WEAK DOLLAR AND STRONG BUSH
China and US Debts
By Ibrahim Warde
[This article published in Le Monde diplomatique, March 11, 2005 is translated from the German on the World Wide Web, http://www.taz.de/pt/2005/03/11.nf/mundeText.artikel
,a0002.idx,0. Ibrahim Warde is an assistant professor at the Fletcher School of Law and Diplomacy (Medford, Massachusetts) and author of “The Financial War on Terror” (2005).]
The rest of the world finances the economic and financial policy of the Bush administration. Central banks and private investors buy dollar bonds and fill the holes in the US budget and in the balance of trade. Europe and Japan assumed this role for a long time. Recently Washington has become dependent on the Chinese. The US faces a dilemma in relation to Peking. The Yuan would be 40 percent more expensive with abandonment of the dollar bond. A “market-just” Yuan price would raise the price of imports from China and relieve the US trade balance. However Peking insists on a cheap Yuan to counter the risk of recession and devaluation of its own dollar assets. The Bush administration refuses to repair its budget.
“The dollar is our money and your problem,” John Connelly, Nixon’s Treasury secretary said in 1971. This remark was also true for the dollar policy of the first Bush administration. Up to today the leaders in Washington are occupied with combating terrorism and the Iraq war and have hardly any interest in international economic problems. According to Washington’s own declaration, a strong dollar and a falling interest rate are crucial. The rapidly mounting “twin deficit” in the national budget and the balance of trade is only partly veiled.
Concerning the national budget, Bush and his administration inherited a surplus of $240 billion from its predecessors. Then the 2001 recession came with lower tax revenues. The tax cuts resolved by the republican-dominated Congress followed. They seemed harmless in view of the supposed structural surpluses. Lastly, expenditures for defense and internal security rose as a result of the attacks of September 11.
The considerable surpluses were transformed into even more considerable deficits. Despite an attractive economy, the deficits in the fiscal year 2004 amounted to $412 billion or 3.6 percent of the gross domestic product (GDP). In the same year the balance of payments deficit after constantly rising for three years reached the historic low of $618 billion (5.3 percent of GDP). This deficit grew a quarter compared to 2003.
The “twin deficit” has recently become one of the most important themes at international meetings and at the summit meeting of the G7 (the industrial countries of the “group of seven” are the US, Japan, Germany, France, Great Britain, Canada and Italy). The proposed solutions offered by the others demand painful measures from the US like higher taxes, lower military spending and savings incentives for private households. However this runs counter to the political priorities of the Bush administration. Others, everyone else, have to bear the costs of the deficit.
Shifting the cost of the balance of trade deficit happens simply. The United States imports 50 percent more than it exports. The international investors who finance the lifestyle of the leading worldwide economic power pay the bill by purchasing US bonds. This mechanism functions at the expense of the growth, employment and savings of other national economies. An anemic dollar strengthens the competitiveness of US products, makes the purchase of American property (assets) more attractive for foreign investors and devalues the foreign debts estimated at $3 trillion. This devaluation occurs to the same extent as the value of the dollar falls.
In history, it was not often that the guardian of the most important worldwide currency was at the same time the land with the greatest indebtedness. In 1913 Great Britain at the height of its imperial power was the most important worldwide creditor. In the next 50 years, the country sought in vain to stabilize the foreign trade value of the pound sterling – even if the strong pound permanently weakened the export-oriented industrial structure.
Today we witness a new edition of what General de Gaulle once described as the “exorbitant privilege” of the United States: to print money for which other countries do not demand any equivalent because their central banks “take it in payment.” In the same way, a weak dollar today insures painlessly balancing the American budget- and foreign trade deficits. At least this is the theoretical assumption.
Political party considerations also played a role. According to polls on the eve of the November 2004 presidential elections, a majority of voters thought democratic senator John Kerry was more capable of reviving the country’s economy. A neck-and-neck race occurred. Bush needed good growth- and employment statistics. Good statistics only seemed possible with an undervalued dollar.
However the downward argument of the dollar that had already begun really picked up steam in the weeks after Bush’s reelection. In December 2004 the US currency set new devaluation records nearly every day and on Christmas eve reached the historic low of 1.35 dollars for the Euro. The greenback lost 20 percent of its value compared to the Euro from 2002 to 2004. The ritual forecasts of bankers and economists at the end of the year that are often incorrect assume that the spectacular decline of US currency will even accelerate in 2005.
