|SocialismToday Socialist Party magazine|
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.