Eva Cheng
As the administration led by President George Bush expands its war spending, the US is digging itself further into a big financial hole. This adds to the country's fast growing negative external accounts. These two shortfalls now need some US$1.5 billion a day to plug.
US current account deficits have grown from$105 billion in 1995 to$542 billion last year, and are expected to balloon to $670 billion (5.7% of gross domestic product) for 2004.
After four years of surpluses, the US federal budget dipped $158 billion into the red in fiscal 2002 (started on October 1, 2001) and the shortfall is expected to shoot up to $445 billion for fiscal 2004, and to stay in the red for years to come.
Recently, the US has been finding it more difficult to get the funds to finance the deficit, and this is made worse by the decline in value of the US dollar. The chance of the greenback recovering soon is slim. This threatens to prompt more investors and speculators to dump it, opening up a turbulent period in international exchange rates and rising interest rates for US-dollar-based assets, which are globally widespread.
Already, the Australian dollar is poised to go above 80 US cents, pushed up by a weak greenback. If this exchange level persists, Australian exports will suffer, as Australian goods become relatively more expensive.
A weak greenback will also force up many other currencies. One victim will be the 12-country euro bloc. The euro has been pushed beyond US$1.30 lately, further damaging the European Union's tentative recovery after it had been dented by high oil prices.
At a mid-November conference in Berlin, German finance minister Hans Eichel urged the US to coordinate its exchange rate policy with the EU and Japan. But US Federal Reserve Board chairperson Alan Greenspan rejected this, saying the US is "already doing as much as necessary".
Does Washington prefer the dollar to weaken further? Many think so. Edmund Andrews, for example, wrote in the November 27 New York Times: "The Bush administration has essentially condoned the dollar's decline...Treasury secretary, John W. Snow, repeated the American mantra of support for a 'strong dollar' but also for letting 'market forces' determine exchange rates."
US gains
The US has much to gain from a weak dollar. Nearly all US external liabilities are in US dollars, while most of its assets overseas are in foreign currencies, especially euros. A declining dollar means the value (in foreign currency terms) of what the US owes the world will go down while the value of what it owns overseas will go up. In 2003, the outstanding sum of US external liabilities amounted to 96% of its $11,000 billion GDP while foreign assets held by US residents were equivalent to 71% of US GDP.
With the dollar the dominant currency of international transactions and reserves since the 1940s, most countries and major corporations lend or borrow internationally in US dollars. The only significant exception is the euro bloc. Washington's low interest rate policy since 2001 has seriously depressed the earnings of the enormous dollar-based assets. So much so that even though the US has net foreign liabilities equivalent to 24% of its GDP, it's still generating a net income inflow.
The November 2004 Reserve Bank of Australia Bulletin spells out why: "This is because the rate of return earned on US investment abroad substantially exceeds that earned by foreigners on their investments in the US."
In the last few years, there emerged a significant new source of foreign demand for US-dollar-denominated assets — from Asian central banks for US Treasury debt. A number of Asian economies are highly export-dependent and have been burnt by the 1997-98 economic crisis, during which their currency slumped and exports were devastated. Since then, their central banks have rapidly increased their holding of US Treasury papers, which they can sell to counter an unwanted surge of their own currencies vis-a-vis the greenback. Japan has been maintaining its exchange rate with the US dollar close to 120 yen, while China has steered its since 1994 around 8.28 yuan.
Huge loss for others
In only two years to the end of 2003, for example, Asian central banks' foreign exchange reserves surged by $700 billion to $1800 billion, according to former US Treasury secretary and current Harvard University president Lawrence Summers in an October 3 lecture. During this period, Summers continued, Japan's reserves rose by $265 billion, China's by $191 billion, India's by $52 billion and that of the so-called newly industrialising economies by $163 billion.
Yet for such vast sums in US dollars, which are mostly for short maturities, the yield after adjusting for inflation has been negative for some time. Washington's low-interest-rate strategy of the last few years has cost these Asian central banks tens of billions of dollars of foregone interest yield.
