Dollar Fall
Adds To Global Turbulence
By Nick Beams
World Socialist
Web
30 September 2003
The
sharp drop in the value of the dollar in money markets last week has
pointed to the underlying instability of the international financial
system and the ever-present possibility of a major crisis. The dollars
decline followed a meeting of the Group of Seven (G7) finance ministers
in Dubai which called for exchange rates to reflect economic fundamentals.
The G7 ministers
declared they would monitor exchange rates closely, cooperating
as appropriate, and emphasised that more flexibility in
exchange rates is desirable for major countries or economic areas to
promote smooth and widespread adjustments in the international financial
system, based on market mechanisms.
This was taken to
mean that the major capitalist powers and their central banks wanted
to see a fall in the value of the US currency, especially against Asian
currencies, and international markets reacted accordingly over the next
few days.
However, for all
the reassuring words about smooth adjustments and global
recovery the world economy is beset by a series of contradictions.
The basic imbalance arises from the fact that the maintenance of world
growth depends on the US going deeper into debt.
The combination
of recessionary conditions in Europethe German economy has barely
grown over the past three yearsand the deflationary environment
in Japan means that these regions provide little global stimulus. Under
these conditions, the chief source of world economic growth is the US
economy. But as long as the US grows faster than the rest of the world
it continues to incur a balance of payments deficit. At present this
stands at around $500 billion a year, requiring a capital inflow of
almost $2 billion a day from the rest of the world to finance it.
So far, this capital
has been provided with one of the major sources being Asian central
banks. Eager to maintain export markets, they have purchased dollar-denominated
assets to ensure that their own currencies do not rise against the US
currency, thereby accumulating vast currency reserves.
According to the
International Monetary Fund, so-called emerging economies
in Asia held about $1,000 billion in official foreign exchange reserves
out of a global total of $2,500 billion, with Japan holding a further
$500 billion. It is estimated that foreign central banks increased their
dollar reserves by $220 billion last year and financed nearly half the
US current account deficit.
This is an unprecedented
situation in which the worlds leading economy is being financed
by the accumulation of debt.
The orthodox
method for unravelling this situation and ensuring global rebalancing
is a reduction in the value of the US dollar, thereby cutting the balance
of payments deficit and lessening the dependence on foreign capital
inflows, coupled with increased growth in Europe and Japan in order
to ensure alternative sources of world growth US.
That appears to
have been the thinking behind the remarks on currency rates contained
in the G7 statement. However, the rapidity of the dollars fall
in the subsequent days ignited fears that too rapid a loss of value
could spark an outflow of capital from the US, leading to a jump in
interest rates and a fall in equity markets.
These fears were
expressed in a number of articles in major newspapers.
Last Wednesday,
the Washington Post noted that the Bush administration has embarked
on a high-stakes effort to reduce the value of the dollar in Asia, hoping
to stimulate exports and jump-start the US job market but ran
the risk of a sudden spike in interest rates and an eventual slide
on the stock market.
According to critics
of the policy, the Post article continued, the risk ... is that
currency traders will dump dollars on the market, pushing it to dangerously
low levels and eventually lowering the international value of other
American investments, such as stocks and corporate bonds. If international
investors lose money on dollar-denominated securities because of the
currency exchange rates, they might reduce their purchases of US securities.
That means that United States would have to offer higher interest rates
on its bonds to attract international buyers...
An editorial in
the Financial Times pointed to potential conflicts in the implementation
of a lower dollar policy. It noted that while the G7 statement called
for greater flexibilityinterpreted by US officials
as meaning a higher value for the Japanese yen and the Chinese yuanJapan
appeared to be continuing with its policy of depressing the value of
the yen while Chinese authorities had given no sign of introducing flexibility
into the yuan-dollar rate which has been pegged at 8.3 since 1994.
Unsurprisingly,
the editorial noted, markets have interpreted this disarray as
troubling, perhaps presaging rounds of acrimonious competitive devaluations.
There will be no winners in this game; but the biggest loser would almost
certainly be the US economy. The dollars decline would accelerate,
forcing foreign investors to dump their US assets, raising interest
rates and probably strangling the nascent recovery.
An article by economist
and money market analyst Avinash Persaud, published in the September
24 edition of the Financial Times noted that the US current account
deficit of 5.2 percent of gross domestic product is approaching the
same level as Mexico and Asian countries before their financial crisis.
While the US has
been running a payments deficit for some time, Persaud pointed to a
basic difference between the situation at the end of the 1990s and today.
In the late
1990s, US overspending had a lot to do with investment in the technology
sector and was partly financed through the sale of equities to foreigners.
Today there is even greater overspending in the face of low corporate
investment and a fast-growing public sector deficit. This over-consumption
is being financed through debt. While equity-financed investment may
be sustainable, debt-financed consumption is not.
Furthermore, the
previous virtuous finance circle of the 1990swhich fuelled the
claims of a new economycould be transformed into a
vicious one.
When interest rates
were still relatively high, but coming down, capital was attracted to
the US by the prospect of still relatively high yields and the potential
for capital gains on bonds. Interest rates and bond prices bear an inverse
relationship, meaning that as interest rates fall bond prices rise giving
rise to the possibility of a capital gain. At the same time, the strong
US dollar created the conditions for foreign investors to secure a capital
gain.
Now financial conditions
have been reversed, increasing the risk that foreign capital may rapidly
shift out of the US. Interest rates are low, with the prospect of rising,
meaning that the yield on bonds is low while at the same time investors
run the risk of suffering a capital loss, either as a result of increased
interest rates or because of a fall in the value of the dollar.
It is a measure
of the depth of the contradictions within the world capitalist economy
that the devaluation of the US dollar, regarded as necessary to effect
a global rebalancing, could in turn set in motion processes
leading to a major financial crisis and a US and global recession.