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TWO CENTS'
WORTH
America's selective strong
dollar policy
By
Henry C K Liu
With its current account deficit
approaching US$600 billion this year and the federal
deficit running at $450 billion, the United States needs
to attract about a net $5 billion of funding every
working day, much of it from overseas. That is 5 percent
of US gross domestic product (GDP) in nominal value.
Assuming money velocity at a conservative multiple of
five, foreign fund inflow supports 25 percent of the US
economy. A weak dollar is supposed to make it easier to
meet this funding requirement, as well as helping to
reduce the trade deficit by making exports cheaper and
import more expensive. But a falling dollar reduces the
net yield of foreign-own dollar debts, generating
incentives for foreign holder of US bonds to sell.
Therein sits the rationale behind the US Treasury's
selective strong-dollar policy, designed to reduce any
incentive for large foreign holders of US bonds, such as
Japan, to withdraw from the US bond market.
While a strong-dollar policy has officially
continued from the administration of president Bill
Clinton to the current administration of George W Bush,
US Treasury Secretary John Snow, at a Group of Seven
(G7) finance ministers' meeting in France in mid-July,
defined the strong-dollar policy in what the market
considered weak terms. "What you want to be strong is
that you want people to have confidence in your
currency, you want them to see a currency as a good
medium of exchange," he explained. This describes a
sound-dollar policy rather than a strong-dollar policy.
What Snow was really saying is that you want certain
foreigners, such as the Japanese and the Chinese, to
continue to buy US bonds.
Federal Reserve
governor Ben S Bernanke remarked before the National
Economists Club in Washington, DC, last November 21: "In
the United States, the Department of the Treasury, not
the Federal Reserve, is the lead agency for making
international economic policy, including policy toward
the dollar; and the secretary of the Treasury has
expressed the view that the determination of the value
of the US dollar should be left to free market forces."
Less than two weeks later, Paul O'Neill, the treasury
secretary Bernanke referred to as having expressed that
view, was told by the White House to resign on December
5.
In February 2001, O'Neill said publicly: "We
are not pursuing, as often said, a policy of a strong
dollar. In my opinion, a strong dollar is the result of
a strong economy." Financial markets reacted with
massive dollar selling, forcing the Treasury Department
to issue this clarification a day later: "The secretary
supports a strong dollar. There is no change in policy."
O'Neill explained on February 18: "I guess I
made a mistake in thinking it was okay to talk beyond
simplistic things. So I'll make it very clear: I believe
in a strong dollar, and if I decide to shift that stance
I will hire out the Yankee Stadium and some rousing
brass bands, and announce that change in policy to the
whole world."
O'Neill was right that the
exchange value of the dollar is not the stuff of
"simplistic things". The US economy has locked on to a
strong-dollar policy for almost a decade. The US
government cannot explicitly abandon it without
undermining international market confidence in the
dollar, promoting an exodus from US bonds and pushing up
long-term interest rates.
While since the start
of 2002 the dollar has fallen as much as 30 percent from
its peak against the euro, it does not add up to an end
of the strong-dollar policy. The United States has been
sanguine about the rapid decline of the dollar only
against select currencies. Since its low for the year in
mid-June, the dollar has rebounded by 6 percent against
the euro.
When O'Neill, Snow's predecessor,
argued that markets rather than governments should
determine exchange rates, he was asserting that US
government policies would aim at preserving long-term
market support for the dollar. He claimed he had been
misunderstood that he meant a strong-dollar policy was
no longer in place. The misunderstanding actually came
not from the market being simplistic, but from the
mismatch of the neo-liberal myth of a free market in
foreign exchange, as espoused by central banks, and the
market's view of the fact that the foreign-exchange
market is anything but free.
During the Clinton
administration, Robert Rubin, widely regarded as the
father of the strong-dollar policy, declared his aim of
a strong dollar soon after his appointment to the
Treasury in January 1995. Rubin understood that a
capital account surplus is the answer for a current
account deficit, based on economics worked out by Martin
Fieldstein in the Ronald Reagan administration. A strong
dollar is key to this capital account surplus/current
account deficit strategy, which has come to be known as
dollar hegemony.
