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BOOK
REVIEW
Economic
doomsday
The Dollar Crisis: Causes,
Consequences, Cures by Richard
Duncan
Reviewed by David Peters
The US
economy is on the verge of collapse, and the whole world
is  going down with it. Or so Richard Duncan would
have us believe. His new book The Dollar Crisis:
Causes, Consequences, Cures offers an unabashedly
alarmist view of the imminent unraveling of the global
economy - an outcome he argues has now become
unavoidable.
And as a longtime financial analyst
in Asia who predicted the impending collapse of the Thai
economy as early as 1993 and worked as a consultant for
the International Monetary Fund (IMF) during the height
of the Asian crisis, he knows a thing or two about
financial crashes.
Duncan traces the current
"crisis" to the end of the Bretton Woods monetary system
in 1973. With the global monetary base indirectly tied
to gold, the total volume of reserve assets worldwide
grew by just 55 percent between 1949 and 1969 - an
average of 2.2 percent per year. Since then, reserve
assets have mushroomed by almost 1,900 percent, or about
9.7 percent annually.
The system that replaced
Bretton Woods saw major foreign currencies floating
against the dollar. Because the world's reserve
currencies were pure fiat money, the author argues, this
system had no built-in check on the growth of the global
money supply. As long as the world's central banks were
willing to hold US-dollar-denominated debt as reserves,
the United States could run an almost endless series of
large trade deficits without paying the monetary
consequences in terms of a collapse of the dollar.
But having sown the wind for 30 years, the US is
now about to reap the whirlwind.
Duncan argues
that the current international monetary system has three
fatal flaws that make it inherently unstable: "First, it
allows certain countries to sustain large current
account and capital or financial account surpluses over
long periods, but it causes those countries to
experience extraordinary economic boom-and-bust cycles
that wreck their banks and undermine the fiscal health
of their governments. Its second flaw is that this
system has made the well-being of the global economy
dependent on a steady acceleration in the indebtedness
of the United States, a state of affairs that is
obviously not sustainable. The third flaw is that it
generates deflation."
Duncan explains, for
example, that Japan's large trade deficits with the US
in the 1970s and 1980s caused a rapid and inordinate
rise in Japan's total reserve assets. Those reserves
entered the Japanese economy as high-powered money,
causing a huge monetary expansion and credit spree.
Asset prices rose until the over-indebtedness of the
business sector caused the bubble to burst. Because of
over-investment during the boom relative to increases in
people's purchasing power, the market had excess supply.
Deflation set in, which further hurt the business
sector, but because of the lack of good investment
opportunities, the banks were ultimately caught in a
liquidity trap.
Like most countries that run a
current account surplus with the US, Japan plows most of
it back into US-dollar assets. Duncan contends that this
massive capital flow in turn prompted a credit spree in
the US during the 1990s, fueling a parallel asset-price
bubble.
Time is running out on this cycle, he
argues. The first stage of the US bust - marked by the
collapse of creditworthiness in the corporate sector -
was mitigated by a continuing consumption orgy led by
households drunk on low mortgage rates. But that bubble
is also bursting, as consumer debt surges to dangerous
levels. Many assets, especially stocks and real estate,
remain overpriced, and over-investment has made the
economy vulnerable to deflation. When the second bust
comes, monetary policy will be to no avail, since
interest rates are already at their lowest point since
the era of US president Dwight Eisenhower.
To
make matters worse, few US securities are generating
positive returns these days. And if the rest of the
world stops buying US assets, how will the United States
fund its US$500-billion-a-year trade deficit? The dollar
will have to collapse, turning an incipient depression
into a global crisis of monumental proportions.
Duncan argues his position forcefully and
clearly. If anything, the reader gets the point all too
early in the book, and ultimately tires of having the
same argument beaten into his or her head again and
again. The Dollar Crisis contains 177 tables and
graphs, which apart from some troubling typographical
errors (were total US credit market assets really only
US$25 billion by the third quarter of 2001?) are helpful
in amplifying the author's points.
But in the
end, what is most frustrating about Duncan's work is the
single-minded way he ignores any nuances that might
detract from his argument. For instance, he describes
how China's large trade surpluses with the US have led
to a credit boom, without ever mentioning that China's
state-owned banking sector allocates credit based on
non-market criteria.
He repeatedly stresses that
the post-Bretton Woods monetary system has no in-built
adjustment mechanism, when in fact the adjustment is
supposed to come from the free floating of currencies.
It's not that there was no adjustment mechanism,
countries just chose to circumvent it by intervening in
the foreign-exchange markets, because they had other
policy priorities. A central bank may simply place more
value on fighting inflation or on keeping exchange rates
stable to facilitate foreign investment than on
retaining the option to use monetary policy to smooth
out the business cycle.
But such concerns do not
register on Duncan's radar. The world he describes is
one in which inexorable macroeconomic forces operate in
a policy void, and with no microeconomic complications.
He argues that Thailand's credit boom was due
simply to the presence of a capital account surplus. But
would that surplus have wreaked the same havoc had the
country not been pressured to liberalize its capital
account before its central bank could provide adequate
prudential oversight? And what if the banks had not been
allowed to take short-term deposits in the international
interbank market with no reserve requirements and lend
long-term at home?
Policy matters, and that is
precisely why the path from the author's observations to
his specific predictions may not follow as straight a
line as he tries to make it seem.
Duncan has
little faith in markets. He asserts, "If all trade
barriers were removed in 2003, practically nothing would
be manufactured in the 'industrialized', advanced
countries by 2010." Free trade, in his view, does little
more than create a structural imbalance in the global
economy that is highly deflationary, due to the low
wages of workers in the developing world.
Even
ignoring the proposition that a group of countries could
have no comparative advantage whatsoever, Duncan still
neglects to mention that wages are, to some extent at
least, governed by productivity differences. The average
worker in a Thai factory is considerably less productive
than her counterpart in the United States, because she
is probably working in a less capital-intensive
environment.
The first of his two policy
suggestions to mitigate the coming collapse touches on
this issue, advocating a global minimum wage, enforced
by international treaty. But since labor productivity
varies widely among developing countries, creating an
artificial price floor would have disastrous effects on
some nations' competitiveness. Yet he blithely asserts,
"The only conceivable reason that any government would
object to a plan designed to raise the wages of its
people in a deflationary age is for fear that other
countries could cheat by paying their workforce less."
Countries don't pay workers, companies do, and
one group that would certainly object is those who foot
the bill, who undoubtedly wield some political
influence. In fact, the truly big winners from such a
policy would be factory owners in industrialized
countries, who would suddenly find themselves more
competitive without having to invest in increasing their
productivity.
Duncan's other policy suggestion
is to create a global central bank (he nominates the
International Monetary Fund for the job), which could
engineer a controlled increase in the global money
supply by allocating new reserves according to criteria
that could include development priorities. However, many
countries world be wary of entrusting such
responsibility to a largely unaccountable organization
whose policymaking system is structurally dominated by
the industrialized countries.
The Dollar
Crisis: Causes, Consequences, Cures, by Richard
Duncan, John Wiley & Sons (Asia) Pte Ltd, Singapore,
2003. ISBN: 0-470-82102-7. Price: US$29.95, 269 pages.
(©2003 Asia Times Online Co, Ltd. All rights
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