Things That Can't Go On, Don't
In Washington you often hear the phrase "This can't go on." The late
economist Herbert Stein used to answer, "Things that can't go on,
don't." The $64,000 question before the world today concerns the U.S.
current account deficit and the dollar. Will they go on? The recent
prominence of the dollar in the world's leading periodicals reveals
growing anxiety. Despite the nervous edge of headlines like "The Makings of a Meltdown,"
many analysts remain sanguine.(19) The U.S. economy is growing faster, they argue, and
has more rapidly increasing productivity than any other economy and thus will continue to be
the most attractive place for foreigners to invest their money. In early December 2004 the
Federal Reserve Bank of New York released a report predicting strong productivity growth at
2.6 percent annually for the next ten years. This is far above the rate of 1973-1995 and
represents a continuation of the strong productivity growth of the dot-com era. Combining
this with population growth, the Fed predicted a trend growth rate for GDP of 3.3 percent,
about double that of the European and Japanese economies.(20) The growth argument is
supplemented by the "no alternative to the dollar" view espoused by longtime Wall Street
guru Henry Kaufman.(21) As the world's only superpower, he says, the United States has
much better growth than other big economies with little risk of inflation, and it has deeper,
broader, better organized markets that currently provide a better return than any other.
Then comes Kaufman's final, intriguing point: realigning global economic and financial relationships
in a smooth and orderly fashion is currently beyond the cooperative and organization capacity
of the Chinese, Japanese, and Europeans. China would have to revalue the yuan by 50 percent
to 70 percent, Japan would have to turn its aging citizens into bigger spenders than they have
ever been, and Europe would have to turn inflationary. Since none of them are going to do any
of this, Kaufman argues, they have no alternative but to continue buying U.S. Treasuries in support
of the dollar. They may do it kicking and screaming, but they will do it.
Academic commentary has been less bullish on growth than the
headlines, but also less nervous. One widely noted study by Catherine
Mann looked at a number of countries and concluded that the United
States could sustain a current account deficit of a little over 4 percent
of GDP.(22) When the paper was written in early 2002, the deficit was 4.3
percent of GDP and thus presumably sustainable. Mann noted, however,
that the deficit would become unsustainable at some point barring
significant structural changes, and suggested that one such
change could arise from global trade in services. Because the services share of GDP normally rises as economies develop, and because new technologies and trade liberalization have made it easier to trade services, there could be a dramatic shift in the U.S. trade account. U.S. exporters of services, said Mann, are "highly competitive" and could take advantage of the new technology to penetrate foreign markets and reverse the long-term trends of U.S. trade. Absent such a shift, however, Mann concluded with what seems to be the current academic conventional wisdom: things are sustainable for now, but Americans will gradually have to adjust to a falling dollar and pressure for less consumption and more saving.
These are all good arguments, but they accept American mythologies
too readily and ignore the realities of the new capitalist road. It is
comforting to Americans to keep telling themselves they have the best
productivity and GDP growth and will therefore remain the location
of choice for foreign investment. But is it true? While there is much
evidence to indicate that U.S. productivity has indeed taken a jump,
there is also cause for prudence about this conclusion. Beyond the
weaknesses I have already outlined, other evidence suggests that the
U.S. performance may not be as overwhelming as it looks. The Financial
Times columnist Martin Wolf points out a paper by Credit Suisse
First Boston showing that, from 1992 to 2002, real net domestic product
per hour increased just 1.1 percent annually in the United States,
while gaining 1.4 percent in the Eurozone.(23) If you remove the effects
of the Internet bubble, in other words, the United States looks a lot
like Europe. Another point is hours. While American productivity per
worker per year is improving faster than that of Europe, on a per hour
basis the Europeans are starting to come out ahead.
