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The United Petrostates of America

Ordinary Americans are about to find out why they call it the “resource curse.”

Currency wars are all the rage these days, as countries from Japan to Switzerland try to depress their legal tenders in hopes of giving their economies a boost. For now, the dollar is holding steady, but soon that will begin to change. The strong dollar, until now only a political shibboleth, will finally become an economic reality. Unfortunately, its strength may not be shared by all Americans.

The roots of this change are in the hills and valleys of the American heartland. Less than a decade from now, the United States will be a net exporter of natural gas thanks to the adoption of newer technologies like fracking. The Energy Department predicts that exports will reach about 4 billion cubic feet per day by 2035, about the same level as today's shipments from Qatar, the world's second-biggest exporter behind Russia. By 2030, the International Energy Agency expects the United States to become a net exporter of crude oil as well. Having already become the world's biggest crude-oil producer by 2020, the nation will undoubtedly be a major force in the export market.

To buy all that oil and gas, America's new customers will need dollars -- and that will begin to push up the currency's value. It will rise further still if the oil and gas industries energize the U.S. economy enough to pull in new investment from abroad. Offsetting this trend somewhat, Americans might also buy up more assets abroad in a rush of cash similar to the petrodollars that flowed out of the Middle East in the 1970s. But overall, the demand for dollars is likely to climb sharply. The prices of gold and other commodities denominated in dollars will plummet, as dollars will have become more valuable while the intrinsic value of the commodities will not have changed.

Though these shifts will be dramatic enough, the most profound effects will be on American workers and consumers. A stronger dollar is usually fine for Americans, as long as their purchasing power keeps up with the currency. Yet this is exactly where the problem will be. The new exchange rates will make it harder for non-petroleum industries -- where many more Americans are employed -- to export their products. At the same time, the strong dollar will make imports more affordable to American consumers. Some of the money generated by oil and gas will still filter through to other industries, but those dependent on exports or competing with imports could find themselves in a dire situation.

The news for consumers is not all good, either. With more income coming into the country, local prices will creep up as well. The United States might go the way of Norway and Australia, rich countries that have become two of the world's most expensive places to visit and live, in large part because of their resource booms. The combination of higher prices for goods and services and falling wages in industries unable to compete at the new exchange rates will squeeze household budgets from both ends.

Over time, an economic divide will open between Americans who benefit from the oil and gas boom and those who do not. If the economy does not change in a way that ensures more Americans fall into the first category, then inequalities will continue to widen, and the United States might end up looking more like Brazil or Mexico.

Of course, the government could have something to say about this. To start, it could try to weaken the dollar. Indeed, for years political leaders and officials have paid lip service to a strong dollar policy while trying to support American exports by pursuing more favorable exchange rates. Sometimes they have told other countries to let their currencies appreciate, and sometimes they have devalued dollars simply by printing a lot more of them.

But what will they do when the dollar really is strong? The likely answer is not much. With a booming economy -- even if some sectors are suffering -- the last thing the Federal Reserve will want to do is add fuel to the inflationary fire by injecting more cash into the markets. The Fed's job is to keep prices relatively stable and maximize employment for the whole economy; if anything, it will keep interest rates high to stop the economy from overheating.

Alas, high interest rates will just inflict more pain on struggling families. A boom for the economy as a whole will be a bust for them, several times over, because their wages will be slipping while prices go up and borrowing becomes more difficult. As a result, their fate will depend on those who can extend a helping hand: state governments, Congress, and the White House.

Analysts of emerging economies have seen all of this before. Windfalls of natural resources are common among poor countries, and the question is always the same: How will they turn these newfound riches, generally controlled by a minority, into long-term economic gains for the majority? The answer is often to retain and set aside a large share of the revenue and invest it in education, health care, infrastructure, and the broader development of the private sector.

For the United States, the answer is less clear. How much petroleum revenue will be collected as taxes? How will those taxes be used to reduce inequality and put the entire economy -- not just the petroleum sector -- on a solid footing?

Today's politicians can't even agree how to budget for the next 10 months, let alone the next two decades. In this case, however, planning ahead will be absolutely essential. Or would you rather live in Sao Paulo than Sydney?

Scott Olson/Getty Images News

Daniel Altman

The Chinese Union

Could China and Hong Kong create a common currency?

Over the weekend, millions of Chinese exchanged red envelopes filled with cash to celebrate the advent of the Year of the Snake. Oddly, most of those envelopes contained a currency that lumbers in the shadows of international markets, the yuan. The world's biggest exporter and second-largest economy still lacks a currency that can be used freely around the globe. China wants this to change, but how and when?

