The
value of the dollar is falling. Does that mean that
our economic sky is falling as well? Not to sound
like Chicken Little, but the answer may well be yes.
If an economic collapse is not in our future, then
at least economic storm clouds are gathering on the
horizon.
It's what lies behind the slide of the dollar that
has even many mainstream economists spooked: an unprecedented
current account deficit-the difference between the
country's income and its consumption and investment
spending. The current account deficit, which primarily
reflects the huge gap between the amount the United
States imports and the amount it exports, is the best
indicator of where the country stands in its financial
relationship with the rest of the world.
At an estimated $670 billion, or 5.7% of gross domestic
product (GDP), the 2004 current account deficit is
the largest ever. An already huge trade deficit (the
amount exports fall short of imports) made worse by
high oil prices, along with rock bottom private savings
and a gaping federal budget deficit, have helped push
the U.S. current account deficit into uncharted territory.
The last time it was above 4% of GDP was in 1816,
and no other country has ever run a current account
deficit that equals nearly 1% of the world's GDP.
If current trends continue, the gap could reach 7.8%
of U.S. GDP by 2008, according to Nouriel Roubini
of New York University and Brad Setser of University
College, Oxford, two well-known finance economists.
Most of the current account deficit stems from the
U.S. trade deficit (about $610 billion). The rest
reflects the remittances immigrants send home to their
families plus U.S. foreign aid (together another $80
billion) less net investment income (a positive $20
billion because the United States still earns more
from investments abroad than it pays out in interest
on its borrowing from abroad).
The current account deficit represents the amount
of money the United States must attract from abroad
each year. Money comes from overseas in two ways:
foreign investors can buy stock in U.S. corporations,
or they can lend money to corporations or to the government
by buying bonds. Currently, almost all of the money
must come from loans because European and Japanese
investors are no longer buying U.S. stocks. U.S. equity
returns have been trivial since 2000 in dollar terms
and actually negative in euro terms since the dollar
has lost ground against the euro.
In essence, the U.S. economy racks up record current
account deficits by spending more than its national
income to feed its appetite for imports that are now
half again exports. That increases the supply of dollars
in foreign hands.
At the same time, the demand for dollars has diminished.
Foreign investors are less interested in purchasing
dollar-dominated assets as they hold more of them
(and as the self-fulfilling expectation that the value
of the dollar is likely to fall sets in). In October
2004 (the most recent data available), net foreign
purchases of U.S. securities-stocks and bonds-dipped
to their lowest level in a year and below what was
necessary to offset the current account deficit. In
addition, global investors' stock and bond portfolios
are now overloaded with dollar-denominated assets,
up to 50% from 30% in the early '90s.
Under the weight of the massive current account deficit,
the dollar has already begun to give way. Since January
2002, the value of the dollar has fallen more than
20%, with much of that dropoff happening since August
2004. The greenback now stands at multiyear lows against
the euro, the yen, and an index of major currencies.
Should foreign investors stop buying U.S. securities,
then the dollar will crash, stock values plummet,
and an economic downturn surely follow. But even if
foreigners continue to purchase U.S. bonds-and they
already hold 47% of U.S Treasury bonds-a current account
deficit of this magnitude will be a costly drag on
the economy. The Fed will have to boost interest rates,
which determine the rate of return on U.S. bonds,
to compensate for their lost value as the dollar slips
in value and to keep foreigners coming back for more.
In addition, a falling dollar makes imports cost more,
pushing up U.S inflation rates. The Fed will either
tolerate the uptick in inflation or attempt to counteract
it by raising interest rates yet higher. Even in this
more orderly scenario of decline, the current expansion
will slow or perhaps come to a halt.
Imperial Finance
You can still find those who claim none of this is
a problem. Recently, for example, the editors of the
Wall Street Journal offered worried readers the following
relaxation technique-a version of what former Treasury
Secretary Larry Summers says is the sharpest argument
you typically hear from a finance minister whose country
is saddled with a large current account deficit.
First, recall that a large trade deficit requires
a large surplus of capital flowing into your country
to cover it. Then ask yourself, would you rather live
in a country that continues to attract investment,
or one that capital is trying to get out of? Finally,
remind yourself that the monetary authorities control
the value of currencies and are fully capable of halting
the decline.
Feel better? You shouldn't. Arguments like these are
unconvincing, a bravado borne not of postmodern cool
so much as the old-fashioned, unilateral financial
imperialism that underlies the muscular U.S. foreign
policy we see today.
True, so far foreigners have been happy to purchase
the gobs of debt issued by the U.S. Treasury and corporate
America to cover the current account deficit. And
that has kept U.S. interest rates low. If not for
the flood of foreign money, Morgan Stanley economist
Stephen Roach figures, U.S. long-term interest rates
would be between one and 1.5 percentage points higher
today.
The ability to borrow without pushing up interest
rates has paid off handsomely for the Bush administration.