This once again raises the issue of living standards. Americans are not only working
more hours than Europeans or Japanese, they are working six more
weeks a year today than they did twenty years ago.(24) Yet median family
income has not risen much. What's going on? Wages are supposed
to rise with productivity. Either the productivity gains are not really
there or they are all going to shareholders. The latter would be consistent
with the likely impact of 3 billion new capitalists on wages. In either
case it is difficult to see how rapid GDP growth can be sustained if workers don't get some of the benefits of rising productivity. Beyond this, the growth is also suspect. As chief IMF chief economist Ken Rogoff says, the United States is getting the "best recovery money can buy."(25) The U.S. economy is a bit of a Potemkin village. GDP growth is high, unemployment appears to be low, and household wealth appears to be increasing. But a closer look reveals a more sobering reality. America's growth is in part borrowed from the future. It's like a company striving to make its annual sales projections by offering special incentives to its accounts to stock up now, before the year closes, instead of waiting to resupply at the normal time. We might call it "shipping in place." U.S. consumers are consuming, but with borrowed money as they have mortgaged their homes to maintain living standards. Yet because investment and production have not kept pace with consumption, more of this borrowed money is flowing overseas to pay for imports. At a national level, Federal Reserve chairman Alan Greenspan says the U.S. government budget deficit is a threat to long-term stability because it is not subject to correction by market forces.(26) At the same time, the country's net international debt is high and rising rapidly. This is not a healthy kind of growth, and analysts like Morgan Stanley's chief economist, Stephen Roach, emphasize that it can't be sustained in view of the "profound income leakage arising from global labor arbitrage."(27) As for unemployment, it's easy to keep it low if you put 2 percent of all the men in the country in jail and don't count them as unemployed, which the United States currently does. Further, we only count as unemployed those receiving unemployment benefits or who tell poll takers they are actively seeking a job. To see how this works, look at Kannapolis, North Carolina. When the town's only mill shut down, reported unemployment soared. A year later, however, unemployment magically disappeared-not because people got jobs, but because their benefits ran out.(28) The real story of the U.S. economy is rising hours worked, rising debt, and job creation largely restricted to lowpaying categories like retail sales and fast food restaurants. This is not a formula for long-term prosperity.
The impact of 3 billion new capitalists on the United States, along with America's abuse of the dollar and its soaring public and private debt, has made foreign central bankers and finance ministers very nervous. They are all in a global game of financial chicken. If foreigners dumped a large portion of their dollar holdings, the dollar would fall dramatically and cause a recession or even a depression in the United States. Because the rest of the world lives by selling to the Americans, a U.S. recession could be devastating to the rest of the world's economies. Dumping dollars could precipitate global stock and bond market crashes that would bring huge losses to, among others, those doing the dumping. From this perspective, Americans are holding the world's financiers hostage. On the other hand, should things fall apart, the first player who gets out of dollars will take the smallest loss. Thus any hint of significant dollar dumping is likely to cause a chain reaction-fast.
If you are a finance minister or central bank director, this possibility creates two worries. First, if it looks like things are beginning to fall apart and you don't move, you could wind up losing billions for your country, along with your reputation. Second, Americans owe so much that they are sure to be tempted to inflate the debt away. If they do that while you are steadfastly holding on, you will again lose gobs of money, and your epitaph will not be heroic. So all the players, or nearly all (about which more later), are damned if they do and damned if they don't. So far they haven't, but tomorrow is another day.
Recently everyone's nervousness has been reflected in some interesting
moves. As private money abandoned the dollar over the past
two years, the European Central Bank followed free market principles
and refrained from any intervention in the currency markets. American
officials said they wanted a strong dollar, but their body language
said weak dollar. Consequently the euro, which had languished during
the dot-com boom, gained over 35 percent against the dollar in a twoyear
period, just as Soros had predicted. The Bank of Japan, on the
other hand, engaged in massive intervention, buying over 623 billion
dollars in 2003 in a largely successful effort to prevent the dollar from
falling against the yen.(29) Because the Bank of China keeps the yuan pegged to the dollar by law, it doesn't intervene in the exchange markets as the Japanese do. But its trade surplus means that to hold the peg, the bank has to keep accumulating dollars. While doing so, however, the Chinese have quietly been buying lots of oil. They need the oil, and buying it now with strong dollars is a way to avoid investing in U.S. Treasuries, whose value could plummet in a crisis. The oil producers, in turn, have been taking the dollars from the Chinese and selling them for euros and euro bonds, putting more upward pressure on the euro. The Russians only added fuel to the euro fire when they announced the decision to reverse the dollar-euro ratio of their international reserve holdings. This activity has begun to price European goods out of international markets. As a result, the Europeans are now talking about "stabilizing" the dollar by organizing a joint buying operation with the Japanese. So far the system is still holding together, but it is increasingly shaky.
