Over the last six years, the United States has been by far the largest beneficiary of foreign aid in the history of the world. Foreigners have been willing to put more than $3 trillion in dollar denominated assets, the vast majority of which provided negative returns (i.e. they lost money) to their foreign holders. There are reasons why foreigners do put money in the United States, even at a loss, the most obvious of which is that foreign central banks (e.g. China and Japan) want to keep the dollar high against their currency in order to preserve their export markets. For these foreign central banks, the point is not to get a good return on their investment or even the "safety" of their investment, the point is to preserve an export market as part of an economic growth strategy. However, there is a frequently heard claim, repeated by the NYT today, that foreign investors somehow need to hold dollars because the United States is the safest or most secure place to hold wealth. It is not clear what people are thinking when they make such assertions. When discussing investments, the term "safe" usually means that the investment will hold its value. Investments in dollars have not held their value over the last six years as the dollar has fallen consistently and sharply over most of this period. The returns in dollars have often been very poor as well (the current ten-year treasury bond rate is less than 4.0 percent), so that investors have not come close to being compensated for the fall in the dollar by high returns. In other words, the dollar has not been and is not a "safe" currency by normal investment standards. If the claim is that the United States will not disappear as a country, this is almost certainly true, but it is also almost certainly true of dozens of other countries around the world. Even a country like Mexico or Chile is very unlikely to disappear. Furthermore, even when such countries do disappear, such as with the dismantling of the Soviet Union or Czechoslovakia, debts are most often paid in an orderly manner. So the United States hardly stands out by having the expectation of continued existence. In short, the decision of so many investors around the world to continue to hold much of their wealth in dollar denominated assets cannot be readily explained by other an interest in returns or the safety of dollar denominated assets. Some other explanation is needed. My personal guess is that the dollar is safe in that an investment fund manager who loses his/her fund a fortune by investing in dollars does not have to worry about any consequences. For example, many fund managers must have lost 20-30 percent on their funds, measured in euros or Canadian dollars, over the last couple of years. Few, if any, of these managers will be fired for this loss. On the other hand, if they had incurred similar losses by investing in Argentina or Mexico, they probably would be getting an unemployment check today. Investing in dollar assets provides fund managers with the same right to be stupid that investing in the stock market in the late 90s provided fund managers at the time. Even though it was obvious that such investments would be big losers, the managers that lost their clients billions could just say "who could have known?" and get off the hook. As long as fund managers know that they can lose their clients a fortune with impunity by investing in dollars, then they will continue to do so. If they are forced to be held accountable for dollar denominated investments in the same way that they are accountable for other investments then they will demand the same returns from investments in the United States that they expect from other investments.
--Dean Baker