The policy exploits the
instinctive penchant of other countries to make export
gains from an undervalued currency. The United States
would open its huge market to the exporting economies of
the world and force them to finance the resultant US
trade deficit with capital inflows from the exporting
economies. A strong dollar ensures the appeal of US
companies to overseas investors and thus aligning global
support for a strong dollar. Dollar hegemony forces the
central banks of US trading partners to hold their
dollar trade surplus in US bonds and assets, if they
want protection from speculative attacks on their
currencies. A fall in domestic currency will cause
domestic interest rates to rise, and make dollar loans
more expensive to service and amortize.
As US
domestic demand skyrocketed in the late 1990s, the 30
percent rise in the trade-weighted dollar between 1996
and 2001 helped keep a lid on domestic inflation and
kept dollar interest rates low, even as the Fed began to
hike the Fed Funds rate target to preempt wage-pushed
inflation caused by structural full employment (at 4
percent unemployment). While US companies managed to
attract overseas investors with low yields that
translated into high yields in their own home currencies
by a strong dollar, the inflow also financed the
merger/acquisition mania of US companies that made the
resultant entities fiercely competitive global giants.
The budget surplus of the Clinton years did not
slow down inflow of funds, which readily went to finance
mergers and acquisition and initial public offerings
(IPOs). The easy money and credit milked from the backs
of underpaid workers in the exporting economies enabled
the US economy to venture into new technological fields,
such as digitized telecommunication that spurred the
dot-com fever, structured finance that gave birth to the
hedge funds industry, and all manners of financial and
accounting acrobatics. Wealth was being created as fast
as the United States could print money, with little
penalty of inflation. The rest of the world was shipping
products they themselves could not afford to consume to
US consumers in exchange for papers of the US financial
system that in turn feeds US consumer power with debt.
A new economic sector called financial services
came into existence. This was the true meaning of the
slogan "a strong dollar is in the national interest".
Dollar hegemony allowed the United States to levy a tax
on the rest of the world for using the dollar, a fiat
currency, as the reserve currency for world trade. The
livelihood of the world's workers came to depend on US
consumers' appetite for debt sustained by loans from the
underpaid workers' own governments. Neo-imperialism
works by making the world's poor finance the high living
of the world's rich. It transcends the Marxist notion of
class struggle and surplus value. In neo-liberal
globalization, not just labor but even capital comes
from the exploited.
What the Wall Street Journal
calls mass capitalism would not have been half-bad if it
were not for the fact that the hard-earned capital was
squandered through fraud and Ponzi schemes. These new
ventures financed by fund inflows did strengthened the
US economy at first. But as the real economy in the
United States did not grow as fast as the inflow of
funds, because fewer and few things were being produced
in the US, the excess funds soon channeled toward
manipulation and fraud on a massive scale, resulting in
financial scandals such as LTCM, Enron, WorldCom, Global
Crossing, and thousands of less-known bankruptcies.
Much of the disaster came from the smoke and
mirrors of so-called financial services, based on minute
technical quantitative advantages that seem benign by
themselves, but can accumulate into huge profit or loss
in hundreds of billions of dollars on the turn of a
penny. Hundreds of billions of dollars of investment and
credit went up in smoke from fraudulent schemes
perpetrated not only by management under the coaching of
ever-enterprising investment banks, but also with the
active, knowing participation of the banks, robbing
workers and retirees the world over of their pensions
and life savings.
Domestic jobs in the United
States were eliminated by the millions and shipped
overseas, while overseas workers were told to be
thankful for inhuman wages and sweatshop conditions that
at least warded off starvation. Instead of confessing
their regulatory failings, US officials such as Alan
Greenspan of the Federal Reserve took comfort in the
role derivatives played in allegedly smoothing over
massive financial shocks in the system, making the
damage longer-lasting. Falling wages and worker benefits
were cushioned by the wealth effect from speculation by
people who could not afford the risk. Now that the US
economy is trapped in a prospect of decade-long slow
growth with a pending onslaught of deflation, and the
hollowing-out of blue-collar manufacturing and
white-collar high-tech sectors, Greenspan has told
Congress that the threat of deflation remains "remote"
and that thinking jobs are better that doing jobs.
What Greenspan told Congress makes perfect sense
in the context of a new strategy for an American empire.
The hollowing out of America's manufacturing and digital
sectors becomes a compelling rationale for US control of
the world to protect its offshore sourcing. After all,
wars have been fought to protect the supply of oil in
places where nature has placed it; why should the United
States not fight to protect where the "free" market puts
its manufacturing and data processing? In this strategy,
the US needs only two things: a powerful military with
instant power-projection capability everywhere around
the globe, and dollar hegemony to print dollars that can
buy all the things that the world makes for export to
the US. The British Empire was rationalized by the need
of Britain to import food as domestic agriculture became
crowded out by industry. Similarly, the US Empire will
be rationalized by the need of the United States to
import manufactured goods as domestic production is
crowded out by financial services.
