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International Socialist Review Issue 39, January–February 2005


INTERVIEW with Joel Geier
Dimensions of the U.S. Dollar Crisis

THE DOLLAR’S value has been falling for some time, and pundits disagree about its significance. On the one hand, some economists are expressing worry that a too precipitous fall in the dollar could push the U.S.–and the world–back into recession. Others, following the line of the Bush administration, see the dollar’s gradual decline as a means to reduce the U.S.’s unsustainable trade imbalance, passing the cost of its past economic excesses onto its competitors. We spoke to JOEL GEIER, associate editor of the ISR, to find some answers.

THE ECONOMIC news is full of reports about the falling dollar. What is it all about?

THE UNITED States dollar is going through a fairly dramatic decline in its value. In the last three years the dollar has fallen by 15 percent on a trade-weighted basis (proportionate to trade with each of its trading partners) and by more than 50 percent against Europe’s currency, the euro. Since the election, the dollar has continued to drop at an accelerating rate. Currency markets reacted to Bush’s election victory by assuming that the U.S. would continue the same tax and economic policies based on persistent and growing budget deficits. Far from showing alarm at the dollar’s decline, however, the Bush administration is now trying to extend the drop by another 10 to 20 percent, in the hope that this may correct the country’s ballooning trade deficit.

There is growing unease that the dollar could experience a sharp drop–a fall by another 40 percent, which then could precipitate an international economic crisis. The currency crisis is not just a problem of changing exchange rates, but has deeper roots. It comes out of long-term weaknesses in the economy–overproduction, weak profits, and a sub-par recovery. Also, it arises from government policies intended to ameliorate those troubles, but which in turn have created additional problems that can no longer be contained. And finally, it arises from the contradictions of globalization, of an economy that is international, while monetary, fiscal, and trade policy are made by national states solely for the competitive interests of their local ruling classes. Those national solutions undermine the stability and equilibrium of the world economy, an inescapable dynamic of the modern imperialist struggle for the world market.

WHAT IS making the dollar’s value fall?

THREE THINGS have come together to create this current dollar crisis; the balance of payments deficit (sometimes called the trade deficit), the government budget deficit, and the war in Iraq. The present balance of payments problem starts with the Asian recession of 1997—1998. Until then, the U.S. was running a sustainable balance of payments deficit of approximately $50—$150 billion a year–less than 2 percent of the economy, of Gross Domestic Product (GDP). In other words, the U.S. was importing $50—$100 billion more worth of goods and services each year than it was exporting.

When the Asian crisis swept through world financial markets in 1998, the Clinton administration and the Federal Reserve tried to avert recession by drastically cutting interest rates and pumping up the money supply. They did something never done before; they massively stimulated an economy still in boom. One unintended consequence was a huge upturn in capital spending that led to overproduction, particularly of high-tech capacity, and to an enormous over-inflation of stock market values–what’s known as a bubble. Two years later came the inevitable dot-com bust–the high-tech collapse; the NASDAQ crash; the wiping out of trillions of dollars of stock market and pension assets; the enormous bankruptcies of WorldCom, Global Crossing, and many others; and an even worse recession.

Another unintended consequence of the financial stimulus the U.S. used to avert crises during the Asian "flu" is the current unsustainable trade relationship between the U.S., Southeast Asia, and China, which is now at the core of shaky exchange rates. The international crisis of overproduction was temporarily alleviated through American importation of Asian exports. This revived Southeast Asia and contributed to the Chinese boom, even if it was beyond the ability of the U.S. to pay for these goods.

The U.S. became what was known as the buyer of last resort. Asian goods and assets became extremely cheap, and the U.S. sucked in cheap exports from first Southeast Asia and then China. Large amounts of capital from the world flowed into the U.S., because it was still in boom and the return on capital was higher than elsewhere. This strengthened the dollar, making Asian goods even cheaper. This initiated an unusual trade system. Asian export-led growth became dependent on consumer spending in the United States; and the U.S., in turn, paid for Asian imports with massive foreign borrowing, often from the exporters themselves. Rather than converting dollars from exports to the U.S. into their own local currencies, the Asian economies keep their export revenues in dollar reserves, which they then loan to the U.S. treasury, keeping interest rates low in this country and holding down the value of their own currencies. This in turn kept their exports cheap.

