[OPE-L] The dollar conundrum by C.P. CHANDRASEKHAR

From: Rakesh Bhandari (bhandari@BERKELEY.EDU)
Date: Fri Dec 03 2004 - 13:10:03 EST

You ask excellent questions. At one level, my interest in this
question about the dollar displacement of the gold standard has been
motivated not simply by analytical concerns but by existential
discomfort with views of the US economy as embedded within what
Poulantzas once called a national spatio-temporal matrix. Let me
think about my discomfort and your questions. More later.
Yours, Rakesh

Vol:21 Iss:25 URL: http://www.flonnet.com/fl2125/stories/20041217008612700.htm

The dollar conundrum


If countries want their cosy relationship with the U.S. to continue,
they have to pay a price for the militarism that makes it a buoyant
economy, a sponge for global exports and a safe haven for investment.


G-20 Finance Ministers and central bank governors at a conference in
Berlin on November 21. The meeting called for a global effort to
reduce trade imbalances, particularly the U.S.' current deficit.

IN international markets, all eyes are on the dollar, since
uncertainty prevails about the depths to which it would decline. The
currency, which appeared to have stabilised relative to the euro in
early 2003 after declining from as far back as early 2002, has been
sliding sharply since early September. The Financial Times reported
on November 26 that the dollar had been through its seventh straight
week of losses, falling to multi-year lows against the euro, yen and
Swiss franc. Currently close to 1.3 euro and 102 yen to a dollar, the
currency still seems heading downwards in the trading days to come.

The principal factor being quoted to explain the weakness of the
dollar is the $570 billion annual current account deficit on the
United States balance of payments. This makes the U.S. appetite for
international capital inflows to finance its balance of payments
insatiable. With the U.S. fiscal deficit running high and delivering
output growth even if not jobs, there is no corrective in sight for
the current deficit, which is seen as unsustainable. The difficulty
with this argument is that the deficit in the U.S. balance of
payments is not new, nor is it a phenomenon specific to recent years
of rising fiscal deficits. Prior to that, consumer spending, fuelled
by debt, tax-cuts and the so-called "wealth effect" of a booming
stock market, triggered growth. This too was accompanied by rising
trade and current account deficits. Thus, the fundamental problem is
that the U.S. economy is not competitive enough to prevent a
substantial leakage of domestic demand abroad and garner a
significant share of world markets. Growth is inevitably accompanied
by external deficits, making the stimulus required for any given
level of domestic growth that much larger.

For long this was not seen as a problem. Initially, the position of
the dollar as a reserve currency and the confidence generated by the
military strength of the U.S. made it a safe haven for wealth holders
across the globe. Dollar-denominated assets attracted the world's
capital and not just financed the U.S. current account deficit but
also fuelled a stock market boom. Subsequently, countries that had
accumulated large foreign reserves either because they were
successful exporters or because their imports had been curtailed by
deflation, invested these reserves in dollar assets, especially U.S.
Treasury bonds, and helped finance the external deficit. The dollar
remained strong despite the current account deficit.

The difficulty is that underlying such confidence of public and
private investors is the view that the trade and current account
deficits in the U.S. would somehow take care of themselves, without
damaging U.S. growth substantially. Unfortunately, while growth has
been better in the U.S. than in the euro area and Japan, the deficit
has not disappeared but ballooned. In the circumstance, the only way
of curtailing the U.S. trade deficit seems to be to curtail growth -
either by depressing consumer spending or by slashing the fiscal
deficit or both. President George W. Bush and his team were unwilling
to concede on either count prior to his re-election. And the evidence
seems to be that he is not going to immediately wipe clean the glory
his victory has brought by declaring war on U.S. buoyancy.

Bush is not the only one who is unwilling to spoil the party. Alan
Greenspan, who nears the finish of what appeared to be an unending
tenure, has warned that the U.S. current account deficit is
unsustainable. But he too has not shown any keenness to raise
interest rates to scorch consumption and investment spending. What is
more, countries that have gained from the U.S. predicament in the
form of large exports to the U.S. market - such as China - are also
not in favour of a U.S. slowdown.

The U.S. has sought to use the last of these by virtually declaring
that its own deficit is not its, but the world's problem. Countries
like China, with a large trade surplus with the U.S., must revalue
their currencies upwards to redress that trade imbalance by exporting
less to and importing more from the U.S. Other countries, such as
those in Europe, need to reflate their economies so as to expand
markets for the U.S. And, finally, all countries must open doors to
their markets by reducing tariffs, so that the U.S. can ship in more
of its commodities. All this, in the U.S. government view, would help
reduce its current account deficit and stabilise the dollar, without
affecting U.S. and, therefore, global growth.