There are
only two difficulties with this grand strategy: 1) to
build the ideal empire, US workers will have to be
retrained for the service sector and large numbers of
both blue- and white-collar workers will fall through
the cracks - and that creates problems in a democracy;
and 2) the rest of the world is not stupid and may not
take it lying down. So freedom and democracy at home
will have to be modified in the name of homeland
security and foreign resistance will have to be crushed
in the name of freedom and democracy. The "war on
terrorism" is tailor-made for this grand strategy.
There are clear signs that US workers are not
taking it lying down. Representative Bernard Sanders
(Independent, Vermont) interrupted Greenspan during a
congressional hearing on July 16: "I think you just
don't know what's going on in the real world. And I
would urge you, come with me to Vermont, meet real
people. The country clubs and the cocktail parties are
not real America. The millionaires and billionaires are
the exception to the rule."
In a blistering
diatribe, Sanders told Greenspan: "I have long been
concerned that you are way out of touch with the needs
of the middle class and working families of our country,
that you see your major function in your position as the
need to represent the wealthy and large corporations.
"And I must tell you that your testimony today
only confirms all of my suspicions, and I urge you - and
I mean this seriously, because you're an honest person,
I think you just don't know what's going on in the real
world - and I would urge you come with me to Vermont,
meet real people. The country club and the cocktail
parties are not real America. The millionaires and
billionaires are the exception to the rule.
"You
talk about an improving economy while we have lost 3
million private-sector jobs in the last two years,
long-term unemployment is more than tripled,
unemployment is higher than it's been since 1994.
"We have a $4 trillion national debt, 1.4
million Americans have lost their health insurance,
millions of seniors can't afford prescription drugs,
middle-class families can't send their kids to college
because they don't have the money to do that, bankruptcy
cases have increased by a record-breaking 23 percent,
business investment is at its lowest level in more than
50 years, CEOs [chief executive officers] make more than
500 times of what their workers make, the middle class
is shrinking, we have the greatest gap between the rich
and the poor of any industrialized nation, and this is
an economy that is improving.
"I'd hate to see
what would happen if our economy was sinking.
"Now, today you may not have known this - I
suspect that you don't - but you have insulted tens of
millions of American workers.
"You have defended
over the years, among other things, the abolition of the
minimum wage - one of your policies - and giving huge
tax breaks to billionaires.
"But today you have
reached a new low, I think, by suggesting that
manufacturing in America doesn't matter. It doesn't
matter where the product is produced. We've lost 2
million manufacturing jobs in the last two years alone;
10 percent of our workforce. Wal-Mart has replaced
General Motors as the major employer in America, paying
people starvation wages rather than living wages, and
all of that does not matter to you - doesn't matter.
"If it's produced in China where workers are
making 30 cents an hour, or produced in Vermont where
workers can make 20 bucks an hour, it doesn't matter.
You have told the American people that you support a
trade policy which is selling them out, only working for
the CEOs who can take our plants to China, Mexico and
India.
"You insulted [Representative Michael]
Castle. Mr Castle, a few moments ago - a good Republican
- told you that we're seeing not only the decline of
manufacturing jobs, but white-collar information
technology jobs.
"Forrester Research says that
over the next 15 years, 3.3 million US service industry
jobs and $136 billion in wages will move offshore to
India, Russia, China and the Philippines.
"Does
any of this matter to you? Do you give one whit of
concern for the middle class and working families of
this country? That's my question."
Then the
following exchange took place:
Greenspan:
Congressman, we have the highest standard of living in
the world.
Sanders: No, we do not. You go
to Scandinavia, and you will find that people have a
much higher standard of living, in terms of education,
health care and decent-paying jobs. Wrong, Mister.
Greenspan: May I answer your question?
Sanders: You sure may.
Greenspan: Thank you. For a major
industrial country, we have created the most advanced
technologies, the highest standard of living for a
country of our size. Our economic growth is crucial to
us. The incomes, the purchasing power of our employees,
our workers, our people are, by far, more important than
what it is we produce. The major focus of monetary
policy is to create an environment in this country which
enables capital investment and innovation to advance. We
are at the cutting edge of technologies in the world. We
are doing an extraordinary job over the years. And
people flock to the United States. Our immigration rates
are very high. And why? Because they think this is a
wonderful country to come to.
