Note:Warren Buffett, the
so-called Sage of Omaha (and the world's
wealthiest investor), reputedly lost $310 million
in the first quarter of this year betting that the
US dollar would fall. On the other hand, he is
said to have made masses of money on the same bet
last year. When asked about the dollar, Buffett
admits he can't say whether its value will be up
or down a year from now, but is confident it will
be down over five years. As long-time Japan
watcher Clyde Prestowitz - author of Three
Billion New Capitalists: The Great Shift of Wealth
and Power to the East (Basic Books) - points
out, Buffett is not at all alone. George Soros,
Bill Gates and many others with plenty of cash to
absorb even immense
losses, are patiently
waiting for America's overheating structural
problems - especially the huge and expanding
budget and trade deficits - to melt more wax from
the still high-flying dollar's wings.
With
the world's savviest private investors and so many
structural problems betting against the dollar,
one has to wonder why it's still up there.
Ironically, the key is the public sector, that is
the public sector in other countries. As US
Treasury statistics show, it's particularly the
demand from East Asian central banks that keeps
the dollar strong and staves off the day of
reckoning on US consumption profligacy. Japan,
China and the rest buy US public sector debt in
order to keep the dollar from depreciating
relative to their own currencies and to maintain
the level of US imports that sustains their
export-driven economies. Their buying has been so
frenzied over the past few years, especially in
the wake of the 1997 Asian currency crisis, that
the World Bank estimates that 70% of global
foreign reserves are now held in US dollars.
Insisting that their perspective on
investment is in the centuries, the Bank of Japan
claims to be unruffled by the prospect of a
collapse in the value of the dollar that would
result in huge losses on the nearly $700 billion
Japan holds in Treasuries. Maybe they're just
putting on a brave face or really don't worry
because it's not their own money and they won't be
held accountable for losing it. But excessive
consumption in the US supported by East Asian
finance is perhaps the most serious structural
imbalance on our era. If this blithe Icarus does
indeed come crashing down in a hard landing, as
Prestowitz and many others warn, the shock will
almost certainly set off recessions as well as
sorely test the asset and other bubbles that
already seem ripe to implode on their own.
Such is the role of the public sector
these days: while Buffett and Soros issue sober
warnings of the disaster ahead, in all likelihood
they will ride the crest all the way to the bank,
while the rest of us will experience a rain of
"creative destruction". - Japan Focus
There is a potentially fatal flaw at the
heart of the global economy: the strong
possibility of financial meltdown following a
collapse of confidence in the greenback. The
nightmare scenario that haunts global strategist
Clyde Prestowitz is an economic September 11 - a
worldwide financial panic triggered by a sudden
massive sell-off of US dollars that would lead
inexorably to the collapse of economies around the
world.
Prestowitz is not a doomsayer,
neither is he alone in his views. As president of
the Economic Strategy Institute, a Washington
think tank, he is in regular contact with the most
influential US business leaders, several of whom -
Warren Buffet and George Soros included - have
taken steps to hedge their currency positions
against the possibility of a cataclysmic plunge in
the greenback.
"Right now," he says, "we
have a situation in which the US is running huge
trade deficits - about $766 billion in 2004 -
which are financed by borrowings from the central
banks of Asia - mainly the Chinese and the
Japanese. All the world's central banks are
chock-full of US dollars - they're holding many
more dollars than they really want. They're
holding those dollars because at the moment
there's no great alternative and also because the
global economy depends on US consumption. If they
dump the dollar and the dollar collapses, then the
whole global economy is in trouble.
"However, some countries have a bigger
stake than others in maintaining the status quo.
China and Japan have a big stake in maintaining
the flow of their exports to the US and keeping
the US economy humming. Russia, on the other hand,
does not export much to the US. India doesn't
export much to the US either. Yet Russia and India
are also big dollar-holders. They hold many more
dollars than they really want or need.
