Shrinking America’s yawning trade deficit is much harder than simply blocking imports and boosting exports—and will likely involve tough tradeoffs, according to Guggenheim Partners’ Scott Minerd.

“There is a reason why the United States has a structural trade deficit. That’s because the world wants to hold the dollar as a reserve currency,” said Minerd while speaking on a panel at the Milken Institute 2018 Global Conference in Los Angeles on April 30. “If we insist that we have no trade imbalance, what we’re saying is that we no longer want to be the reserve currency.”

Minerd, the asset management firm’s chief investment officer, has a good point. In its role as the de facto reserve currency, the US essentially provides the rest of the world with liquidity and a safe place to store their assets.

What does the trade deficit have to do with it?

A country that runs a trade deficit—meaning it imports more than it exports—is by definition consuming more than it produces. That doesn’t mean Americans are bad at saving or wanton materialists. It does, however, mean that the US is forced to borrow to finance its purchases. Countries like the US that run trade deficits borrow from the rest of the world to keep up their spending, on net, while those that run surpluses are net creditors.

Here’s where currency enters the picture. When Americans buy other countries’ exports or invest abroad, they fork over dollars to do it. The foreign recipients can then use those dollars to buy US exports or invest in US assets (among other things).

Now, if the rest of the world took the dollars they earned from selling their wares to American consumers and used all of them to buy goods and services imported from the US, the system would balance out.

Bam! No more US trade deficit.

But if that happened, foreigners would have no dollars left over to hold for safe keeping or put to other uses. (Also, the US might not be a position to export enough to meet the demand, in any case.) So, in the end, to ensure that the global trade and financial system is awash in dollars, the US must run a trade deficit.

Not just a US thing

Running a chronic trade deficit is what any country must do if it aims for its currency to serve as a global reserve currency.

That’s what’s “structural” about the US deficit: As long as the rest of the world grows faster than the US, the expanding demand for dollars will force America to either create more and more debt—as has been happening—or sell more and more assets. Among the first to identify a tradeoff between acting as a reserve currency and running a deficit was Robert Triffin, a Belgian-American economist at Yale. This tension is sometimes called the “Triffin dilemma.”

Aside from the pride of seeing your currency in use around the world, there are economic advantages to running the dominant global reserve currency.

Demand for dollar-denominated assets, like US Treasury bonds, keeps interest rates low. And while foreign investors buy short-term, low-yielding US assets, Americans can invest abroad in longer-term, higher-yielding assets. The US usually reaps a higher return on those investments than it must pay on its debts. This is sometimes dubbed America’s “exorbitant privilege.”

In his remarks at the Milken conference, Minerd brought up another issue.

Giving up the dollar’s global reserve status would have “big implications on a defense and quality-of-life level,” he said. “If we wish to continue down that path, Americans will slowly surrender their standard of living. We will ultimately become a second-rate power, and we will cede our position of military superiority to other nations.”

“If we wish to continue down that path, Americans will slowly surrender their standard of living.”

His argument rests on the relationship between diplomatic alliances and foreign currency reserves. Barry Eichengreen, a Berkeley economics professor and one of the foremost scholars of currency policy, notes that countries in military alliances with reserve-currency-issuing countries hold about 30% more of the partner’s currency in their foreign-exchange reserves than countries not in an alliance. If the US retreats from the global diplomatic stage, argues Eichengreen, countries that step in to take its place—namely, China—will gain an advantage both geopolitically and in the amount of their currency held in reserve abroad. The ensuing global economic shift would hurt both the dollar’s exchange rate and US borrowing costs.

Yet the “exorbitant privilege” of cheap borrowing doesn’t necessarily outweigh the costs of providing what is essentially a public service to the global economy. The US’s struggle illustrates that it’s actually more of an “exorbitant burden,” argues Michael Pettis, a finance professor at Peking University.

About that cheap financing—and that deficit

For Exhibit A of the burden in practice, look at the US trade deficit. Cheap financing might be a nice perk if the US lacked the savings to fund its investments. Since this isn’t a problem, all that extra money gushing into dollar assets doesn’t flow into productive investments like new factories and jobs. Instead, it inflates credit-backed consumer and asset bubbles. As the US subprime housing bubble demonstrated, things tend not to go so smoothly for a country that borrows vastly more than it can productively absorb.

On the flip side, the chronic surfeit of foreign capital makes the dollar—and, hence, US exports—artificially expensive. That’s devastated US manufacturing. For instance, a 2017 study (pdf) by economist Douglas Campbell links the overly strong dollar with the loss of around 1.5 million manufacturing jobs between 1995 and 2008.

Part of the problem is the mercantilist moral hazard encouraged by limitless access to dollar-denominated assets. Central banks in countries like Singapore and Switzerland—and, most notoriously, China of the 2000s—buy US assets to make their own currency cheaper. Here’s how Quartz explained this phenomenon in a recent story:

When Nation X buys assets from Nation Y, it suppresses the value of its own currency relative to Nation Y’s. That makes the exports from Nation X more competitive (and imports more expensive), boosting domestic export jobs. But it also hurts Nation Y by making their currencies pricier and exports more expensive, putting their laborers out of work. (Note that this happens even if Nation X and Y don’t actually trade with each other.)

There’s also the theoretical specter raised by Triffin that the debt racked up as a consequence of providing the world’s liquidity will trigger panic, eventually, about ability to repay. A selloff in assets that drives up rates would ravage the borrower’s economy.

Many analysts expected this to happen in 2008, when the global financial crisis hit and investors dumped all those toxic US assets at the center of the storm. But instead of pulling money out of the US entirely, the world recycled its funds into the safest, most liquid dollar assets.

Still, just because it didn’t happen doesn’t mean it couldn’t.