Sanders:
That is an incredible answer.
Payrolls outside
the agricultural sector fell by another 44,000 in July,
the sixth consecutive monthly fall. The unemployment
rate fell to 6.2 percent from 6.4 percent - because an
estimated 556,000 US residents dropped out of the labor
force through discouragement.
While Greenspan is
losing his infallible image, Congress is nevertheless
making only helpless noises about the need for a weaker
dollar to revive struggling US manufacturers without
sparking inflation. The logic is to increase export
through a weak dollar and to retain jobs at home by
making imports more expensive. Under these conditions,
it seems only natural that the United States should not
object to a weaker currency.
The reality is that
while a weak dollar makes imports more expensive, it
might only reduce import volume but not necessarily the
total import value, and while US export may become more
price-competitive, a drop in US import may also reduce
foreign purchasing power for US exports. Thus the US may
increase export volume but not necessarily increase
total export value. The only beneficiary is likely to be
US transnational corporations with foreign revenue whose
dollar profit from non-dollar operations will be boosted
by a weak dollar, thus neutralizing any incentive for
overseas investors to sell US equity. The fact is that
once jobs are being done for 30 cents an hour overseas
as a result of "free" trade, the only way these jobs
will return to the United States is if employers can
find workers in the US who will work for 30 cents an
hour. The solution has to be a rapid rise of wages
outside the G7 economies that rapidly increase the
purchasing power of non-G7 workers.
So far, even
with the US dollar at four-year lows against the euro
and six-year lows against the Canadian dollar, overseas
investors have chosen simply to hedge their currency
risks instead of abandoning US assets. Yet today's
unregulated financial markets can turn suddenly. If an
accelerated fall in the dollar starts to disrupt asset
markets and pushes up interest rates, the United States
may need to reactivate fully the half-dormant
strong-dollar policy. Recent concerns for the budget and
trade deficits appear to be undermining already shaky
market sentiment further and risk sparking a spiral of
dollar selling. The twin deficits imply that the US
needs strong inflows into the dollar daily to maintain
its value, and if foreign investors become fearful that
the currency could fall sharply, those inflows could
drop off. There are signs that this fall-off is
happening in the US equity market. Recent trading data
showed a net outflow from US stocks - the sixth in seven
weeks. The dollar is in a fix in which a falling dollar
makes the dollar fall more.
The US dollar has
fallen by more than 10 percent this year against the
euro and nearly 15 percent against the Canadian dollar.
These are hefty falls in currency-market terms, where
the sheer levels of liquidity available in the leading
currencies often limit the size and pace of moves. The
speed of the dollar's recent slide has largely caught
currency strategists by surprise. Many had previously
thought that the main phase of dollar weakness would
come to a halt around the middle of 2003, but now expect
that weakness to persist for at least through the end of
the year, citing deflation fears and the twin deficits.
Dollar-based investors take comfort from the fact that
few strategists are yet predicting the sort of
disorderly market that would precipitate a dollar crash,
and that domestic deflation increases the purchasing
power of the dollar.
The Bank of Japan (BOJ) is
thought to have intervened covertly in the foreign
exchange market in July, selling massive amounts of yen
for dollars in a bid to stem the yen's rise and support
its struggling exporters. There is speculation that BOJ
spent at least 1 trillion yen ($8.5 billion) on one
Monday alone as the dollar fell to two-year lows against
the yen. It bought $34 billion in May to stop the yen
from appreciating against the dollar.
Yet even
if market participants are scared off by BOJ
intervention, market sentiment toward the dollar remains
overwhelmingly bearish. Speculators can still find other
currencies, such as the euro, where there is less
official resistance, to short against the greenback. The
European Central Bank (ECB) is institutionally
structured to prevent the euro from falling, but it
possesses little authority or tools to prevent the euro
from rising. It was a worry that seemed unnecessary at
the time of the ECB's formation. When the euro was
launched in 1999, most observers hoped the euro would
strengthen against the dollar.