None of these countries is willing to toe that line. China, under
pressure to permit an appreciation of the yuan, has come out quite
strongly. In an interview with the Financial Times, Li Ruogu, the
deputy governor of the People's Bank of China, warned the U.S. not to
blame other countries for its economic difficulties. "China's custom
is that we never blame others for our own problem," he reportedly
said. "For the past 26 years, we never put pressure or problems on to
the world. The U.S. has the reverse attitude, whenever they have a
problem, they blame others."

At the recent G-20 meeting, Finance Ministers and central bank
governors called for a global effort to reduce trade imbalances, and
in particular, the U.S. current account deficit. The rhetoric seemed
to be that everybody should share the costs of that adjustment. John
Snow, the U.S. Treasury Secretary, chipped in by promising to work
towards halving the U.S. budget deficit and increasing U.S. national
saving. But no concrete measures were on offer.

IN sum, there is a degree of global paralysis on the issue of the
U.S. deficit and its impact on global growth. This implies that the
only way in which the external deficit may stop rising and possibly
decline is through a downward adjustment of the dollar, which renders
imports into the U.S. expensive and cheapens U.S. exports.

However, an adjustment of the dollar has been under way not so much
because of any automatic responsiveness to U.S. trade trends, but
because of a growing fear among wealth holders that excess exposure
to dollar-denominated assets threatens erosion of the value of that
wealth. The gradual adjustment of private portfolios explains the
dollar's decline in the past. More recently, however, pressure from
the dollar has come from a different, and more powerful, source: the
growing unwillingness of central banks to hold a disproportionate
quantity of dollar reserves and risk substantial losses.

Russian central bank officials recently declared that they are likely
to adjust the structure of its reserves, estimated at around $105
billion, by substantially reducing the share of the dollar. Even a
small country like Indonesia with just $35 billion of reserves has
threatened to cut its dollar holding. But the real threat comes from
China, with $515 billion in its chest, and Japan, which together
account for the bulk of Asia's $2.3 billion of reserves. A recent
statement by a Chinese academic, which was quickly retracted, that
the rate of increase of China's holdings of U.S. bonds had fallen and
the total was now around $180 billion, was enough to trigger a slump
in the dollar in jittery markets.

If this trend of policy makers in the U.S. and elsewhere adopting a
wait-and-watch line and wealth holders and central banks turning
cautious on the dollar persists, the downward slide of the currency
is likely to accelerate. Unfortunately, this would help no one. The
appreciation of the euro and the yen would affect their exports. The
slowing of growth in the U.S. that an enforced cutback in government
and private spending and inflation induced by a falling dollar would
result in, would hurt most exporters, including those from China. And
a possible meltdown in U.S. markets is bound to wipe out a huge
quantity of paper wealth that sustains even the current level of
business confidence. Above all, the fragility in financial markets
that the process generates can trigger a liquidity crunch that would
spell deflation.

The fundamental problem is that countries desperate to accelerate or
protect the growth of their markets and exports are unwilling to come
together to deal with what is not just a U.S. problem. On the other
hand, their failure to do so hurts not just the U.S. but the world
economy as a whole.

These contradictions in the current global conjuncture reflect the
peculiar nature of U.S. leadership. That leadership is no more
attributable to the relative strength of the U.S. economy, but rather
is explained by the military might of the U.S. and its self-assumed
role of global policeman. However, despite the lack of U.S. economic
supremacy, there is a bias to bilateralism in the global system. The
U.S. remains an important market for most countries, especially the
successful exporters like China in goods and India in services. The
U.S. has also been the most favoured destination for financial
investment for private wealth holders and governments.

If countries want this cosy but undeclared relationship with the U.S.
to continue they are bound to be asked to pay a price for the
militarism that makes the U.S. a buoyant economy, a sponge for global
exports and a safe haven for investment. If they are unwilling, they
must seek out strategies that break this undeclared bias to
bilateralism that is reminiscent of colonial times. That would spell
an end to U.S. supremacy and the emergence of a truly multi-polar
world. However, the transition is not guaranteed. The costs are
likely to be substantial and the outcomes are uncertain. But,
perhaps, the dollar conundrum signals that there are no mutually
acceptable choices left.

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