The forecast is based on several considerations. Bush’s reelection suggests a continuation of foreign policy adventurism and lax budgetary policy. The US president sees himself vested with a mandate making possible bold and costly reforms notwithstanding his modest advantage of only 3 percent of the votes. Bush has already declared his readiness to use “his political capital” to push through very controversial measures, for instance a partial privatization of the pension system that may burden the national budget with several hundred billion dollars (1).
Mistrust toward the dollar can also be explained from the fact that the economic attempt to leave reduction of the foreign trade deficit to the market has failed. A weak dollar would favor US exports and raise the prices of imports. However instead of equalizing the foreign trade deficit, this policy has only worsened the deficits that testify to the structural weaknesses of the US economy. The financial operators conclude that the dollar has not fallen enough. Some even think cutting the balance of payments deficit in half requires a further devaluation of 30 percent so the dollar would only be worth 0.55 Euro.
The understandable unrest was triggered among the large dollar owners, particularly the central banks, who for a long time preferred US currency in their portfolios. The central banks financed 83 percent of the 2003 US balance of payments deficit. They did not exchange the greenbacks with which the United States paid for its imports in other currencies. Therefore the dollar reserves of Asian central banks mow amount to three trillion dollars.
Why have China, Japan and other countries of the region remained so long with a currency increasingly eroding in value? The answer is they want to prevent an upgrading of their own currencies that would have inevitably occurred if they had sold off the surplus greenbacks and demanded their own money. In other words, as export nations they had to protect above all the competitiveness of the products of their own countries.
Since they instantly invested their dollars in US bonds, they insured that the interest level stayed at a low level. When other currencies are demanded intensely, the US interest rates rise to keep the dollar competitive. Only in this way will US bonds be accepted in the world. In this strange cycle, the foreign trade deficit of the US ultimately finances its state indebtedness and the low savings inclination of US citizens.
As a reaction to the continuous fall of the price of the dollar, several central banks prefer to hold part of their reserves in other currencies, above all in the Euro. This is very reasonable. It is one thing to accept some losses to strengthen one’s own export economy. It is very different to bear the costs of a constant loss in value. On November 19, 2004, US Federal Reserve chief Alan Greenspan expressed the concern that foreign investors could lose patience and thus inevitably “appetite for dollar reserves” given the constantly accumulating new US deficits (2). Several days later Yu Yongding, member of the monetary committee of the Chinese central bank stressed that China reduced the share (not the absolute volume) of US bonds in its currency reserves to steel itself against the dollar’s weakness.”
INTEREST-RATES BEGIN TO RISE
This tendency is confirmed by a survey carried out by Central Banking Publications of the 67 central banks. More than two-thirds of the institutes reduced the dollar share in their currency reserves in the last third of 2004. This share at 70 percent was very high though 10 percent less than thirty years ago. Nick Carver, one of the authors of this study, concluded: “The enthusiasm of the central banks for the dollar is obviously cooling. American should no longer rely on their unconditional support.” (3)
Oil-producing countries that transact a good share of their foreign purchases in the Euro zone are not enthusiastic that the higher price of their raw material is largely shattered by the fall in value of the key currency. Some Arab states fear that their US assets could be frozen one day in the realm of combating terrorism.
Monetary policy is an inexact discipline that takes unexpected turns again and again. The advantages with a devaluation course will be consumed by the negative consequences. In view of its powerlessness to break the depreciation of its currency, US leaders are now discovering that the dollar weapon could turn against them.
To stabilize the value of the dollar at the present level, the US needs a daily currency inflow of $1.8 billion. If credit worthiness is scratched, the dollar is no longer only “a problem for others.” The anticipation of future losses can trigger a chain reaction. The interests have a key function. First foreign investors demand higher yields for their readiness to acquire or hold dollars and US bonds. The greater the risk of a loss in value, the higher is the expected bonus in the form of higher interests. However higher interests put pressure on readiness for investment and consumption, above all in the US where much more is bought on credit than in other parts of the world. For example, the real estate market could collapse that profited for a long time from historically unique low interests. Given the intense interconnection of the world economy and currency markets, a recession in the United States would inevitably pass through to the world economic system.
Europe and to a lesser extent Japan have to shoulder the price of the fall in the dollar almost alone. In Europe, hardly anyone was happy about the strong upgrading of the Euro, even though the first president of the European central bank, Wim Duisenberg, wrote the slogan on his banner “A strong Euro for a strong Europe” (4). The first part of his desire was fulfilled. However his successor Jean-Claude Trichet now complains that the dollar’s “abrupt” downward slide seriously damages the industrial competitiveness of the old continent. Last year the Euro zone was one of the economic regions with the lowest growth rates.