As a result, the U.S. current accounts deficit went from $100—$150 billion to $250—$300 billion a year at the end of the 1990s, and since then has gotten worse. In 2001 it was $400 billion; in both 2002 and 2003 it was $500 billion; this year it is $650 billion, despite the large dollar decline of the last two years, which according to economic theory is supposed to correct the trade imbalance.

The U.S. cannot pay for this trade deficit from American savings. Savings in the U.S. have collapsed as real wages declined with the start of the recession in 2000. In the early 1990s savings were 7—8 percent of GDP, this last year they were less than 1 percent of GDP, the lowest rate since 1933. So the U.S. has been borrowing money from the rest of the world, sucking in 80 percent of the disposable savings of the rest of the world. The U.S. now depends on foreign borrowing of $1.8 billion a day. It is a situation that could not be sustained indefinitely. Now that the two deficits have come together as one intractable problem it is impossible for the system of trade-financial recycling of the last seven years to be continued.

HOW HAS the U.S. managed to avoid a crisis from such high deficits for so long?

UP UNTIL two or three years ago, other capitals took the money from exports to America and invested in U.S. business–direct investment in plant and equipment. In the 1990s, the country that received the largest amount of foreign direct investment (FDI) was the U.S, not China. Labor is cheaper here than in Western Europe or Japan, so other advanced capitalist countries built factories in the US, contributing to the boom. For example, you had BMW opening up plants in South Carolina. That’s one way money came in. Another way was to buy American stocks or bonds–government or corporate. Capital flowed into the U.S. as American assets were sold to pay for consumer imports, a situation common in underdeveloped countries, but abnormal for the world’s leading imperialist power.

That could go on when the rate of return in the U.S. was higher than elsewhere, and where investments in the U.S. were more secure than elsewhere. In the last three years, though, that has stopped. There is very little FDI in plant and equipment and the foreign buying of stocks and corporate assets has dried up. The rate of return in the U.S. is no higher than many other places, and the decline of the dollar makes American investments often a net loss in foreign currencies.

The money that is coming into the U.S. in any significant amount is the buying of debt–of U.S. treasury securities, as well as government backed mortgage securities (Fannie Mae and Freddie Mac) by the central banks of China, Japan, and the Southeast Asian countries. That’s where the money to finance this deficit is now coming from. But it is unsustainable, particularly now as the dollar goes into crisis.

The second aspect that allowed this to go on for so many years was that the Clinton administration sustained a government budget surplus that offset the stock market bubble and accelerated the trade deficit. When Clinton left office there was a $250 billion a year budget surplus.

The Bush administration took that money and gave it to the rich as tax cuts. It was a disaster for the economy, but that never stopped the greed of the rich, particularly if they can get others to pay for the problems they create. Since the tax cuts, the government has been running a budgetary deficit of $400—$450 billion a year–a swing of almost three-quarters of a trillion dollars a year, from surplus to deficit. That surplus in the late 1990s acted as a form of national savings. The government was paying down its own debt. It did not require foreign capital. The government budget deficit as a result of the Bush tax cuts now requires foreign capital to float the government deficit, on top of the enormous current account deficit.

HAVE THERE been currency crises like this in the past?

THIS IS the third dollar crisis in thirty years. The last two turned out very badly. The first dollar crisis of 1971—1973 came at the end of the postwar boom. The United States was no longer capable of maintaining the Bretton Woods agreement, which had consolidated U.S. monetary domination at the end of the Second World War, when it emerged as the dominant power. Under Bretton Woods, Western currencies were interchangeable with the dollar at fixed rates, and the dollar was backed up by gold reserves at $35 an ounce. The relative decline of American power and profits in the next few decades–precipitated by the costs of the permanent arms economy and the Vietnam War, plus the reemergence of Japan and Germany as economically competitive powers–forced the United States to pull the plug on the Bretton Woods currency system. The U.S. devalued the dollar, replaced fixed currency exchange rates with floating ones, and went off the gold standard.