"It
doesn't take any great stretch of the imagination
to see what could happen if one of these central
bank managers decides to dump dollars. We had a
situation recently when a mid-level official at
the Central Bank of Korea used the word
'diversification'. It was a throwaway remark at
some obscure lunch, but there was instantaneous
overreaction. The US stock market fell by 100
points in 15 minutes because the implication was
that South Korea might be shifting out of US
dollars," says Prestowitz. "So picture this: you
have a quiet day in the market and maybe some
smart MBA at the Central Bank of Chile or
someplace looks at his portfolio and says, 'I got
too many dollars here. I'm gonna dump $10
billion'. So he dumps his dollars and suddenly the
market thinks, 'My god, this is it!' Of course,
the first guy out is OK, but you sure as hell
can't afford to be the last guy out. You would
then see an immediate cascade effect - a world
financial panic on a scale that would dwarf the
Great Depression of the 1930s."
Prestowitz
says the panic could be started by something as
simple as a hedge-fund miscalculation. "We had
exactly that scenario in the US recently," he
points out, "when a big hedge fund called Long
Term Capital Management went belly-up. These guys
were pros. They had two Nobel prize-winning
economists writing their trading algorithms, and
their traders were the creme de la creme among New
York bond traders. They made a big bet - a
trillion dollars leveraged 20 to 1, and they blew
it. They went belly-up. That threatened to bring
down the whole system so US Federal Reserve
chairman Alan Greenspan had to organize a bailout
through the Federal Reserve Bank of New York.
"Now consider this: there are currently
8,000 hedge funds in the US alone. Every day $6
trillion of derivative instruments trade on
international markets. If there are four people in
the world who understand those trades, I'd be
surprised. So the potential for another disaster
is not insignificant. This is why Warren Buffet,
chairman of investment giant Berkshire Hathaway,
is betting $21 billion against the dollar. This is
why currency speculator and hedge fund manager
George Soros has also made a big bet against the
dollar.
"Soros is one of the greatest
currency speculators of all time. He was the guy
who broke the British pound in the early 1990s by
betting $10 billion it would fall. He made a quick
billion when it did. In 2002, he warned that the
greenback was in danger of losing a third of its
value. Of course, it could be argued that Soros is
a professional hedge fund manager whose job is to
play the ups and downs of currencies and his
remarks could be seen more as manipulation than
prophecy. And yet, in conversations with me, Soros
has expressed concern about the market
fundamentalist view that prevails in Washington
and parts of Wall Street. This is the belief that
markets are self-correcting and best left alone.
Soros calls this a dangerous siren song. Far from
being self-correcting, he emphasises, markets tend
to excess. They over-shoot. Anyone with any
experience of markets knows this."
According to Prestowitz, "When markets are
going down, all the weaknesses get concentrated,
and you need intervention at the right time to
stop things from getting out of control. If the
dollar started to melt down, the results could be
really nasty. A 1930s-style global depression is
not out of the question."
To underscore
the point that he is not alone in this, Prestowitz
cites Paul Volcker, head of the Federal Reserve
before Greenspan, who has said publicly there is a
75% chance of a dollar crash in the next five
years. "No wonder people look at this and say,
'Holy cow!' No one knows for sure what will
happen, but clearly the global markets could
implode very quickly. The lack of an alternative
to the dollar is the only reason it hasn't taken a
big fall already."
Prestowitz, formerly a
trade adviser and negotiator for former US
president Ronald Reagan, believes the US will
continue to be the world's most powerful economy
for the foreseeable future. But he foreshadows an
inexorable decline, a trend that is likely to
continue "depending on the way we play our cards
... Right now, we're playing them just about as
badly as it's possible to play them, and that has
geopolitical implications. We've outsourced trying
to deal with North Korea to China, we really can't
deal with Iran, so we've outsourced that to the
EU, which is struggling, and Iran is cozying up to
China. Other bad actors like Zimbabwe's Robert
Mugabe and Sudan are cozying up to China.
"America's global hegemony is already
under challenge, and that challenge is going to
become more and more evident as the extent of the
relative US economic decline becomes evident.
Right now, the US dollar is probably 40%
overvalued versus the Japanese yen or the Chinese
yuan. How's the US going to look as a global power
when the dollar is at 50% of its current value?"
