<nettime>the dollar's demise (and the rise of Asia)

[Keith Hart <keith@thememorybank.co.uk>]

"A pool of fools to buy it all the way down."

The ASEAN-India-China summit is taking place in Laos this week, where a=20
major free trade pact to create the world's largest trading bloc between=20
Southeast Asia and China was signed yesterday. India will be signatory=20
to a similar but more gradually phased set of trade liberalisation=20
measures soon. In the meantime, the follopwing article appeared in The=20
Economist. My comments first. Thanks to Shekhar Krishnan for bringing it=20
my attention.

Bush's economic policy should be seen as Keynesianism for the rich,=20
spending public money to line their pockets. Pat Buchanan has written a=20
fine book, Why the right went wrong, that forecasts the doom entailed in=20
Bush's rejection of the two cornerstones of republicanism -- balance the=20
budget and stay at home. Bush's bet is that the rest of the world can't=20
afford to call his bluff. First of all because the US economy is the=20
only one that is steaming ahead (on borrowed money) enough to buy their=20
exports. (The Chinese are booming but mainly importing raw materials=20
from the poor countries). This is linked to the American global policy=20
of threatening to exclude countries from the US market unless they sign=20
up bilaterally for a strict intellectual property treaty and another=20
exempting the US military from prosecution for war crimes. Second, as=20
this article makes clear, its main trading partners will keep up the=20
price of the dollar in order to protect their own assets, both in dollar=20
paper and US property. The EU is really caught, since home demand is=20
sluggish and an overpriced euro means they are priced out of the US marke=
t.

So the neocons have taken two huge gambles, based on impeccable logic,=20
that they are going to lose -- Iraq and the dollar. They really think=20
that being the only military superpower trumps all other factors and=20
they are wrong. God, I hope they are wrong, but I beleive they are. This=20
is my delayed reaction to the election result, that these bastards are=20
really going to reap the whirlwind they sowed.

The other main feature of the article is the role that Asia now plays in=20
financing the US trade and budget deficits. (Have you seen the latest on=20
the projected social security bill that will involve incredible=20
government borrowing in order to give each citizen a personal account?=20
It really is a Keynesian recipe -- spend money you don't have and tell=20
the markets to get lost, except that globalisation and the money=20
slushing around the world today makes it a very different scene from the=20
1930s). So it is China and Japan that are holding the tab for America's=20
profligacy, plus some lesser Asian countries like Singapore. I like the=20
idea of calling it a cartel and waiting for the first member to break=20
ranks (a liberal economist's dream, but not always true to life). On=20
ideological grounds alone, India will probably go with the euro. But=20
this article doesn't mention the Saudis and all that Arab oil money.=20
Does Iraq make them more or less dependent on the USA? The neocons think=20
they can just take the Saudis over if they get obstreperous. But the=20
Pentagon is strapped for resources and Saudi Arabia is a very=20
complicated country to invade right now.

Anyway, read on, nettimers, and contemplate the end of the world as we=20
know it. Or at least get out while you can.

Keith Hart


The dollar=92s demise

Nov 23rd 2004
  From The Economist Global Agenda

http://www.economist.com/agenda

Is the dollar=92s role as the world=92s reserve currency drawing to a clo=
se?

WHO believes in a strong dollar? Robert Rubin, Bill Clinton=92s treasury=20
secretary, most certainly did. John Snow, his successor but two, says he=20
does but nobody believes him=97if only because he wants other countries=92=
=20
currencies, in particular the Chinese yuan, to go up. Mr Snow=92s boss,=20
President George Bush, in one of his mercifully rare forays into=20
economics last week, also said he wants a muscular currency: =93My nation=
=20
is committed to a strong dollar.=94 Again, it would be fair to say that=20
this was not taken as a ringing endorsement. =93Bush=92s strong-dollar=20
policy is, in practical terms, to maintain a pool of fools to buy it all=20
the way down,=94 a fund manager was quoted by Bloomberg news agency as=20
saying. It does not help when the chairman of your central bank, Alan=20
Greenspan, whose utterances on the economy are taken rather more=20
seriously than Mr Bush=92s, has said the day before that the dollar seems=
=20
likely to fall: =93Given the size of the current-account deficit, a=20
diminished appetite for adding to dollar balances must occur at some=20
point,=94 were his exact words. The foreign-exchange market immediately=20
decided that it was sated, and the dollar fell to another record low=20
against the euro.

America's Federal Reserve posts Alan Greenspan's comments. The US=20
Treasury Department offers information on monetary and fiscal policy.=20
The People's Bank of China, the Bank of Japan and the European Central=20
Bank give economic statistics and publish statements on monetary policy.=20
The New York Federal Reserve publishes Matthew Higgins and Thomas=20
Klitgaard's paper, =93Reserve Accumulation=94. The Institute for=20
International Economics posts research and policy briefs on exchange=20
rates and monetary policy.

Mr Greenspan=92s words were of huge moment, and not just because he spoke=
=20
clearly, unusual though this was, nor because the Federal Reserve rarely=20
comments on foreign-exchange movements. No, Mr Greenspan=92s words were=20
significant because he was tacitly admitting what right-thinking=20
economists the world over have long believed: that the emperor has no=20
clothes.

Mr Greenspan=92s previous line had been that America=92s ever-expanding=20
current-account deficit was not a problem when capital could flow so=20
freely around the world; and that, in effect, it would continue to flow=20
to America because the country is such a wonderful place in which to=20
invest. Now he is saying that it won=92t, or at least that investors will=
=20
demand a cheaper dollar, or cheaper assets, or both, to carry on=20
financing America=92s deficit.