The next decade was a period of stagflation, with high inflation, high interest rates, weak or stagnant growth, and three devastating recessions between 1973 and 1982. American capitalism restored itself through an enormous cut in the living standards of the American working class. Real wages and social benefits were slashed. This employers’ offensive really hasn’t stopped since then. Despite substantial economic growth, real wages are no higher today than they were thirty years ago, before the first dollar crisis. The crisis was essentially pushed off onto the backs of the working class.

The second dollar crisis in the 1980s was the result of Reagan’s massive rearmament policy to restore American military power after the Vietnam defeat. It produced an enormous government budgetary deficit, which doubled the national debt in a few years. To attract such huge borrowing, the government pursued an artificially strong dollar policy that eventually priced American manufacturing goods out of the world market and led to a large trade deficit. The U.S. was increasingly unable to sustain these "twin deficits." The threat this U.S. crisis posed to the world economy produced an agreement by the major capitalist powers to bring down the value of the dollar, known as the Plaza Accord. It was bitter medicine. From 1985 to 1987, the dollar declined by over 50 percent, shrinking the accumulated value of U.S. capital’s assets by one half on the world market, reducing its economic and political power. Dollar devaluation is not some clever solution to trade problems, as the media often pretends; it’s a desperate strategy forced on a weakened national capital.

The second dollar crisis produced a renewed bout of inflation and higher interest rates, with the United States eventually losing control over its own monetary policy. That in turn led to the stock market crash of October 1987, when in one day the market dropped by 22 percent, its biggest loss ever.

The dollar devaluation was devastating to some other countries, particularly Japan, whose currency went from 260 yen to the dollar to 130. Japanese assets became valued twice as much but the asset inflation of property and stocks created a bubble economy. The inevitable collapse of the bubble destroyed enormous amounts of capital–Japanese stocks and real estate prices are still 70 percent below where they were thirteen years ago–crippled the banking system, and set in motion a decade of stagnation and recession. Japan appeared to be getting out of this in the last year, but this new dollar crisis may throw Japan back into recession.

IS THIS new crisis worse than the previous ones?

THIS NEW dollar crisis has the potential to be even more disruptive than its predecessors. The crippling trade deficit of the 1980s was 3 percent of GDP, whereas the trade deficit today is 6 percent of GDP. The International Monetary Fund (IMF) usually steps in and carries out a structural adjustment program in countries with 5 percent deficits. Moreover, with the growth of globalization in the last twenty years, U.S. foreign trade has become more central to the world economy, and therefore any readjustment will have a bigger global impact.

In the preceding two crises, the U.S. had a buffer; it was the world’s largest creditor. The rest of the world was in debt to the United States. But in the last few years the U.S. has become the world’s largest debtor, with a staggering foreign debt of over $2.7 trillion, and by other estimates $4.5 trillion. And debt at all levels–state, corporate, mortgage, and personal–have expanded massively in the last three decades, making the economy much more vulnerable to sudden interest rate swings. The repudiation of much of the government’s foreign debt through devaluation could be the largest default in history, it’s impossible to predict all of its ramifications on the world economy.

The twin deficits of government and trade have come to crisis together just as they did in the mid—1980s–only this time both of them are worse. The current account deficit is double what it was, the debt is enormous, and the U.S. is now in hock to the rest of the world. The Asian countries alone have $1.8 trillion worth of American dollars in their foreign reserves.

The catalyst has been the war in Iraq, in three fundamental ways. One, the Bush administration thought that like the first Gulf War, this war was going to pay for itself–Iraqi oil would pay for it. Instead, the wars in Iraq and Afghanistan are costing the American government over $100 billion a year now, increasing the budget deficit and the dependency on foreign capital. The Bush administration also predicted that its control of Iraq and the Middle East was going to lower world oil prices, which would act as a stimulus for stronger economic growth. Instead, world oil prices have doubled. This has increased the oil import bill intensifying the trade deficit. Moreover, oil at $40—$55 a barrel has cut into profits, restricted consumer spending, and slowed growth here and internationally. Oil everywhere is paid for in dollars, and OPEC raised oil prices so as not to be a victim of the depreciating American currency. The war is not just a political disaster for American imperialism; it is an economic albatross, which has brought unsustainable problems to an immediate boil.