The declining US dollar is just rubbing salt into the wound. Since July 2001, it has fallen 37% versus the euro or 14% on a trade-weighted basis.
Are these investing entities really so stuck with the US dollar? Some are. Those which have a freer hand have been moving away. Hence the dollar decline. Those which are "more stuck", such as the Asian central banks, feel a rising pressure to look for alternatives.
In July, foreign private investors' purchases of US Treasury notes dropped 20% and purchases by foreign central banks plunged 76%. In August, the latter's purchases recovered, but not enough to prevent a rare net reduction in foreign purchases of Treasury papers of $4.4 billion.
Then in November, when a Shanghai newspaper quoted Yu Yongding of China's central bank as saying that China was reducing its US Treasury holdings, Wall Street jittered. Yu later clarified that China wasn't reducing its US Treasury holdings in absolute terms, but the underlying implications remain.
After Tokyo's months of rumblings, a senior leader of Japan's ruling Liberal Democratic Party openly warned of the likelihood of an "enormous capital flight from the dollar" if it continues its slide, reported the December 5 British Guardian. Russia and India, both significant holders of US Treasury papers, have also recently voiced similar concerns.
Would Washington engineer the decline of its own currency? This actually happened, and was formally announced, in 1985 under the Plaza Accord, coordinated with the European countries. The main target then was Japan, which had to sustain a sharp appreciation of its currency over the next two years that precipitated the country's economic collapse in the late 1980s, from which it has never fully recovered.
Washington's recent target is China. Beijing has resisted the appreciation of its currency because of the potential devastating effect on its economy and stability it would have. Washington hasn't yet forced this, but has already lined up legislation in both houses of Congress to punish China with high tariffs.
US politicians blame China for the US's growing trade deficits and rapid decline in manufacturing jobs. They conveniently ignored how a substantial slice of China's exports to the US actually originated from US capitalists' manufacturing activities in China, using China's cheap labour, but sold their products back to the US.
Economic unilateralism
A second "Plaza offensive" can't be ruled out. In fact, it seems to be under way in a less explicit manner than in 1985. It is more unilateral this time round.
But the US trade deficits won't be turned around easily. With exports amounting to only 11% of US GDP, currency manipulation is a blunt tool to boost US exports. Washington's 1985-87 currency offensive towards Japan, and towards China today, are aimed less at improving its trade balance than disabling a key competitor. One other bird that it can kill with this stone is the EU.
But doesn't the US need capital inflow from the external-surplus-holding countries such as Japan and China to fund its huge domestic and external liabilities? It does. Adequate US national savings could have plugged the gap but such savings hardly exist in the US in recent years. Moreover, in the absence of a viable alternative soon to the greenback as the world's dominant currency, Washington seems confident that these countries' reliance on US dollars is more a necessity than a choice.
This, however, doesn't stop them from reducing, temporarily at least, their exposure to US dollars in order to leverage for a higher investment return. Yet the unlikely ability of this huge number of countries and entities to act in a united way has increased Washington's likelihood of getting the upper hand. Washington seems prepared to pay a higher rate than recently in order to obtain the needed funds. Greenspan warned in November that US interest rates are on their way up.
But plagued by structural overcapacity and poor profits, productive investments have been depressed in the US since the 2001 recession. Rising interest costs will make it worse. This will make the current "jobless recovery" even more jobless, not only in the US. Meanwhile, the Third World's ability to service its enormous (mostly greenback-denominated) external debt is already precarious. Rising interest rates only increase the likelihood of default, as happened in the early 1980s.
Boosted by its military unilateralism since 9/11, the US empire is abusing its decisive position in the post-1973 paper dollar standard by once again waving a "weak dollar" stick to assert economic domination. But this is a high-risk game, full of social contradictions, a process it can't have full control over.
From 91×ÔÅÄÂÛ̳ Weekly, December 15, 2004.
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