A country that planned to tighten monetary policy would face a more manageable task of dealing with speculative capital inflows.

As any book on money will tell you on the first page. But the problem is, which of these functions is crucial? The dollar does fine for liquidity, which you seem to think is the crucial thing, but not nearly so well on the other two criteria.

To restate your first para, I agree that the $US is not that far below its previous all-time low , though the weakening against the euro is more marked. But the post gives plenty of reasons why circumstances are worse now than then. In 1995, the US was clearly set to address its budget problems, for example.

“Adopting the euro is effectively irreversible. Leaving would require lengthy preparations, which, given the anticipated devaluation, would trigger the mother of all financial crises. National households and firms would shift deposits to other euro-area banks producing a system-wide bank run. Investors, trying to escape, would create a bond-market crisis. Here is what the train wreck would look like.”

http://www.voxeu.org/index.php?q=node/729

As for why one needs a reserve currency (#29), well, I am not sure how one can post this post without actually knowing the answer to that question John. The reserve currency provides a numeraire, it provides liquidity for international trade, and it serves as a store of value. Yes, you do kind of need these things if you are going to have a global economy.

The reason the euro isn’t capable of serving in that role is because it lacks sufficiently deep and liquid markets for super low-risk euro-denominated assets. That is, there is really no large supply of the euro equivalent to US treasuries. Until such a market develops, the dollar is the only game in town when it comes to reserve currency status.

The doomsayers were all telling us to buy gold, silver, wheat, platinum, coal, and oil, and for most of a decade they were right. After October 1979, when Paul Volcker became Chairman of the Federal Reserve, they were wrong. The dollar recovered after its demise seemed real.

In routine conditions, sure. But the whole point of reserves is for protection in the event of crises. And in a crisis, the value of such a mixed pool of reserves could fluctuate unpredictably.

This is (I had thought) why the conventional view is that in a world without a reserve currency, there would be pressure to back away from multilateral (free) trade and move back toward more bilateral arrangements.

The autonomy of the European Central Bank and its anti-inflationary priority, both set in stone, guarantee that Eurozone politicians like Sarkozy will make populist anti-ECB noises at frequent intervals, without any risk that they might lead to anything.

Paradoxically, though the Brussels Commission resent the ECB over which they have no control, it represents the purest achievement of Monnet’s supranationalism: the real delegation of precisely defined executive functions to unaccountable European technocrats. And it works.

And the reason foreigner borrowers accept this, is that a lot of their own contracts and obligations are written in dollars, so in the short run they are less sensitive to dollar depreciation than to other coins.

But why this would work for long-term lending is not clear to me. This would have more to do with a confidence that the dollar will not collapse entirely, wouldn’t it?

A dollar note is a promissory note for what, precisely?

One big value is that if you owe the US government taxes, it will accept US dollars to pay off the debt. Another big one is that US courts are generally satifised by payment of legal settlements in dollars. And of course if you have a contract in USD, that needs US dollars to settle. But there’s no general obligation on the US government or US citizens to charge the same amount in US dollars, if the US dollar is less valuable, they can raise their prices, or taxes. This has happened in inflationary periods in the past. Inflation isn’t good, but the most direct costs are borne by savers, for example those foreign banks.

So how will these dollars find their way home?

Isn’t there of the order of $400b of US currency held abroad (about half of the ~$800b total, i.e. M0), which if it was funded at current US treasury interest rates would cost about $10b a year to service. While this is a noticeable amount, it is hardly a magic checkbook.

Huh? Why are you only counting cash? US dollar bonds, particularly ones with ahistorically low long term interest rates, are the magic checkbook.

Isn’t there of the order of $400b of US currency held abroad (about half of the ~$800b total, i.e. M0), which if it was funded at current US treasury interest rates would cost about $10b a year to service. While this is a noticeable amount, it is hardly a magic checkbook.

The more important thing seems to be that there are lots of US treasury notes ($2.4T at the beginning of the year) being held by foreign organisations (banks and governments mostly) while the US dollar slid in value so consistently against most currencies. Essentially the US government has sold debt while the price was high, and will probably be repaying it while the price is low, which is a good deal for the US.

Of course the reason most governments didn’t sell is that they need US dollar denominated reserves to prove their solvency to their local trading partners, etc. If another currency (or several, preferably) became generally acceptable as a reserve currency (as the Euro is starting to) then reserves could react against devaluations like this, basically various reserve currencies could compete against each other, with the more stable (or appreciating) ones being preferred.