadership and exposing their economies to reality; because only then will they be able to move away from the dollar standard about which they are so bitterly complaining.