The Independent Market Observer

Q&A with Brad

Posted by Brad McMillan, CFA®, CFP®

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This entry was posted on Jun 29, 2018 2:41:50 PM

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Q&A

Whether it is in the Comments section of this blog, the Have a Question? form you see on the right, e-mails, or everyday conversations, people ask me a lot of great questions. It’s just the nature of the work I’m in. But since these questions come in from so many different places, I thought it would be useful to accumulate them—and my responses—and share them here for the benefit of all my readers. Today, we have two reader questions, so let’s dive right in.

Q: “Are we not at the lowest unemployment level in many years, and the recent statistic says there are more jobs-seeking employees than people seeking employment? So, why are we so worried about creating more jobs, especially with the tariff weapon?” 

A: This is a good question. You have your facts correct, and we are indeed close to running out of labor, if we haven’t already. More to the point, over time with the increasing retirement of the baby boomers, the situation will worsen.

In theory, of course, a tariff can be used to help create and retain high-value jobs (i.e., those that pay high wages and that people want) and to allow undesirable jobs to go abroad. Here in the U.S., however, that is what has already happened over the past 30 years due to trade. So, the additional potential benefit is small. In fact, there are already signs (Harley-Davidson being the most recent) that tariffs might drive desirable jobs out of the U.S. In fairness, it might not be just trade issues that are causing that, as skill shortages are already forcing companies to look outside the U.S. The unemployment rate for skilled and educated workers is well below the already very low rate for all workers.

Bottom line? With the economy humming along, we don’t need more jobs. But we do need more people. Any policy, such as tariffs, designed to create more jobs is going to run into that same problem.

Q: “Could you elaborate on the idea of the U.S. dollar as the reserve currency? What do you mean by ‘each dollar held by foreigners as an interest-free loan to the U.S. government’?" 

A: This is another good question, and one that is often misunderstood. To start, a reserve currency is the currency that other governments choose to hold as a store of value in addition to their own. The idea is that while a country can usually print its own money (members of the eurozone excepted), the value of that currency can fluctuate. So, it is important to hold other currencies as a store of value to protect against those fluctuations. This idea does not apply so much to the U.S. We hold dollars, which is by and large all we need. But for other countries, especially smaller ones or ones that trade a lot, holding dollars—or yen, or euros, or renminbi—in reserve can act as a stabilizer for the economy and the currency. Hence, the term reserve currency.

Even large countries (e.g., China) or rich countries (e.g., Saudi Arabia) can end up holding lots of dollars due to trade. Since they do trade so much, they can use those dollars more easily than trying to convert and then reconvert them to their own currency. In this case, the dollars are more a reserve for use in trade, but the same ideas apply.

Now to your actual question of how this is an interest-free loan to the U.S. government. Well, look at it this way: when the U.S. issues a dollar bill, it is a promise from the U.S. government that the dollar will buy a dollar’s worth of goods. This is not unique to the U.S., of course, as it applies to any fiat currency. When a foreign country, say China, then ships a real good, like a car, to the U.S. and accepts dollars in exchange, it is accepting a U.S. promise that the dollar will be good later. In other words, by exchanging real goods for a promise of a future benefit, the exporter is making a loan. Since dollars don’t pay any interest, as long as that dollar just sits there, the loan is interest free.

Other countries are not stupid, of course. As quickly as possible, they will convert those dollars into dollar-based assets that do pay interest. In fact, this is a big reason why foreigners buy so many U.S. Treasury bonds and notes. But the dollars themselves are an interest-free loan.

Got questions?

Thanks for reading and thanks for the thoughtful questions. I will be running this Q&A format periodically, so please keep the questions coming in!


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