According to
conventional wisdom, a weaker dollar is supposed to
provide just the relief that corporate America needs as
companies confront the threat of deflation and continued
weakness in the domestic economy. But US companies are
unlikely to change their investment and sourcing plans
unless they can be sure that the dollar will not spring
back soon. Most US transnationals, such as General
Electric and Citigroup, routinely hedge against currency
risks, or their revenue is so well spread across the
globe that the overall exchange-rate impact is almost
neutral. In fact, currency hedges have become one of
their major sources of corporate profit. If the dollar
stays low for long periods, companies may decide to
source more expensive raw materials from new, cheaper
plants - possibly even in the United States, but this is
unlikely to make high US wages competitive with wages in
Asia or Latin America. Even an illegal immigrant worker
in the lowest-paying job in the US commands a higher
wage than does a floor manager in a Third World
sweatshop. Certainly, no re-sourcing decisions will be
made by short-term currency fluctuations.
The
2003 first-quarter earnings from the immediate impact of
a weaker dollar on the translation of international
sales into US currency benefited many US companies.
United Technologies (UT), the US industrial group that
owns Otis, the elevator company, and Pratt &
Whitney, the aircraft-engine maker, recorded $1 in
earnings per share for the first quarter, of which 5
cents was from favorable foreign-currency translation.
UT receives 60 percent of its revenue from outside the
United States and 20 percent alone from Asia, where
growth is expected to remain strong. The currency effect
helped offset weakness in some other major markets such
as the EU, Latin America and the US.
The
stronger pound sterling, euro and Canadian dollar
contributed $219 million to the $10.3 billion of
revenues that Wal-Mart, the retailer, recorded in its
international operations in the first quarter. But most
big US companies' trading relationships are founded on
multilateral rather than bilateral exchange rates.
Walt-Mart's positive currency effect was offset by the
weaker Mexican peso. The change in the euro-dollar
exchange rate has also allowed some companies - such as
Dell, the computer maker - to raise market share outside
the United States by cutting prices.
Experience
has shown that it will take a lag of at least four or
sometimes eight quarters for the realignment of the
dollar to feed through into US exports. Trade economists
have claimed that each percentage-point drop in the
trade-weighted dollar index (TWDI), if sustained over at
least eight quarters, is worth a $10 billion annual
increase in exports, measured in constant dollars.
Imports are quicker to respond, with a fall normally
detected within one quarter of a change in the value of
the currency. The US trade deficit in May 2003 was
$41.84 billion. The TWDI in April 2003 was 109 and was
88.5 on June 13, still above the 1990s average of 87.8.
The TWDI was 178.9 in August 1998 at the height of the
Asian financial crisis.
Speculators appear to be
gearing up to bid the euro even higher, creating fresh
challenges for global companies as they navigate
volatile currency markets amid difficult economic
conditions. After rising more than 10 percent against
the dollar so far in 2003, the euro in mid-July matched
its 1999 launch level, above $1.1742. Against sterling,
the euro has gained 9 percent, peaking in July above its
launch level Stg0.706. More than half of the fund
managers recently surveyed believed for the first time
that the euro to be overvalued rather than undervalued.
Yet more than half said the euro was their favorite
currency, with long-euro, short-dollar trades the most
popular. This indicates that herd instinct is alive and
well.
G7 finance ministers, in concert with US
Treasury Secretary John Snow, raised doubt about
Washington's strong-dollar policy. As usual, the sole
dissent came from Japan. Eurozone finance ministers
reiterated support for a "strong and stable" euro. They
echoed Wim Duisenberg, outgoing president of the
European Central Bank, who recently said the euro was
trading at fair value.
Recent surveys showed
that average forecast projects the euro to trade up
toward $1.20 from the $1.13-$1.14 level by year-end.
Policymakers' comments could extend those forecasts
further still to $1.25 or even beyond $1.30.
The
dollar's gains in the late 1990s were based partly on
dollar-buying by eurozone groups, such as Vivendi and
Daimler, which bought US companies. These companies and
their eurozone investors are now nursing heavy losses
after three years of falling equity prices in the United
States and worldwide. The result is a drying up of
capital flows to the US from the eurozone. In deficit
until 2002, the eurozone current account now runs a
surplus that gives confidence to investors assessing the
currency risk of eurozone assets.
The US twin
deficits by contrast are seen as a risk for the dollar's
value, leading greater numbers of investors to hedge
against the risk by buying forward contracts - sending
the dollar lower still. The eurozone's economy is likely
to fall into deflation if the euro returns to its
equivalent peak levels of the mid-1990s and stays there
for long periods. Simulations models suggest that if the
euro rises by about another 20 percent, there is a
roughly two in three chance that deflation will hit the
eurozone.