No one knows for certain what will happen, but clearly the global
financial markets could implode very quickly. Former Federal Reserve
chairman Paul Volcker says there is a 75 percent chance of a dollar
crash within the next five years. This is Soros's great fear too. In public
statements and in conversations with me, he has expressed concern
about the market fundamentalist view that prevails in Washington
and parts of Wall Street. This is the belief that markets are
self-correcting and best left alone-a dangerous siren song, says
Soros. Far from being self-correcting, he emphasizes, markets tend to
excess. They overshoot. Anyone with any experience of markets
knows this. When markets are going down, all the weaknesses get
concentrated, and you need intervention at the right time to stop
things from getting out of control. If the dollar started to melt down,
the results could be really nasty. A 1930s-style global depression is not
out of the question.(30)
The lack of an alternative to the dollar is the only reason it hasn't
taken a big fall already. But now those alternatives are emerging. The
euro, though not a perfect substitute, is becoming more attractive. Besides
the Russians, others are also sneaking into euros, which is why it
has recently strengthened so much.(31) In Asia there is serious discussion of creating an Asian currency unit, or Acu, in imitation of the European Ecu, which preceded the euro.(32) In the end, it is very simple: the global economy is highly distorted.
Americans consume too much and save nothing and the rest of the world, especially Asia, consumes too
little and saves too much. There are three ways for this situation to work itself out. Americans could consume
less and save and invest more. The fastest way to do this would be to cut the federal budget deficit. There are
two problems. If Americans take all the adjustment, it would entail a big reduction of GDP. Since no political
leader could survive that, it is not going to happen voluntarily. Nor is the federal deficit likely to be cut. If anything,
it will increase as the baby boomers retire and cause a dramatic rise in social security and medicare payments.
The second option would be for Asia and the rest of the world to cut saving and increase consumption. That
will undoubtedly occur over the long run, but in the short run it would slow up the growth that is the raison
d'être of these regimes, especially China's. Moreover, if it did occur, the reduction of the flow of Asian savings
to U.S. financial markets would cause the dollar to fall.
That is, of course, the third and by far most likely event. When and how it might occur no one knows. Most analysts would like to see a smooth, gradual decline of 30-50 percent from present dollar values. How things develop will be significantly determined by China. To many Western economists China's policies seem foolishly mercantilist. But China's accumulation of dollar reserves has given it great negotiating leverage against the United States, and its policies induce rapid industrial development and technology transfer. So China might decide to prop the dollar up for a long time, as will, almost certainly, Japan.
Europe might even join in to avoid the pain of the rising euro. But
there is always the unexpected. Vladimir Putin is increasingly unhappy
with the United States. Could he show his dissatisfaction by dumping
dollars? What about OPEC? There are surely a number of members
who have no love of the United States and might jump at an opportunity
to dethrone the dollar. Remember also that before the Asian financial
crisis of 1997, no one anticipated the damage hedge funds could cause. Recently a little bond market maneuver by Citibank caused a scary ripple in the European markets. There's no guarantee that something like that won't trigger a dramatic dollar crisis, and if it does, it won't just be another decline. It will be the end of the dollar's dominant role as the world's money.
It is on this-the end of the dollar's hegemony-that Soros and Buffett are betting. That, after all, is the logical outcome when some people squander their resources and others take thrift to the extreme.
Rights: Copyright © 2005 Clyde Prestowitz. Published by Basic Books. All rights reserved.
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