Oil prices, the cost of the war, and lowered profits have all combined to aggravate the economic problems facing the U.S. For example, in the third quarter of this year, in spite of 3.9 percent growth, profits dropped from the preceding quarter.

YOU SAID that the Bush administration wanted to let the dollar fall so long as it didn’t turn into a collapse. What do they hope to gain from that?

THEIR SOLUTION is to lower the dollar–gradually so that it does not precipitate a crisis–to make imports more expensive and to make exports to other countries less expensive. By doing this, they hope to increase exports and decrease imports, thereby bringing down the trade imbalance. Over time that might work, according to bourgeois economic theory, but so far it hasn’t. The trade deficit has gotten worse, despite the decline of the dollar in the last three years. Moreover, they have done this unilaterally. Just like they carried out a unilateral foreign policy in Iraq, made a mess of it, and then told the rest of the world they have a stake in cleaning it up. Unlike the international cooperation they got with the Plaza Accords, the U.S. this time is trying to drive the dollar lower, no matter what the consequences are for the rest of the world. It’s a kind of financial unilateralism.

They think that lowering the dollar will help. They thought that invading Iraq would lower the price of oil. There are unintended consequences of the policies of an arrogant ruling class whose incompetent political representatives act on the assumption that the world’s only superpower can unilaterally impose whatever it wants on the world.

WHAT ARE the likely problems, the "unintended consequences," that might result from this?

LET’S START with this country. First, higher inflation. The prices of goods that are going to be imported are going to be a lot higher. U.S. manufacturers will take advantage of higher import prices to also raise their prices. If an import goes up from $100 to $120, domestic manufacturers can raise their price to $110, still be cheaper than their foreign competitors, but with an additional $10 of inflated profits. Interest rates are going to go up quite a bit, because of higher inflation, and in order to attract continued foreign loans.

In essence, what is happening is that the American government is defaulting on a part of its debt. They will pay back the debt at its face value, but in a devalued currency. It’s not declaring bankruptcy, but the world’s biggest debtor is telling its creditors: "We’ll pay you 80 cents on the dollar, or 60 cents on the dollar." Try that with your credit card company. The biggest losers, Japan, which holds $720 billion and China with $400 billion of U.S. debt, will take steep losses. The question is, why should foreigners invest in the U.S. when their assets lose value? This will necessitate even higher interest rates in order to continue to attract foreign borrowing.

In this country, it means that the standard of living is going to be cut. In the last three years, real wages have been declining. With inflation, they will continue to decline, because wages are unlikely to go up as much as prices. The government is not worried about wages going up because there’s such high unemployment. Officially unemployment is 5.4 percent, but that’s propaganda. In the real world, unemployment is closer to double that, if you count people who have dropped out of the labor market (discouraged workers), or people who work part time because they can’t get full time work. There are large numbers of people who have not been able to enter the labor force in the last four years because of the absence of new hiring, the millions in the prisons, and in the army. That high unemployment has held wages down and allowed for benefit cuts. The American ruling class wants to force the working class to pay for its problems.

People used mortgage refinancing, taking equity out of the rise in value of their houses, to the tune of $600 billion last year, to make up for the decline in real wages. It’s a big part of what held up consumer spending despite the recession. That’s now over, as mortgage refinancing is ending with the rise of interest rates. Many people have adjustable rate mortgages, and as they go up, it will cut into their disposable income, further restricting consumer spending.

Because there have been such low interest rates and the banks have speculated with very low down payments, a real estate bubble was created, as housing prices have risen outstripping income or rents. That bubble may burst. The bond market bubble, the artificially inflated capital markets, due to low interest rates that have existed as a result of Asian loaning to the to the government, may also pop. The cut in consumption will further slow the economy. And if the bubbles in housing, stocks, and bonds deflate abruptly, wiping out capital and savings, it could throw the economy back into recession.

WHY WILL interest rates go up?

FIRST THEY are going to raise interest rates to account for the inflation. Low interest rates were used to stimulate the economy by making borrowing easier. But low interest rates plus inflation creates negative interest rates, which lenders won’t tolerate indefinitely. The Federal Reserve thinks that the economy still needed this stimulus in the third year of a recovery–a testimony as to how weak it considers this recovery. They cannot maintain that policy any longer because it is aggravating inflation. The Fed started to gradually raise interest rates six months ago, and will be forced to continue to do so. If the economy starts to slide, they may not have the weapon of lowering interest rates to try to stimulate more growth, because the decline of the dollar may prevent that option.