The dollar has fallen 30 percent
against the euro since its peak in 2000. In 1985-87, it
fell by 54 percent against the deutschmark. The dollar
rose by a trade-weighted average of 35-50 percent
(depending on which index is used) from early 1995 until
February 2002. Since trade economists claim that every 1
percent increase in the dollar produces an increase of
$10 billion in the annual US current account deficit
after a phase-in period of two to three years, this
appreciation accounts for the bulk of the total deficit
that now approaches $600 billion (about 6 percent of
GDP) per year. These deficits have risen by almost one
full percentage point of GDP in each of four of the last
five years. The exception occurred during the recession
year of 2001.
As a result of the current account
deficits of the past 20 years, the negative net
international investment position (NIIP) of the United
States now exceeds $3 trillion (30 percent of its GDP)
and is climbing by about 20 percent per year. This has
been sustained by dollar hegemony in which the role of
the dollar as the reserve currency for trade keeps the
trade surplus in dollars earned by countries exporting
to the US as captured investment or loans in the dollar
economy. It is a phenomenon in which the US produces
dollars and the rest of the world produces things
dollars can buy, making the US trade deficit tolerable
and its impact on the exchange value of the dollar
negligible.
The dollar has been declining in a
gradual and orderly manner since early 2002 by 10-20
percent as measured by various indices. So far it has
reversed one-third to one-half of the run-up of the
previous six-and-one-half years, since 1996. The sharp
rise of the dollar that began in 1996 in an unregulated
global financial market detonated the Asian financial
crisis of 1997. If the dollar stays down, which is
likely as long as the Fed maintains its near-zero
interest-rate policy, the US annual current account
deficit may decline by $100 billion to $200 billion over
the coming two to three years from where it would
otherwise have been. The impact on imports on the fall
of the dollar up to this point would translate into a
drop of more than half from its $600 billion peak. This
means the economies exporting to the United States will
not be in any position to absorb more US exports, even
if prices are lowered by the lower dollar exchange
rates, unless they incur massive trade deficits. But
because of dollar hegemony, no country can sustained a
dollar trade deficit without the penalty of a collapse
of its currency, except the United States.
Adverse effects of the dollar's decline on the
US economy are just beginning to show up in the bond
market and in the US capital account. The Bush
administration has accepted the correction, frequently
reiterating that the exchange rate should be left to
market forces and discouraging any thought that it might
intervene directly to interrupt the decline. But the
market knows that the Fed, unlike other central banks,
can intervene in the foreign-currency market indirectly
because of dollar hegemony. The Fed has unlimited dollar
resources, through what Bernanke called "the printing
press", to keep dollar interest rates low and the dollar
exchange rate high. Other central banks cannot print
dollars.
Some economists suggest that the United
States can sustain a current account deficit at about
half the current level, or $250 billion to $300 billion
per year (2.5-3 percent of present GDP). At this level,
the ratio of the US NIIP to GDP could level off at 30-35
percent, below the conventional "danger zone" of 40
percent. Given that every 1 percent decline in the
dollar will produce a reduction of $10 billion in the
external imbalance, the US trade-weighted exchange rate
needed to fall by 25-30 percent from its recent peak.
Hence the depreciation of the dollar to date has
probably gone only about half the needed distance to
date. But the conventional 40 percent danger zone may
not apply to the United States because of dollar
hegemony.
The dollar decline to date, however,
has been selective among the major trading partners of
the United States. The dollar has fallen by about 30
percent against the euro but only about 15 percent
against the yen. The dollar rose against the Chinese
yuan in 1994 to 8.278 to a dollar when it had been
pegged in a very narrow range around 5.8 per dollar. But
since the yuan is not freely convertible, its effect on
the foreign-exchange market is immaterial. To sell
dollars, the Chinese central bank would have to accept
other foreign currencies rather than yuan.
The
concentration on euro appreciation against the dollar is
paradoxical, since Japan is by far the world's largest
surplus and creditor country, while China is the
second-largest holder of foreign-exchange reserves. As
for Chinese exports, many economists have pointed out
that China's share of world trade is still small for the
size of its population. A World Bank report estimates
that China's share of world trade will be 9.8 percent by
the year 2020, with 20 percent of the world's
population. The Plaza Accord in 1985 forced the Japanese
to push the yen up to reduce its trade surplus, but it
did not help the US economy, nor did it help the
Japanese economy. Chinese exports rose by one-third in
the six months to June, to $190 billion, while imports
jumped 46 percent to $186 billion. On a global basis,
Chinese foreign trade has been balanced. The Chinese
economy has been holding up the anemic global economy.