Incorrigible optimists discovered something good in the Euro upgrading: a milder rise of oil prices factored in dollars. Therefore the ex-French minister of finance Nicolas Sarkozy said in November 2004 that the overrating of the union currency was “not only a disaster.”
Since China coupled the Yuan (officially termed Renminbi, “the people’s money”) to the dollar in 1994, the country has been on a common currency course with the United States. With the decline of the dollar, China could safeguard its competitiveness toward America and strengthen itself toward the rest of the world. The asymmetry in Chinese-American economic relations is glaring. More than a third of the US balance of trade deficit ($207 billion) is in trade with China. (5) Some importers welcome the stream of cheap products from China. For example, the Wal-Mart chain of stores, the largest employer of the US, imports 70 percent of its goods from the kingdom of the middle. However more and more businesses, unions and politicians see a case of unfair competition in such cheap imports and urge Washington to let the Chinese government freely float the Yuan.
Officially the US administration emphasizes again and again that the Chinese currency is 40 percent undervalued. Therefore the Chinese central bank should stop its massive foreign exchange market interventions in favor of the Yuan. The answer from Peking is ambivalent. In government circles, there is vigorous debate. Nevertheless the signals remain contradictory. Now and then leading politicians insist China desires a flexibility of its own capital markets to loosen and perhaps even abolish the dollar bond of the Yuan. According to vice-prime minister Huang Ju, Peking’s “reform of the Yuan exchange rate regime” will be in stages. Huang did not give an exact timetable. What is central is creating “stable macro-economic conditions for the future introduction of market mechanisms and a healthy functioning system.” (6)
On the other hand, other voices from China categorically reject any change of policy. If one believes the director of the economic policy division of the emissions institute, Yi Gang, Peking will hold fast to its “monetary policy regime of uniform exchange rates and controlled floating” to “guarantee stable economic conditions and promote the growth of the Chinese economy.” At the G7 summit of the finance ministers on February 4, 2005, China’s head of the central bank Zhou Xiaochuan refused to answer the question who has kept the markets on their toes for quite a long time.
Peking obviously wants to take optimal advantage of its monetary policy sovereignty. With extraordinarily high growth rates of an average 9.5 percent from 1997 to 2004 and a gigantic domestic market of 1.3 billion consumers. China today is the Eldorado for multinational conglomerates. According to estimates, around 15 percent of world production will come from the kingdom of the middle in 2020.
China sees itself more as the locomotive of the world economy and future technological and scientific superpower. The China factor already plays a decisive role for all-important developments of today’s world economy. This is true for the shift of production sites, the rising raw material prices and the revival of the Japanese economy. That the Chinese business group Lenova is taking over the PC-division of IBM demonstrates the ambitions of a state that already includes 40 satellites in its earth orbit, plans manned space flights and prepares a moon-landing program.
The Chinese leadership knows that a change of monetary policy has considerable risks. There are enough economic risks: inflation, real estate speculation, structural weaknesses of the banking system and underdeveloped capital markets. The political situation seems even more explosive when one adds the growing income disparities and the absence of democratic conditions. (7) One can understand the caution of the Chinese elites intent on avoiding a sudden slowing down of economic growth. Such a development would have incalculable economic and political consequences for relations with the US. China pursues different goals than Washington in many sensitive areas of foreign policy from Iran and North Korea to Taiwan.
With the exception of some speculators, the whole world agrees that a concerted monetary policy is better than single-handed national efforts. Nevertheless most analysts of the international monetary situation start from a logic of confrontation. There is the emphasis on a “balance of monetary policy terror,” a Europe/ Japan alliance for joint currency market interventions, a “great alliance” between China and the United States directed at the rest of the world that functions as the US buys Chinese products and the Chinese finance the US deficit as a return favor. That one country or another could carry out its threats – like Japan selling off an important part of its US government bonds or the US taking retaliatory measures against China is a fear that appears so realistic that it erratically shakes the financial markets.
