Yes, I know that the Titanic was not
registered as a United States ship. The title
though refers to the startling comparisons that
can be made to the ill-fated vessel after it hit
the iceberg in 1912, and the US today after it has
hit the twin icebergs of the idiotic George W Bush
presidency and the subprime mess in the economy. I
am not suggesting that the two were linked, only
that an ineffectual government frequently makes a
cyclical problem much worse by its own actions.
US Federal Reserve head Ben Bernanke has
taken on the role of the second in command whose
job it is to scream "full steam ahead", even as it
becomes wildly apparent that it is a structural
problem in the economy, not a mere cyclical
downturn. As a
number of other commentators
have written in Asia Times Online, including
Julian Delasantellis and The Mogambo Guru, the
problem with the US is that of excessive borrowing
that has fed a consumption boom. Almost
three-quarters of the US economy is consumption,
compared with the more usual 50-50 mix considered
"normal" in Economics 101 textbooks.
This
excess of consumption creates the massive
borrowing needs of the US, which are immediately
supplied by a bunch of supplicants, be they Middle
Eastern dictators or imagination-free Asian
central banks. What many of us on this website
have been writing about is that this edifice is
cracking and quite likely to fall over.
Kuwait
strikes On Thursday (May 1), the
finance minister of Kuwait, Mustafa al-Shiwali,
suggested that Gulf Cooperation Council (GCC)
countries were considering an idea to abandon
their long-standing US dollar pegs. This is a
minor news item to be tucked away in page 20 of
the financial press, which it has been – but
rather emblematic of a systemic shift.
For
years, Gulf countries have held US dollars as an
article of faith, with an almost religious fervor.
These were the same countries that considered the
same action in the 1970s, and indeed it was the
Kuwaiti finance minister of that time who famously
asked, "Why should we sell our black gold in
exchange for unguaranteed currency notes [US
dollars]"?
The aftermath of the crisis in
the 1970s was greater US meddling in the region,
propping up friendly dictators around the region
and stoking the flames of war in Iran-Iraq that
culminated in Saddam Hussein marching his forces
into Kuwait in 1990. Perhaps that was America's
idea of punishing the Kuwaitis, but we would never
know that for sure.
Despite owing a debt
of gratitude for getting their country back, it is
interesting that Kuwait today is concerned more
about domestic inflation that has run away to
absurd levels, and less about kicking the US when
it is down. Call that the new world, if you will.
The story though is complicated, because
on the same day, the Kuwait Sovereign Fund
announced it would increase its stakes in US
financial firms Citigroup and Merrill Lynch, in
effect continuing the trend for the rest of the
world propping up the US financial system's
malcontents.
The likely consequences of
Gulf countries abandoning their US dollar pegs
will be twofold. Firstly, their overall holdings
of US financial assets, such as government bonds
and shares, will have to fall dramatically.
Financial analysts around the world assume that
this will take the form of such investors in
future buying fewer US dollar assets. I however
think that it is more likely we will see actual
selling of such assets, particularly the really
dumb US Treasury bonds that offer yields roughly
in line with official inflation and less than half
of unofficial inflation figures.
The
second consequence of Gulf states abandoning their
dollar pegs is that they will increase the price
of oil commensurately to ensure that their "local"
income does not suffer. For example, if you pegged
your currency at 100 to the US dollar and so were
getting 1,200 in your currency for oil; and after
de-pegging let us say that it rises to 75 on the
dollar, you would need to bump up prices to ensure
that you still get 1,200 in your local currency
for oil. That means oil prices denominated in US
dollars would have to go up some 30% to
compensate.
The immediate impact of this
on Asia would be quite nefarious, particularly for
oil-importing countries ranging from Japan to
India. Every one of them with an ability to allow
their currencies to appreciate (and here I include
only Japan, China, South Korea and India) will do
so, in turn triggering the same first- and
second-level reaction as suggested above from Gulf
states' de-pegging, that is to sell US financial
assets and raise prices of their exports
accordingly.
It gets worse for weaker
Asian states such as the Philippines and
Indonesia, which don't really have the ability to
push up their currencies. They will struggle to
control inflation and failing that, embark on new
rounds of government borrowings. This is the
scenario I painted earlier in the year, which
highlighted increased problems for smaller
countries against the bigger ones in Asia.
The final consequence of the decline of US
power is global in nature, namely a search for an
absolute value reserve. That would be physical
commodities including oil, copper and whatever
have you. The easiest though would be gold.
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