13. Januar 2004
The substantial decline of the US dollar raises the question of how much further and how much faster the decline will go and what will be its impact on the value of other currencies and on the world economy.
The dollar‘s value has been sustained for around two decades by the holdings of many countries, especially but not only in Asia, of dollars acquired by selling more to the United States than they have bought. These surpluses have been used to acquire American assets - stocks, bonds, factories, real estate and the rest.
This has been the means by which the American economy has been able to shift the domestic inflation of the 1970s and early 1980s into deficits in the balance of trade. As a consequence, domestic inflation in the United States, in the last twenty years, has been relatively benign. As another consequence, we must also bear in mind that, ever since the early 1970s, the United States dollar has nevertheless lost value against a variety of world currencies, especially in Western Europe and Japan. Against this background, the revival of the strength of the dollar, in the late 1990s and growing out of the Clinton boom years, might be regarded as an anomaly. If the current decline in the dollar‘s value means no more than an orderly return to the longer-term downward trend, that might offer us some comfort and be expected to cause us no special concern.
However, we have no assurance that the decline of the dollar will be no more than this. A sudden and critical loss of confidence in the dollar could cause a panic run that could inflict financial chaos on the United States itself and extend that chaos around the world.
Is there any reason to suppose this might happen?
There are some elements that are relatively new and there are some older elements that have acquired a magnitude that we have never known before.
One of the most worrying features is the massive amount of personal, corporate and public debt in the United States. The gifted analyst, Dr Kurt Richebächer, has drawn our attention to „the credit horrors of the present...Net national savings are at best close to zero, if not negative. Nonfinancial borrowings ballooned in 2002 by $1,374.6 billion, of which $771.8 billion was on account of the consumer.“
This is in the context of the more than $500 billion annual deficit in the balance of trade and the $500 billion - and rising - deficit in the federal budget. State budgets are mostly in a dire state of heavy deficit.
And still piled on all this are the trillions wandering in the ghostly purlieus of the derivatives markets. We do not know the extent of involvement of major financial institutions, but we have reason to believe that it must be huge, that the funds committed to derivatives must be at high risk, and that volatility in the basic markets must intensify volatility in the derivatives markets which then bears back again on the basic markets. The credit deployed in these operations dwarfs anything known in the past. It also dwarfs aggregate funds involved in world trade. In the recent past, one firm alone was said to command open positions of US$1.2 trillion financed by 100-fold leverage. That is equal to the entire daily transactional value of the world‘s foreign-exchange markets. Another hedge fund is reputed to be exposed to potential asset loss of US$20 billion by a 10 percent appreciation of a single currency (yen) against the US dollar.
One commentator has said that „This invisible supply of virtual liquidity supports an artificial level of asset value very much detached from fundamentals, and the unbundling of their underlying open private contracts will inevitably cause drastic readjustments in asset prices in the formal markets.“
Even against that frightening background, we can hope that an orderly decline in the value of the dollar to a trend line in keeping with that before the 1990s boom, might be manageable.
What seems to be happening now however is that a more widespread awareness of the size and significance of the trade deficit and the unlikelihood that it will be remedied soon or through the processes of normal trade and finance, is causing people to get out of dollars more rapidly and comprehensively. One angle on this, put forward by David Chiang is that „my best recommendation to protect your personal wealth and capital is to reduce exposure to US dollar based investments. The de-industrialized American economy has already passed the rubicon or the point of no return. There simply is very little in the way of ‚real‘ wealth-producing industrial capacity left. Our federal reserve Chairman continues to propound dubious analyses. As an economy, we are massively inflating financial claims without the backing of tangible assets or the capacity to produce true economic wealth. When the mortgage-finance driven credit bubble implodes, we need to have our personal finances protected for the inevitable.“ On the back of that real-estate bubble, the US Government has now backed $8 trillion of mortgage securities at Fannie Mae and Freddy Mac. The financial fallout when the bubble bursts must give cause for grave concern, with the repercussions potentially worldwide.
Going back to the trade deficit, the monthly capital inflow needed to cover the gap is between $US40 billion and $50 billion. On some recent occasions, the net monthly inflow has been much less and, on at least one occasion, less than $2 billion.
If the net monthly inflow disappears altogether, what will be the effect?
Let us recall that the chronic trade deficit has been a means of shifting domestic inflation by importing massive, unrequited supplies from overseas. The huge American appetite for oil, for example, has been satisfied to a large extent by the oil suppliers asking for nothing in return, except to hold US dollars or to invest those dollars in US bonds, stocks, real estate and other assets. In theory at least, if the deficit disappears, the American economy must again become reliant on domestic production, with the result that domestic inflation will be shifted back to the relationship between domestic supply and domestic demand.
Is this what will happen?
The actual result will be more complex; but the decline and perhaps disappearance of unrequited supplies must mean the rationing of available supplies by price and a consequent upsurge in prices. In the short term, the American economy will not be able to expand domestic output over a whole range of consumer goods and a reversal of deeply embedded attitudes and policies will be needed even to get the process started.
How great will be the effect on consumer prices? Any estimate could only be wildly speculative.
However, we must note that the decline in the value of the dollar will lift the dollar prices of dollar-denominated goods and services in world markets. Already, a wide range of minerals have shown steep rises in dollar prices. Gold and silver have already moved up substantially and could reach all-time record prices if the already quite sharp fall in the dollar degenerates into some sort of stampede into other currencies or gold.
On oil, we might have a situation similar to that of 1973, with a falling dollar and continuing strong demand for oil giving the producers, including OPEC, an opportunity to push prices to all-time record levels, at least in nominal dollars. The oil shock of 1973 did not CAUSE inflation in the United States but it did intensify it. The same could happen again.
There will be offsets. China and other suppliers will try hard to keep their prices down and their exports to the US high. They will try not to let the depreciation of the US dollar push them out of or reduce their share of the US consumer market. There is now some suggestion that China might allow some gradual appreciation of its currency but at a modest and carefully controlled pace. On the other hand, despite Bank of Japan intervention, the yen is likely to continue to rise in dollar terms, perhaps reaching as high as 85 to the dollar; and, in the EU, the European Central Bank (ECB) seems prepared to live with a stronger Euro, at least until it reaches $1.35 or $1.40. This means that import prices both from Japan and the EU will rise in dollar terms and, in the short term at least, it may not be possible to replace those imports with supplies either from US domestic or other foreign sources.
It would be unwise to speculate too far at this juncture on how far these pressures will go. What we can say is that the US dollar is likely to continue to lose value as a result of growing reluctance of foreigners to hold dollars and dollar assets. This will establish a trend to return inflationary pressures, arising especially from chronically loose credit in the United States, from trade deficits to domestic price rises. This could force „remedial“ financial and economic policies on the United States and its major - and minor! - trading and financial partners that could endanger the whole financial and economic structure as we have known it. We can do little now to alter the nature of the problems confronting us or their magnitude. We must also accept the fact that we must find „remedies“ for these problems or the „remedies“ - mostly unpleasant - will find us and force themselves on us anyway. It would seem wise to seek remedies of a gradual and flexible kind that will win the support of all the principal countries - preferably the poor as well as the rich. Whatever the details of those remedies, the broad aim must be to get back to a system for creation of real wealth through real fixed-capital public and private investment, rather than through financial speculation and the untrammelled operation of the supposedly „free“ market. This calls for a fundamental turnaround in policymaking in the United States and elsewhere. If there is too much friction in achieving this turnaround, we - virtually all of those who inhabit the planet - could be confronted with long-lasting economic depression and the social and strategic conflicts that go with it.