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The Rise and Fall of the US dollar
THE US DOLLAR appears to be on the verge of a sharp decline.
Officially, the Bush administration continues to support the strong-dollar
policy associated with the 1990s bubble economy. "I favour a strong
dollar", announced the new US Treasury secretary, John Snow: "It’s
in the national interest". (International Herald Tribune, 29 January)
In reality, however, the Treasury and the Federal Reserve
have adopted a policy of ‘benign neglect’ towards the dollar’s recent
decline. As of 12 May, the dollar was 9.1% down against the euro for the year,
and 27.5% down from its July 2001 peak. Against a ‘broad basket’ of 37
currencies (of all the US’s main trading partners), however, the dollar was
down only 3.7% on the year and only 6.4% since July 2001. Without publicly
acknowledging it, the US government appears to be encouraging a steady decline
of the dollar in the hope that this will boost US exports and reduce the
ballooning trade deficit (and the growing overseas debt resulting from the
deficit).
It is far from certain, however, that the US can engineer a
smooth, controlled decline of the dollar. A number of states which rely on
exports to the US market, notably China and Japan, are working to counteract the
dollar’s decline by buying US government bonds. (In other words, they are
investing some of their trade surpluses in dollar assets rather than converting
all their export earnings into their domestic currencies.) At the same time,
there is an increasing flow of private capital out of the US, which is
undermining the dollar’s value internationally. Much of the capital outflow
from the US has moved into the euro, now the world’s second main trading
currency. This is why the euro has risen sharply against the dollar while the
majority of broad-basket currencies have risen only marginally (6.4%) since
2001. If this US outflow gathers momentum, however, the dollar could plunge
relative to a broad range of currencies – bringing about a sharp contraction
in the US economy.
The dollar bubble
THE OVERVALUED DOLLAR was a major component of the bubble
economy of the late 1990s. The dollar was pushed up by the massive inflow of
capital into the US from the rest of the world. Foreign investors saw the US as
a ‘safe haven’ in a turbulent world, while corporations and wealthy
investors were attracted by the prospect of the high profits apparently
available in the US. Between 1995 and 2001 the real value of the dollar rose 34%
against a basket of major industrial country currencies and 41% against a
broader range of currencies that included all the US’s major trading partners.
This took place in spite of the USA’s growing trade deficit. According to
textbook bourgeois economics, a large and growing trade deficit should lead to a
weaker currency, tending to correct the deficit through cheapening exports and
making imports more expensive. Instead, the ever rising dollar exacerbated the
US trade deficit, which rose from around $200 billion in the mid-1990s to over
$500 billion in 2002. The trend growth of US imports (in constant prices)
between 1980-2002 was 7.6% a year, compared to 3.1% growth for GDP. In contrast,
the trend growth for exports between 1997-2002 was 2.2% a year.
The high dollar allowed US companies and consumers to buy
imported goods at a massive discount, a kind of subsidy for US consumers at the
expense of the rest of the world. The high consumption of imports, however, hit
US manufacturing hard. At the height of the boom, between 1998 and 2001, around
1.2 million manufacturing jobs were lost. The 1990s boom was the first US
expansion in which there was a decline of manufacturing jobs. The elimination of
relatively highly paid jobs in the manufacturing sector, replaced by relatively
lower paid service-sector jobs, contributed to the growth of inequality.
In the world economy, the US demand for imports acted as a
powerful stimulus, providing a ‘market of last resort’ for European, Asian,
and other exporters. The effects of a high dollar, however, were not all
positive. Dollar-denominated debts and raw materials (like oil) priced in
dollars became more expensive. Some of the countries which pegged their
currencies to the dollar were plunged into crisis by its soaring value (South
East Asia in 1997, Argentina more recently). Moreover, the flood of capital into
the US, which lifted the dollar, at the same time depressed capital investment
in other countries (some of the EU states, many underdeveloped countries).
