Dollar Worries
By Nick Beams
30 November 2004
World Socialist Website
The
US dollar went down to a record low of $1.33 to the euro at the end
of last week amid signs that foreign central banks, which have invested
heavily in US treasuries and other forms of debt, are looking to shift
some of their resources out of US financial markets. Besides recording
an historic low against the euro, the dollar reached a four-and-a-half
year low again the yen, a nine-year low against the Swiss franc, a 12-year
low against the Canadian dollar and a 16-year low against the New Zealand
dollar. In another indication of the growing loss of confidence in the
US currency, the gold price hit a 16-year high of $455.
The latest fall
in the dollars value was touched off by a report in the Shanghai
publication China Business News that China had reduced its holding of
US treasuries. China, which has some $515 billion in foreign currency
reserves, has been one of the key purchasers of US financial assets
and any withdrawal from the market could see a rapid exit by other central
banks and foreign investors.
The slide was only
halted when Yu Yongding, a member of the monetary policy committee of
the central bank, issued a statement saying that his remarks to a seminar
had been misrepresented by the newspaper. As of the end of September,
he explained, the total of US treasuries held by Chinas monetary
authorities had increased but the proportion of US treasuries in Chinas
total foreign exchange reserves had decreased.
The most recent
figures indicate that Chinas holdings of US treasuries increased
by 11.3 percent from January to the end of September, compared to an
increase of 21.5 percent for the same period last year. This means that
while still purchasing US dollar assets, the Chinese monetary authorities
are stepping up their purchases of gold, euros, Swiss francs and other
strong currencies in order to lessen their risk exposure in the event
of a rapid dollar fall.
Nervousness over
Chinas position was not the only factor. Earlier last week, Alexei
Ulyukayev, first deputy chairman of the Russian central bank, indicated
that the bank was looking to increase the proportion of foreign currency
reserves it held in euros. Most of our reserves are in dollars,
and thats a cause for concern, Bloomberg News quoted him
as saying. Looking at the dynamics of the euro-dollar rate, we
are discussing the possibility to change the reserve structure.
The Bank of Japan
has also indicated that it is looking to shift its mixture of foreign
currency reserves and has been virtually absent from the US foreign
exchange market over the past six months, with purchases of US treasuries
falling during September.
So far this year,
despite the growth of both the fiscal and balance of payments deficits
to record levels, the US bond market has remained firm, thereby keeping
interest rates low. But all that could change if the Asian central banks,
whose purchases of US treasuries have largely sustained it, decide to
withdraw. Last year, for example, foreign central banks bought $441
billion of treasuries, equivalent to 83 percent of the US current account
deficit.
While there has
yet to be a major withdrawal from the US market, there is a limit to
the investment by foreign banks because of the ever-increasing risk
of over-exposure to a fall in the dollar. Quantifying this risk, the
New York Federal Reserve Board noted in a recent paper that a 10 percent
appreciation of the Singapore dollar against the US dollar would bring
a capital loss equivalent to more than 10 percent of the island-states
gross domestic product (GDP). A similar loss would also be experienced
by Taiwan, with China and Korea facing losses equivalent to 3 percent
of GDP.
Given the massive
losses they could incur, all the players in the US market keep a nervous
eye on each other. They all want the inflow of funds to continue in
order to maintain the value of their assets. But at the same time, they
are all looking to reduce their own dollar holdings in order to lower
their risk exposure. Consequently in these conditions, even a relatively
minor movement out of the US market by one of the major players could
provoke a rush to the exit, setting off a collapse of the
dollar and a consequent escalation of US interest rates.
As the risks of
a dollar collapse and the onset of a global financial crisis mount,
there have been calls for a new Plaza accord, along the lines the September
1985 agreement in which the major powers agreed to joint action to lower
the value of the US dollar.
Writing in the Financial
Times of November 17, New York financial consultant and author Peter
Bernstein recalled that within two years of the accord, the dollar had
dropped by 30 percent and by 1991 the US current account was roughly
in balance. But he acknowledged that the situation today was far
more complex.
In 1985, the US
current account deficit was 2 percent of GDP compared to 5 percent today,
foreign asset holdings in the US were a fraction of what they are today
and in 1986 the oil price dropped by 50 percent, in contrast to the
sharp rises of the recent period.
There are other
significant differences, which militate against any viable agreement.
In the mid-1980s, Europe and Japan were experiencing higher growth rates
than the USin effect the Plaza accord was an agreement to boost
US growth by lowering the value of its currency. Today, the situation
is the reverse, with the US is experiencing higher growth rates than
either Europe or Japan. Another major change is the rise of China which
is now a major player in global financial markets, with its holding
of more than $515 billion in foreign currency reserves. Above all, the
most significant difference is the growth of the financial superstructure
of global capital, far above what existed nearly 20 years ago.
A recent article
published by the online magazine Asia Times pointed to the deep structural
problems besetting the US economy. Drawing an analogy with the collapse
of New Yorks twin towers, the author, W Joseph Troupe, editor
of the Global Events Magazine, asked whether the apparent strength and
imposing size of the US economy deceptively mask[ed] an imminent
collapse and whether events which would bring about a collapse
of the towering US economy might have already begun.
He noted that the
US economy has been built around the strength of the US dollar and
the apparently firm and virtually unbreakable international support
it enjoys. But in the aftermath of the Bush re-election international
support for the dollar and for related US economic and foreign policies
is noticeably weakening, at a time when it is most needed to support
an unprecedented and mushrooming mountain load of debt.
The numbers involved
have been described as nothing short of frightening. US
government debt is now well over $7 trillionCongress had to lift
the ceiling earlier this monthtotal consumer debt is more than
$8 trillion, and the government deficit is running at more than $400
billion.
Towering over all
these is the figure for derivatives, the financial instruments involving
interest-rate futures, and currency swaps and options, described last
year by financier Warren Buffet as financial weapons of mass destruction.
The derivatives market now totals $180 trillion, equivalent to around
17 times US GDP. Any rapid movement in the US dollar, and consequent
shift in interest rates, could well see the collapse of this vast financial
superstructure.