These are questions of intense interest to investors, speculators, and corporate managers around the globe. Right now, the yuan's value moves within a band enforced by the People's Bank of China, and there are restrictions on how it can be used by foreigners. A convertible yuan would trade without limits on currency markets, becoming more liquid, permitting bigger transactions, and responding more quickly to changes in the demand for Chinese assets and products. Convertibility would also pave the way for the yuan's use as a reserve currency by central banks and sovereign wealth funds, and perhaps even as the standard currency for pricing some commodities, such as copper. 

These things would benefit China. When other countries use your currency for their reserves, they link their economic fortunes to yours. The stability of your currency is of material interest to them, and they can even help to defend your currency against speculative attacks or other unwanted fluctuations. And when your currency is used in trade, the private sector needs to hold more of it, lowering the cost of financing.

Naturally, China's present regime for the yuan also has some benefits. People who do business with China can count on a fairly narrow range for exchange rates, so it's easier to make long-term contracts. Convertibility would erase this implicit guarantee, but it would simultaneously solve the problem of volatility by opening the door to much greater hedging. Multinational companies could trade yuan and related derivatives by the billion to balance their risks. So far, China has taken only baby steps in this direction, with the first yuan futures hitting the markets just last September.

Typically, a country in China's situation might move to convertibility once it felt comfortable opening its financial markets and relying on domestic demand to drive the economy. But China has a complication: Hong Kong. The city-state became part of the People's Republic in 1997, but it maintains its own economic system and its own currency, the Hong Kong dollar (HKD). With a population of just 7 million, its exports amount to a quarter of the total for the rest of China.

Just as convertibility is a long-term goal, so is reincorporation of Hong Kong into the Chinese economy. Today this process would be like a snake swallowing an ostrich egg. Yet China is changing rapidly, both in terms of financial sophistication and the openness of its markets. With time, Hong Kong will be less different from the rest of China, and thus the separation will seem less necessary. If the yuan is to become convertible, it will likely be as part of a long-term plan for economic convergence.

Paradoxically, however, as China has grown more similar to Hong Kong, its currency's value has diverged. For the past three decades, the HKD has been pegged to the U.S. dollar within a very slim band, roughly 1 percent of its value. Meanwhile, from 1995 to 2005, the yuan had its own peg to the American dollar and was reliably worth about HKD 0.93. But since 2005, the yuan has risen to HKD 1.23 as China's trade deficit has dwindled. 

Recently, there has been pressure on the HKD to appreciate as well, thanks to enormous incoming investment in real estate and other assets -- driven, of course, by China's growth. Hong Kong's monetary authorities will not give up their peg lightly, however. Their bosses have long advertised the HKD's rare combination of convertibility and a virtually fixed exchange rate as a godsend for companies involved in global commerce.

But the presence of a convertible yuan might force them to reconsider their currency regime. Two-way trade between Hong Kong and the rest of China is worth close to $200 billion each year and will surely continue to grow. With a convertible yuan, the exchange rate for all that trade would become completely unpredictable. 

Unfortunately, the obvious solution to this problem -- a currency union -- is not a particularly good one at the moment. To be sure, a single Chinese currency would not keep Hong Kong from holding on to many other distinct aspects of its economy. Its legal, tax, and regulatory systems could still remain independent. Rather, the problem is that Hong Kong and China have not met enough conditions for a successful currency union; though their trade is fairly free, they don't share fiscal policy or allow unfettered migration, and hence their economic cycles have yet to synchronize. With monetary policy set in Beijing, as it surely would be, Hong Kong's economy would probably be in for a bumpy ride.

More likely, Beijing will use convertibility as part of a gradual program to dismantle Hong Kong's monetary independence. Once the yuan becomes convertible, China will undoubtedly encourage its use in Hong Kong. Just as the euro is used in some European Union countries that have yet to adopt it, and the dollar is used around the world, the yuan will operate alongside the HKD until conditions are right for a changeover. 

Pressure will grow on the Hong Kong authorities to allow the HKD to rise in anticipation of an eventual currency union. Hong Kong's "high degree of autonomy" is guaranteed until 2047, but smoothing the eventual transition into China is a high priority that officials on both sides are already discussing. Though a shared fiscal policy is unlikely, free migration will become less of a political liability as China gets wealthier. In this light, and given the heroic efforts needed to protect the peg to the American dollar, Hong Kong's leaders may eventually become willing partners in a currency union.

Xi Jinping, China's new leader, has strong ties to the country's entrepreneurial south and is expected to usher in the next major wave of economic reforms. He will likely have two five-year terms to bring the rest of China closer to Hong Kong, perhaps assisted by Yi Gang, a talented governor-in-waiting at the central bank. Convertibility would make a good capstone for term number one. Currency union may have to wait for his successor.

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