Under Clinton, the ‘strong dollar’ was promoted as a
symbol of a pre-eminent US capitalism. The strong dollar was good, in
particular, for US international financial operations. The price, however, was a
growing trade and payments deficit. (The trade deficit is the balance of imports
and exports of goods and services; the payments deficit is the trade deficit
plus the balance of currency transfers, profits, dividends, etc.)
Despite the recession, the payments deficit rose to $500
billion between 2001-02 or 5% of GDP, a post-war record. As the payments deficit
has to be financed by an inflow of capital, this gave rise to an increasing US
debt to the rest of the world – over $2.5 trillion or 25% of GDP. This trend
is unsustainable.
US capitalism now needs a net capital inflow of around $1.9
billion a day to cover its deficit. Over the last year, however, the flow of
foreign direct investment (corporate investment within multinationals) and
portfolio investment (private investment in shares, bonds, etc) has declined
sharply. Foreign direct investment fell from $308 billion in 2000 to $14 billion
in 2002. Foreign private purchases of US shares, bonds, etc, fell from $978
billion to $560 billion. (Martin Wolf, The Rake’s Progress, Financial Times, 8
January 2003) Inward investment has continued to decline in the first quarter of
2003.
This trend has been counteracted, to some extent, by a
number of central banks, such as those of Japan and China, buying US government
bonds. Japan, China, Taiwan, Hong Kong and Singapore together have accumulated
official reserves worth more than $1,100 billion, mostly invested in US
government bonds. The biggest investor is Japan, which is desperate to minimise
the appreciation of the yen that would make its exports more expensive. At the
same time, a number of central governments are increasingly fearful that a sharp
fall in the value of the dollar will substantially devalue their reserves, and
both China and Russia have begun to shift some of their reserves from the dollar
to the euro.
No longer a ‘safe haven’
US CAPITALISM NO longer has the magnetic attraction for
international capital that it exercised during the late 1990s. "The US has,
since the bursting of the stock market bubble, become a relatively unattractive
destination for foreign private capital. Interest rates are low, the dollar is
weak and the US economy will advance this year at less than its underlying trend
growth rate". (John Plender, The Sinews of War, Financial Times, 21 March)
"Last month, according to a report by Morgan Stanley,
foreign investors’ demand for treasury securities suddenly slackened. And well
before the possibility of a war in Iraq began to concern investors, corporate
scandals pushed foreigners to shift their portfolios away from American
securities, said a senior executive of a major European bank. In addition to
changes in portfolios, the pace of foreigners’ direct investment in the US has
slowed". (Daniel Altman, International Herald Tribune, 4 April) There is an
increasing trend for international investors to lend US corporations the money
they need (through bonds, etc) rather than investing in assets or shares. Such
borrowing, commented John Rathbone, a European financial analyst, is evidence
that the US is "taking on the financial characteristics of a banana
republic". (International Herald Tribune, 8 March)
The US invasion of Iraq has undoubtedly exacerbated this
trend. "What the rest of the world is being asked to fund is very different
from what they were being asked to fund three years ago", said David
Bowers, chief global investment strategist of Merrill Lynch: "Three years
ago they were being asked to fund a private-sector miracle. Now they are being
asked to fund Bush’s tax cuts and the war on Iraq".
"The US is prepared to act unilaterally", said
Bowers. "The bottom line is that if you are a net debtor to the rest of the
world, ultimately you have to be multilateral". (David Altman, Paying the
Cost of Unilateralism, International Herald Tribune, 2 May)
A dream scenario for the US?
CAN THE US find a way out through devaluation of the dollar?
The dream scenario, envisaged by such economists as Fred Bergsten (a former US
Treasury assistant secretary), is for a steady, continuous descent of the dollar
which would gradually reduce the US payments deficit to around 2% to 2.5% of
GDP, considered a ‘sustainable’ level. This would require a devaluation of
at least 25%. (Let the Dollar Fall, Financial Times, 18 July 2002) Under
capitalism, however, complex economic forces rarely unfold in a coordinated,
balanced way, especially in a period of world economic stagnation.