The International Monetary Fund has thrown its
weight behind the Chinese exchange-rate policy and
rejected mounting global pressure for China to revalue
its currency. IMF chief economist Kenneth Rogoff,
speaking at a Washington conference on the US dollar and
the world economy recently, said currency appreciation
was risky for some countries. The IMF's support of China
is at odds with US Treasury Secretary Snow and Fed
chairman Greenspan, both having suggested that China
should liberalize its exchange-rate system so that its
currency can gain in value. The EU and Japan have also
made calls on China to abandon the peg for the yuan.
Hugo Restall, editorial-page editor of The Asian
Wall Street Journal, wrote on July 31: "Asians seem to
have realized that not only is the China threat
overrated, but the country is an engine of growth that
benefits them.
"In fact, US and Chinese economic
interests are quite closely aligned, because the two
economies are so complementary. You might even say that
China is an economic colony of the US, with its currency
so tightly pegged to the dollar and American companies
using it as a base for their low-cost manufacturing.
"That might seem like a strange idea given how
nationalistic the Beijing regime is. But consider the
government's actual behavior, and it's not hard to
imagine that if Paul Bremer were running China instead
of Hu Jintao, he'd be accused of exploiting the
country's economy to benefit the US and other Western
countries.
"First of all, the most productive
sector of the economy is largely run by foreigners, for
the benefit of foreigners. China may boast of being the
largest recipient of foreign direct investment in the
world, but it got that way in part by offering
preferential tax treatment and other incentives to
multinational companies. Those ventures in turn export
not only their products, but also their profits, often
hidden by manipulating the prices used for transactions
within the companies.
"There's still time for China
to get wise. But the point here is that Americans should
be sanguine about China's development model. Thanks to
Beijing's own policies, China is giving them cheap
capital, cheap manufactured goods sold below their true
cost and a market for sophisticated, high-value-added
goods. At the end of the day, China will be left with
uncompetitive companies, depleted savings and a
balance-sheet recession. It will have to sell off the
distressed assets of its failed banking system, at which
point Western companies can buy up even more of the
economy at fire-sale prices.
"One more thought
about China: Since the two economies are complementary,
it's ultimately not in the US interest for Beijing to
continue with its self-defeating policies. A sudden
collapse would hurt the US because the market for US
Treasurys might be disrupted, social unrest could damage
American-owned factories and the market for US goods
could dry up. In short, Americans should be somewhat
concerned about China, but not for the reason they
think. The good deal they're getting now can't last
forever."
Though the article's focus on
inefficient state-own enterprises is not directly on
target, truer words have seldom been said about the
stupidity of an export policy that depresses domestic
wages to earn dollar trade surpluses within the context
of dollar hegemony. Mercantilist policies are rendered
inoperative by dollar hegemony. The aim of China's
planners to build the domestic economy through export
earnings is fundamentally flawed. Trade can only
supplement domestic development, never replace it. With
a non-convertible currency, a large economy such as
China's can finance its domestic development through
state credits based of the State Theory of Money, with
no need for foreign loans or capital. The value of the
Chinese currency is a function of the strength of the
Chinese economy, from which the government has the
authority to levy taxes, and not by the foreign-currency
reserves held by its central bank. Central banks can
affect the supply of money through monetary policy, but
they cannot affect, except in very indirect ways, the
demand for money in the economy. James A Baker, treasury
secretary under Reagan, has a score to settle with
Greenspan, whom both George Bush Sr and Baker blamed for
Bush's one-term presidency. Baker's record of
outsmarting Fed chairmen was nevertheless impressive.
Baker's aim of pushing down the dollar in 1985
was to cure the anemic US economy, not to cause it.
Baker became Reagan's White House chief of staff in
1980, with Don Regan of Merrill Lynch as treasury
secretary. Paul Volcker was a holdover Fed chairman
appointed by Jimmy Carter, whose supporters justifiably
thought Volcker's monetary policies were the reasons for
Carter's one-term presidency.
Volcker on
September 29, 1979, presented the Fed's "new operating
system" to combat hyper-inflation on board the Treasury
secretary's official plane on the way to an IMF meeting
in Belgrade to secretary G William Miller and Charles
Schultz, chairman of the Council of Economic Advisers
(CEA). While agreeing that the Fed must do more to
tighten money supply and credit, both immediately
opposed the idea that would set the Fed on a course of
target money supply, a pure monetarist measure.