But Buttonwood suspects that the deeper significance of Mr Greenspan=92s=20
admission is that the game that has been played since the collapse of=20
the Bretton Woods system in the early 1970s is drawing to a close. The=20
dollar=92s status as the world=92s reserve currency=97its preferred store=
  of=20
value, if you will=97is gradually coming to an end. And, ironically, the=20
fact that it has become so popular in recent years will only hasten its=20
demise.

One man who undoubtedly believes in a strong dollar is Japan=92s prime=20
minister, Junichiro Koizumi. Unlike America, Japan has been putting its=20
money where its leader=92s mouth is. On behalf of the finance ministry,=20
the Bank of Japan has bought more dollars than any other central bank=20
has ever done. At last count, it had the equivalent of $820 billion in=20
foreign-exchange reserves, most of it denominated in the American currenc=
y.

As goes Japan, so goes the rest of Asia. In an interview this week with=20
the Financial Times, Li Ruogu, the deputy governor of China=92s central=20
bank, the People=92s Bank of China, said that his country would not be=20
rushed into revaluing the yuan, and that America should put its own shop=20
in order. Mr Ruogu=92s bank, too, has been a huge buyer of dollars in=20
recent years. China and the rest of developing Asia now have $1.4=20
trillion of reserves, mostly dollars. This is more than the combined=20
reserves of the rest of the world (excluding Japan). Thanks mostly to=20
Asian intervention, foreign-exchange reserves at the world=92s central=20
banks have climbed from $2 trillion in 2000 to $3.5 trillion in 2004.

It used to be that countries amassed reserves as a war chest to protect=20
against a run on their currencies of the sort suffered by East Asia in=20
1997, or Russia in 1998. But Asian countries have snaffled up far more=20
than would be justified to prevent such crises. Their aim in=20
accumulating these reserves is generally different now: to stop their=20
currencies rising against the dollar and so keep their exports=20
competitive. In effect, they are trying to peg their currencies; China=92=
s=20
peg is explicit. Huge foreign-exchange reserves are the result.

Some pundits have dubbed this arrangement the new Bretton Woods. The=20
Bretton Woods arrangement (a post-second world war agreement that tied=20
the dollar to gold and other currencies to the dollar) collapsed in=20
1971. The present arrangement seems similarly doomed to failure. The big=20
question is whether the world will suffer similarly ill effects when it=20
collapses.

Past saving?

The upward pressure on Asian countries=92 currencies stems either from=20
their saving too much and consuming too little, or from America saving=20
too little and spending too much. American politicians, naturally, tend=20
to concentrate on the first interpretation, because it stops them having=20
to recommend unpleasant remedies, such as cutting deficits or=20
encouraging Americans to save more. But Mr Greenspan=92s most recent=20
comments show that he recognises the problem is more home-grown.=20
Personal saving in America, as a percentage of household income, slumped=20
to just 0.2% in September, close to a record low. Indeed, the savings=20
rate has been declining remorselessly since 1981, when it reached a high=20
of 12.5%. This lack of saving shows up in the current-account deficit,=20
which is a record near-6% of GDP and rising.

In effect, foreigners are saving on America=92s behalf. In a recent study=
=20
for the New York Fed, two economists, Matthew Higgins and Thomas=20
Klitgaard, point out that the United States now absorbs more than the=20
measured net saving of the rest of the world combined (suggesting=20
someone=92s got their figures wrong somewhere). The American economy=20
cannot continue to expand at its current rate without those foreign=20
savings. The question is whether foreigners will be happy to carry on=20
financing this growth with the dollar and asset prices at their present=20
level. The private sector is already voting with its wallet: it has been=20
financing an ever smaller percentage of the deficit, and there has been=20
a net outflow of direct investment. That leaves the public sector=97ie,=20
central banks=97and those, in particular, of Asia. At the heart of the=20
central banks=92 calculations is a trade-off: intervening to keep your=20
currency down can be costly, but it is good for exports. Though the=20
costs of intervention are hard to quantify, they are potentially big.=20
Because the domestic money supply is expanded=97those dollars must be pai=
d=20
for with something=97it can cause inflation (though this can be=20
neutralised through =93sterilisation=94, ie, bond sales). But the big=20
potential cost is in amassing a huge stash of dollars with precious=20
little exit strategy. Quite simply, Asian central banks now own too many=20
of them to exit en masse, for their exit would cause the dollar to crash=20
and American interest rates to soar, which would cause huge losses on=20
their holdings of Treasuries.

Get out while you can

The biggest risk, of course, is that lenders would lose pots of money=20
were the dollar to fall. As the printer of the world=92s reserve currency=
,=20
America can pass on foreign-exchange risk to the lenders because, unlike=20
other indebted countries, it can borrow in its own currency. Messrs=20
Higgins and Klitgaard reckon that for Singapore, the most extreme=20
example, a 10% appreciation against the dollar and other reserve=20
currencies would lead to a currency capital loss of 10% of GDP. Though=20
loading up with even more dollars might of course stop the dollar from=20
falling for a while, it would increase the risk of still larger losses=20
were it eventually to do so. America already needs almost $2 billion a=20
day from abroad to finance its spending habits, and the situation=20
deteriorates by the week because America imports more than it exports,=20
which worsens the current-account deficit.

The incentives to flee the Asian cartel (to give it its proper name)=20
thus increase the bigger the game becomes. Why take the risk that=20
another central bank will leave you carrying the can? Better to get out=20
early. Because the game is thus so unstable it will come to an end, and=20
probably a messy one. And what will then happen to the dollar? It is=20
hard to imagine its hegemony remaining unchallenged when so many will=20
have lost so much. And doubly so given that America has abused the=20
dollar=92s reserve-currency role so egregiously that its finances now loo=
k=20
more like those of a banana republic than an economic superpower.




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