Now when the government spends more than it takes
in to prosecute the war in Iraq and bestow tax cuts
on the rich, savers from foreign shores finance those
deficits at reduced rates. And cash-strapped U.S.
consumers are more ready to swallow an upside-down
economic recovery that has pushed up profit but neither
created jobs nor lifted wages when they can borrow
at low interest rates.
How can the United States get away with running up
debt at low rates? Are other countries' central banks
and private savers really the co-dependent "global
enablers" Roach and others call them, who happily
hold loads of low-yielding U.S. assets? The truth
is, the United States has taken advantage of the status
of the dollar as the currency of the global economy
to make others adjust to its spending patterns. Foreign
central banks hold their reserves in dollars, and
countries are billed in dollars for their oil imports,
which requires them to buy dollars. That sustains
the demand for the dollar and protects its value even
as the current account imbalance widens.
The U.S. strong dollar policy in the face of its yawning
current account deficit imposes a "shadow tax"
on the rest of the world, at least in part to pay
for its cost of empire. "But payment," as
Robert Skidelsky, the British biographer of Keynes,
reminds us, "is voluntary and depends at minimum
on acquiescence in U.S. foreign policy." The
geopolitical reason for the rest of the capitalist
world to accept the "seignorage of the dollar"-in
other words, the advantage the United States enjoys
by virtue of minting the reserve currency of the international
economy-became less compelling when the United States
substituted a "punywar on terrorism" for
the Cold War, Skidelsky adds.
The tax does not fall only on other industrialized
countries. The U.S. economy has not just become a
giant vacuum cleaner that sucks up "all the world's
spare investible cash," in the words of University
of California, Berkeley economist Brad DeLong, but
about one-third of that money comes from the developing
world. To put this contribution in perspective: DeLong
calculates that $90 billion a year, or one-third of
the average U.S. current account deficit over the
last two decades, is equal to the income of the poorest
500 million people in India.
The rest of the world ought not to complain about
these global imbalances, insist the strong dollar
types. That the United States racks up debt while
other countries rack up savings is not profligacy
but a virtue. The United States, they argue, is the
global economy's "consumer of last resort."
Others, especially in Europe, according to U.S. policymakers,
are guilty of "insufficient consumption":
they hold back their economies and dampen the demand
for U.S. exports, exacerbating the U.S. current account
deficit. Last year U.S. consumers increased their
spending three times as quickly as European consumers
(excluding Britain), and the U.S. economy grew about
two and half times as quickly.
Global Uprising
Not surprisingly, old Europe and newly industrializing
Asia don't see it that way. They have grown weary
from all their heavy lifting of U.S. securities. And
while they have yet to throw them overboard, a revolt
is brewing.
Those cranky French are especially indignant about
the unfairness of it all. The editors of Le Monde,
the French daily, complain that "The United States
considers itself innocent: it refuses to admit that
it lives beyond its means through weak savings and
excessive consumption." On top of that, the drop
of the dollar has led to a brutal rise in the value
of the euro that is wiping out the demand for euro-zone
exports and slowing their already sluggish economic
recoveries.
Even in Blair's Britain the Economist, the newsweekly,
ran an unusually tough-minded editorial warning: "The
dollar's role as the leading international currency
can no longer be taken for granted. Š Imagine if you
could write checks that were accepted as payment but
never cashed. That is what [the privileged position
of the dollar] amounts to. If you had been granted
that ability, you might take care to hang to it. America
is taking no such care. And may come to regret it."
But the real threat comes from Asia, especially Japan
and China, the two largest holders of U.S. Treasury
bonds. Asian central banks already hold most of their
reserves in dollar-denominated assets, an enormous
financial risk given that the value of the dollar
will likely continue to fall at current low interest
rates.
In late November, just the rumor that China's Central
Bank threatened to reduce its purchases of U.S. Treasury
bonds was enough to send the dollar tumbling.
No less than Alan Greenspan, chair of the Fed, seems
to have come down with a case of dollar anxiety. In
his November remarks to the European Banking Community,
Green span warned of a "diminished appetite for
adding to dollar balances" even if the current
account deficit stops increasing. Greenspan believes
that foreign investors are likely to realize they
have put too many of their eggs in the dollar basket
and will either unload their dollar-denominated investments
or demand higher interest rates. After Greenspan spoke,
the dollar fell to its lowest level against the Japanese
yen in more than four years.
A Rough Ride From Here
The question that divides economists at this point
is not whether the dollar will decline more, but whether
the descent will be slow and orderly or quick and
panicky. Either way, there is real reason to believe
it will be a rough ride.
First, a controlled devaluation of the dollar won't
be easy to accomplish. Several major Asian currencies
are formally or informally pegged to the dollar, including
the Chinese yuan. The United States faces a $160 billion
trade deficit with China alone. U.S. financial authorities
have exerted tremendous pressure on the Chinese to
raise the value of their currency, in the hope of
slowing the tide of Chinese imports into the United
States and making U.S. exports more competitive. But
the Chinese have yet to budge.