Miller, the businessman, objected that if the
Fed targeted reserves directly, it would result in more
volatility in interest rates that would exacerbate both
inflation and market instability. Schultz, the
economist, objected to fundamental issues of locking the
Fed on a course toward recession it could not reverse.
Volcker listened politely but held on to his belief that
the technical decision was the Fed's "independent"
prerogative. The new operating system caused the Fed to
lose control of US interest rates and cost Carter a
second term.
The economic disorder that had
helped to elect Reagan reached a new height as he took
office. Price inflation remained in double digits.
Interest rates were driven to double digits by inflation
and the Fed's tight money supply policy. Bank prime rate
hit 21 percent. Unemployment hit 7.4 percent. Both were
rising with no end in sight. Reagan declared that
government was the problem, not the solution, reversing
the failed Carter approach of relying on government
policy to halt inflation. The Reagan cure was a 30
percent, three-year tax cut and a balanced budget,
cutting $100 billion a year from government revenue over
the next five years and a $41 billion budget reduction
in the first year. Voodoo economics was in full swing.
Reagan wanted "sound money", a fixation of his
half-baked monetarist preoccupation. Optimism was relied
upon to defy economic logic. Volcker made obscure
speeches on the unavoidable clashes between monetary
restraint and economic growth, but the White House was
not listening. The United States was ignoring an
economic truth about inflation: that the economy must
always decline first, before prices will decline. Sound
money means capping the money supply, which means either
price inflation or that real output would fall.
Historical data have always sided with real output
falling first, before prices will fall. Thus sound money
is a recipe for negative growth: recession, way before
any benefit can appear. Moreover, despite slogans,
Reagan's policies of slowing the economy and tax cuts
were heading for increased deficits, the opposite
direction of sound money. Reagan rehabilitated classical
economics, which had been discredited since 1930, and
its four main strands of conservative economic thinking:
monetarism, tricking down growth, balanced government
budgets and unregulated markets.
Baker was
uneducated about monetary policy and did not claim to be
otherwise. Ironically, Reagan, who was a passive
president on most other issues, was forceful on monetary
policy on account of decades of ideological incubation.
He was a diehard anti-inflation monetarist and an apt
student of Milton Friedman as superficially presented by
the popular press. Now Baker and the two Bushes, being
all Texans, have a genetic hostility toward big money
center banks in the eastern US, and despite being
financial elites themselves, are imbedded with Texan
populism. Bush Sr even proposed, when he was still
Reagan's vice president, an excess profit tax on banks
if prime rates remained high. But Ronald the king had
spoken, and everyone worked to give the king what he
wanted. The economy plunged from the frying pan to the
fire. Penn Square Bank failed from bad loans due to
falling oil prices and a Third World debt crisis
developed due to a fall in inflation engineered by the
Fed, most dangerously in Mexico, which was about to
default on $80 billion of debt owed to US banks, placing
the US banking system under threat of collapse.
Predictably with US domestic politics, what
severe pain suffered by US citizens could not
accomplish, the threat to the banking system produced
immediate government action. A deal was made between the
Fed and the White House to cut the interest rate and to
raise taxes to cut the deficit. A Mexican bailout with
$3.5 billion from the Fed and the Treasury, plus a $1
billion advance payment oil purchase from Mexico by the
Department of Energy, another $1 billion line of credit
from Department of Agriculture for future purchase of US
grain and a Fed-orchestrated $1.85 billion from other
central banks, half from the Fed. This was the beginning
of the international debt crisis that still remains
unresolved. It set the basic formula for protecting the
banks while the price is paid by the world's poor in
hunger and deaths.
Alan Greenspan has in essence
followed this policy since he took over from Volcker.
The Fed has since shifted its role from regulator to
that of a cleanup crew, and the biggest cleanup job is
yet to come.
But Snow and Greenspan in 2003 have
less room to maneuver than Baker and Volcker did in
1985. The odds are that Snow will still push down the
dollar at least by another 10 percent and the Fed will
keep Fed Funds rate target near zero. But while these
moves may deflect some political heat, they are not
likely to save the US economy from a long period of
stagnation.
Henry C K Liu is chairman
of the New York-based Liu Investment Group.
(Copyright
2003 Asia Times Online Co, Ltd. All rights reserved.
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