Managing a decline of the dollar against the yen, the
Chinese renminbi, and the currencies of other states which depend decisively on
exports to the US market, will not be easy. Major exporters to the US will
strive to counter a higher dollar price of their goods for US consumers by
cutting their production costs even further and also through accepting smaller
profit margins (which they are already doing to some extent). Such a reaction
would accentuate the deflationary pressures in the world economy.
For as long as it is effective, big exporting countries to
the US will try to use part of their trade surplus to invest in dollar assets in
order to prevent a big fall in the value of the dollar against their own
currencies. However, if such a tactic becomes unsustainable, and the dollar
begins to plunge anyway, they are likely at a certain point to resort to a
policy of devaluation, most likely leading to another wave of competitive
devaluations (as in the 1997 Asian currency crisis). This could again provoke a
regional downturn in Asia or even internationally.
In theory, a weaker dollar should mean lower prices for US
exports on the world market. However, worldwide overcapacity and stagnant growth
will make it difficult for the US to massively boost its exports. Even with the
advantage of a dollar devaluation, US big business would have to drive down wage
levels and intensify the exploitation of workers even more to compete against
low-cost producers in China and elsewhere.
The recent decline of the dollar in relation to the euro is
already demonstrating the contradictory effects on the world economy of shifts
in currency alignments. Higher eurozone export prices, resulting from the
strengthening of the euro, have already hit eurozone exports, helping to depress
growth. The high euro will intensify the growing internal tensions within the
eurozone, which are aggravated by the restrictive fiscal policy (under the ‘growth
and stability’ pact) and the European Central Bank’s (ECB) reluctance to
follow the US Federal Reserve with interest rate cuts. Stagnation in Europe,
Japan, and elsewhere will restrict the market for US exports.
The US also faces the danger that a relatively gentle
decline of the dollar may, at a certain point, turn into a plunge as overseas
governments and investors rush to withdraw their capital in order to avoid a
massive devaluation of their dollar-denominated assets. The US’s massive
overseas debt, accumulated through recurrent deficits, would then become
absolutely unsustainable. The US government would be forced to take drastic
short-term measures to curb the demand for imports, which would induce a slump
in the US economy.
One possible policy to curb imports would obviously be
protectionist measures, either through tariffs or quotas. Bush has already
imposed a 30% tariff on steel imports, ruled illegal by the WTO. There is
growing pressure from US big business for protection for a wider range of
manufactured goods. Protective measures by the US would have a devastating
effect on the world economy, especially on economies that currently have big
trade surpluses with the US. Protectionism, however, would not provide a way out
for US capitalism: big business, relieved of international pressure to invest in
the most productive technology, would attempt to boost its profits through
raising domestic prices (pushing up the cost of living) while intensifying the
work-place exploitation of US workers (further restricting the consumer market).
If, as is likely, the dream scenario does not work out, and
US capitalism fails to massively reduce its payments deficit through increased
exports and reduced imports, the correction will take place through a massive
reduction in US consumption on a scale that would most likely provoke a major
downturn in the economy. US workers would suffer devastating cuts in jobs, wages
and social conditions as the capitalist class attempted to force the working
class to pay off the external debts accumulated during the 1990s bubble economy.
The complexities of the factors involved in the world
currency and financial system make it extremely difficult to predict the exact
course of events in the next period. One thing is clear, however. Every period
of major currency realignment (as when the post-war Bretton Woods system
disintegrated after 1970, or when the European Exchange Rate Mechanism collapsed
in 1992) has been accompanied by convulsions in the world economy. The
contradictions currently facing the world economy are far deeper than any time
since the Great Depression of the 1930s. The slide of the dollar, which could
become a precipitous collapse under certain conditions, will have incalculable
consequences for the world capitalist economy.
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