BUDGET DEFICIT AS AN ECONOMIC PROGRAM
There is a remedy for stabilizing these speculations and turbulences: a concerted intervention of the “four superpowers” (United States, European Union or Euroland, China and Japan). The model is the Plaza argument that brought about a change in international monetary relations twenty years ago. On September 22, 1985 the finance ministers and heads of the central banks of the former G5 (“group of five” from the US, Japan, Great Britain, France and Germany) met at the New York Plaza Hotel and agreed that a “controlled upgrading of non-dollar currencies was desirable.” The price of the dollar should fall… The encoded agreement was the prelude to a coordinated devaluation of the dollar under the leadership of Reagan’s Treasury secretary James Baker. (9)
An agreement of this kind is unlikely today. The unilateralism of the US and diverse “ideological” considerations against such state intervention would block any kind of concerted action from the beginning.
None of the current economic leaders can assume the role once played by James Baker. The personal magnetism or charisma that the US Treasury Department possessed twenty years ago does not exist any more. Bush’s first Treasury secretary Paul O’Neill had to resign because he opposed the president’s tax cuts. In his book about his time in Washington, he described the current president as a man who didn’t have the faintest idea about the economy and related with his cabinet like a “blind with the deaf” (10). Since the Iraq war, Bush only had in mind a crusade for freedom and was less interested in business and trade.
Since his reelection in November 2004, Bush only surrounds himself with yes-men. Whoever desires a political office under Bush must be loyal. Competence is obviously not so important. Unlike Bush’s advisors, Treasury secretary John Snow has little to report. The 79-year old head of the Federal Reserve Alan Greenspan will retire next year. The battle around his successor has already begun. Whoever wants to have a chance as a candidate must do what is nearly impossible, win the trust of the “markets” and the absolute confidence of the president who alone determines Greenspan’s successor. (11) Meanwhile the political circle that “sells” the Iraq war to the public and were concerned for Bush’s reelection try to present his budget- and financial decisions in the most favorable light.
Since the official assumption of office of the new Bush administration on January 20, 2005, the twin deficit stands in the center of a new discourse and a new strategy. The danger of an abrupt drop in prices can no longer be dismissed. The deficits should be reduced through strong economic growth, not through further devaluation. The economy should be encouraged with more tax cuts. In Bush’s words, “the best way to reduce the deficit is a long-term stimulation of the economy. That’s why we will take all necessary measures to strengthen the innovative power and competitiveness of the American economy.”
The foreign trade deficit that can also be understood as demand has been recently described as a sign for the relatively robust state of the US economy that does not need any special attention. It is now up to the others, above all the Europeans, to encourage more internal growth through tax cuts and other investment-friendly measures. According to John Snow, the balance of trade deficit reflects two developments: “Our economy grows much faster than our trading partners. The income of private households rises and employment increases. Thus we have more disposable income. Part of this flows in foreign purchases with our trading partners.” (12) Even Alan Greenspan who didn’t want to get used to the mammoth deficits has more important things to do and describes the dollar as healthy. “The increasing flexibility of the American economy with certainly make easier adjustment processes necessary for economic activity altogether.”
Nothing has changed in official discourse about the necessity of a strong currency since Bush’s first term in office. However current economic policy is actually pursuing the goal of a further downward slide of the dollar. On February 2, 2005 the monetary policy committee of the US Federal Reserve raised the prime interest rate to 2.5 percent. The higher yields of US investments support the dollar over against the Euro since the European central bank resolved to leave the prime rate at 2 percent.
In budget policy, Bush confirmed his intention of “cutting the deficit” in half. All departments are affected by the “economizing” measures except for expenditures in domestic security and defense that will be $10 billion more than in the past year. The 2006 budget draft includes drastic cuts or complete abolition for fifty national programs that appear “inefficient superfluous or not pressing” to the government. Social programs and programs benefiting children and the distressed are affected first of all. The funds spent there should be shriveled absolutely.
The budget plan of the White House rests on unrealistic assumptions and completely disregards some of the most costly expenditures. This is true for the immense costs of the military operations in Iraq and Afghanistan (13) and for the costs arising in the partial privatization of the pension system estimated at $754 billion in the next ten years.
The Bush administration and its congressional clique assume drastically higher revenues by means of the tax cuts. In 2004, fiscal revenues already sank to the lowest level since 1959. They corresponded to only 16.3 percent of the gross domestic product. Four years ago they amounted to 21 percent when the national budget was in the black. For some top politicians in Washington, tax cuts always have a priority over reducing the budget deficit. For example, US vice-president Dick Cheney who wants to push through far-reaching domestic reforms in the next years proclaims full of conviction: “As Ronald Reagan showed us, the deficits don’t have any importance at all” (14).