Beyond that, a fall in the dollar sufficient to close
the current account deficit will slaughter large amounts
of capital. The Economist warns that "[i]f the
dollar falls by another 30%, as some predict, it would
amount to the biggest default in history: not a conventional
default on debt service, but default by stealth, wiping
trillions off the value of foreigners' dollar assets."
Even a gradual decline in the value of dollar will
bring tough economic consequences. Inflation will
pick up, as imports cost more in this bid to make
U.S. exports cheaper. The Fed will surely raise interest
rates to counteract that inflationary pressure, slowing
consumer borrowing and investment. Also, closing the
current account deficit would require smaller government
deficits. (Although not politically likely, repealing
Bush's pro-rich tax cuts would help.)
What will happen is anyone's guess given the unprecedented
size of the U.S. current account deficit. But there
is a real possibility that the dollar's slide will
be anything but slow or orderly. Should Asian central
banks stop intervening on the scale needed to finance
the U.S. deficit, then a crisis surely would follow.
The dollar would drop through the floor; U.S. interest
rates would skyrocket (on everything from Treasury
bonds to mortgages to credit cards); the stock market
and home values would collapse; consumer and investment
spending would plunge; and a sharp recession would
take hold here and abroad.
The Bush administration seems determined to make things
worse. Should the Bush crew push through their plan
to privatize Social Security and pay the trillion-dollar
transition cost with massive borrowing, the consequences
could be disastrous. The example of Argentina is instructive.
Privatizing the country's retirement program, as economist
Paul Krugman has pointed out, was a major source of
the debt that brought on Argentina's crisis in 2001.
Dismantling the U.S. welfare state's most successful
program just might push the dollar-based financial
system over the edge.
The U.S. economy is in a precarious situation held
together so far by imperial privilege. Its prospects
appear to fall into one of three categories: a dollar
crisis; a long, slow, excruciating decline in value
of the dollar; or a dollar propped up through repeated
interest rates hikes. That's real reason to worry.
If the United States Was an Emerging Market
If the United States was a small or less-developed
country, financial alarm bells would already be ringing.
The U.S. current account deficit is well above the
5%-of-GDP standard the IMF and others use to pronounce
economies in the developing world vulnerable to financial
crisis.
Just how crisis-prone depends on how the current account
deficit affects the economy's spending. If the foreign
funds flowing into the country are being invested
in export-producing sectors of the economy, or the
tradable goods sectors, such as manufacturing and
some services, they are likely over time to generate
revenues necessary to pay back the rest of the world.
In that case, the shortfall is less of a problem.
If those monies go to consumption or speculative investment
in non-tradable (i.e., non-export producing) sectors
such as a real estate, then they surely will be a
problem.
By that standard, the U.S. current account deficit
is highly problematic. Economists assess the impact
of a current account deficit by comparing it to the
difference between net national investment and net
national savings. (Net here means less the money set
aside to cover depreciation.) In the U.S. case, that
difference has widened because saving has plummeted,
not because investment has picked up. Last year, the
United States registered its lowest net national savings
rate ever, 1.5%, due to the return of large federal
budget deficits and anemic personal savings. In addition,
U.S. investment has shifted substantially away from
tradable goods as manufacturing has come under heavy
foreign competition toward the non-traded goods sector,
such as residential real estate whose prices have
soared in and around most major American cities.
Capital inflows that cover a decline in savings instead
of a surge in investment are not a sign of economic
health nor cause to stop worrying about the current
account deficit.
* John Miller
teaches economics at Wheaton College and is a member
of the Dollars & Sense collective.
March 30, 2005.
RESOURCES
"Dollar Anxiety," editorial, Wall Street
Journal, 11/11/04; D. Wessel, "Behind Big Drop
in Currency: U.S. Soaks Up Asia's Output," WSJ,
12/2/04; J. B. DeLong, "Should We Still Support
Untrammeled International Capital Mobility? Or are
Capital Controls Less Evil than We Once Believed,"
Economists' Voice, 2004; R. Skidelsky, "U.S.
Current Account Deficit and Future of the World Monetary
System" and N. Roubini and B. Setser "The
U.S. as A Net Debtor: The Sustainability of the U.S.
External Imbalances," 11/04, Nouriel Roubini's
Global Macroeconomic and Financial Policy site <www.stern.nyu.edu/globalmacro>;
Rich Miller, "Why the Dollar is Giving Way,"
Business Week, 12/6/04; Robert Barro, "Mysteries
of the Gaping Current-Account Gap," Business
Week, 12/13/04; D. Streitford and J. Fleishman, "Greenspan
Issues Warning on Dollar," L.A. Times, 11/20/04;
S. Roach, "Global: What Happens If the Dollar
Does Not Fall?" Global Economic Forum, Morgan
Stanley, 11/22/04; L. Summers, "The U.S. Current
Account Deficit and the Global Economy," The
2004 Per Jacobsson Lecture, 10/3/04; "The Dollar,"
editorial, The Economist, 12/3/04; "Mr. Gaymard
and the Dollar," editorial, Le Monde, 11/30/04.
Issue #257, January/February
2005.
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