Thursday, October 18, 2007

The Staggering Dollar

The U.S. dollar hit an all-time low against the euro on October 18, 2007. The secretary of the treasury, Henry Paulson, repeated the mantra of all treasury secretaries that the U.S. supports a strong dollar policy. In contrast, Harvard professors Martin Feldstein and Kenneth Rogoff, in chorus with the International Monetary Fund, assert that the dollar has more to fall, perhaps another 20-30 percent, in order to reduce the U.S. trade deficit with the rest of the world.

In September, foreign investors were net sellers (sales minus purchases) of U.S. securities, resulting in the biggest monthly outflow since 1990. This suggests that support for the dollar is continuing to wane. Numerous reasons have been cited for the falling dollar, among them the large $800 billion annual current account deficit, the rising price of oil (surpassing $89 a barrel on October 18, 2007), the ongoing (seemingly endless) cost of U.S. military operations in Iraq, the fear of an expanded conflict in Iraq due to a possible Turkish military incursion to suppress Kurdish rebels, a slowing U.S. economy, and others. At some point, further increases in the price of oil will take a real bite out of the U.S. economy, with adverse effects on the dollar, growth, and inflation.

The G-7 (the seven leading industrial democracies) meet Friday, October 19, 2007. Topics on the agenda include the rising euro (the flip side of the falling dollar), financial turmoil stemming from the sub-prime mortgage mess, and the growing investments of sovereign wealth funds (government controlled pots of money) in private companies, which implies a partial nationalization of assets by those countries, in marked contrast with private investment. The harsh truth is that there is little the leaders of the G-7 countries can do to alter these trends, until and unless the U.S. substantially reduces its dependence on, or weans itself off, foreign sources of energy.

China is Changing Everything

Business cycles come and go. What has changed in world affairs is the rise of China, the beginnings of high growth in India, economic recovery in Russia, and the transformation of former centrally-planned economies around the world into rapidly-growing market economies. China by itself is responsible for a disproportionate increase in the global demand for energy, copper, iron ore, and other natural resources. Annual economic growth of 11 percent in China means that output doubles in 6.5 years and quadruples in 13 years. U.S. growth of 2-3 percent means that it takes between 24-36 years to double output and 48-72 years to quadruple it. Higher growth in China, India, Vietnam, and other countries implies that demand for commodities will remain strong and that prices are likely to continue to rise.

This new world differs from the twentieth century, in which China and other emerging economies were backwaters. The U.S. is so preoccupied with Iraq that it has little energy left to plan for the consequences of the new economic reality.

Chinese companies, both private and state-owned, have abundant cash to purchase overseas assets at an ever-accelerating rate. If they are blocked from doing so, this will not endear the Chinese government and people to the U.S. The official reserves of the People’s Bank of China (the central bank) have surpassed $1.4 trillion and continue to grow at a rapid rate. Should China decide to sell, or simply announce its plan to sell, a large portion of its portfolio of U.S. government securities, the dollar could fall even more rapidly.

The (Mis)Conduct of U.S. Foreign Policy

It is one thing to offer advice when asked. It is another to give unsolicited opinions, especially when it comes to telling other nations how they should change their policies to what we (the U.S.) wants because we say it is in the interest of other nations. Imagine how Americans feel when other nations tell us, without our asking, how we should behave because they know better what is in our interest.

President George H. Bush routinely advises Russia and China how to behave in their domestic and foreign affairs. He does so in a way that appears arrogant, out of place, and only strains relations with these countries. His welcome mat for the Dalai Lama, the spiritual leader of Tibet, at the White House and Congress during the weeklong meeting of the Chinese Communist Party held every five years amounts to poking a finger in the eye of the Chinese leadership. This action will be duly noted in China’s little black book of insults, to be dealt with at a later date. Instructing Russia’s president Vladimir Putin on how Russia should behave in its relations with Iran only strengthens Russia’s resolve to pursue an independent foreign policy.

The U.S. remains by far the strongest economic and military power in the world, but each year that edge slips a bit. China’s growing economy and Russia’s vast natural resources give these two potential adversaries of the U.S. more and more power and control in their relations with Asia and Europe respectively. The time when other countries will listen to unsolicited advice or implied threats from the U.S. may draw to a close sooner than U.S. leaders recognize. And the means of the U.S. to backup its advice or threats becomes less credible with each passing year.

1 comment :

David Wozney said...

A “Federal Reserve Note” is not a U.S.A. dollar. In 1973, Public Law 93-110 defined the U.S.A. dollar as having the value of 1/42.2222 fine troy ounces of gold.