Foreign central banks are already starting to shift some of their reserves from dollars into euros and yen, contributing to the dollar decline. To stop that process the Fed would have to raise rates to make up for currency losses. Eventually it will cost capital more money, cost all debtors more money, cut into profits, and hold down growth. If the dollar decline turns into an abrupt plunge, they will be forced to raise interest rates dramatically and other central banks, particularly in emerging countries, will also raise rates. That then will threaten growth, the housing market, the bond market, and the stock market, which is still vastly overinflated. It currently trades at 17—20 times earnings at this point, quite a bit higher than it should be. All these things threaten what is already been a weak and fragile recovery here and internationally. One thing is for certain, it is going to cut consumption and living standards in this country, and will have a negative impact on all the things I mentioned even if it does not lead to a more disastrous collapse.

WHAT’S THE impact of the dollar crisis on the rest of the world?

GROWTH IN the U.S. in the third quarter was 3.9 percent. In Europe, it was 1.2 percent, and in Germany and France it was 0.4 percent. Much of that weak growth in Europe is based on strong export demand. As the euro goes up in value, European exports will decline as their prices rise on the world market. That threatens to throw some European economies back into recession. One of the peculiarities of the situation is that the U.S. economy, which is stronger than Europe or Japan’s, is attempting to get these countries to subsidize higher growth in the U.S. by slower growth in their own economies. It’s what’s known as a "beggar thy neighbor policy"–get out of your problems by exporting them to someone else, even if they are in a weaker position economically than you are. At the time of the Plaza Accords, Europe and Japan were doing better. Now that they’re not, the U.S. feels it can act unilaterally, even if it may throw those countries into recession.

In Japan, there’s been a fifteen-year-long crisis since the last dollar crisis in the 1980s. In the last year, Japan had just started to climb out of recession, with 6 percent growth, based upon the boom in China and Asia. The Japanese yen has been revalued upward by 10 percent in the last few months, which abruptly braked growth to 0.2 percent in the last quarter. Just as a weak dollar contributes to inflation in this country, a stronger yen contributes to the deflation problem in Japan that it has not been able to overcome in years. The drop in the dollar will also have a negative impact on some of the Asian countries that have depended on growing exports to the U.S. to propel economic growth.

But the big question mark is China, which has been the other engine of world growth alongside the United States. In return for the balance of payment surplus it runs with the U.S., China has used these surplus dollars to finance America’s budget debt. That has kept interest rates low here as a trade-off for keeping the Chinese currency low. In China it has produced enormous liquidity in the Chinese banks, which led to an overheated boom–9 percent annual growth–and an enormous speculation in property. China already has a bubble economy, and a revaluation of its currency could create an even bigger bubble in asset prices.

The Chinese banking system is among the most fragile in the world, with over 40 percent of its loans considered non-performing or bad loans. Therefore the Chinese have been reluctant to lift capital controls and allow their currency to freely float for fear the Chinese banking system would collapse. If the Chinese boom turns into the Chinese bust, it will effect the entire global economy.

All of these things are potentials, in what is already a weak and fragile world economy–one that is in recovery, but that is not having great growth in Europe or Japan. That is because the problems that precipitated the last recession have not been solved. That would require restructuring on a world scale to do away with the overproduction of means of production. The wiping away of capital value, of excess capacity worldwide, was not fully accomplished in the last recession. Now you have China coming on line with much cheaper manufacturing exports. And China, if its currency were revalued to reflect real values, would probably be the second largest economy in the world. Of course, the Chinese economy would also probably collapse if that occurred. Europe has 10 percent unemployment. This puts a break on capital investment–why invest in Europe when you have more than enough capacity?

So you have a weak recovery, and you have this attempt on the part of the U.S., which has a stronger recovery than Germany and Japan, to lower the dollar. But this isn’t being done from a position of great strength. It is coming out of a situation in which the U.S. economy can no longer use tax cuts or lower interest rates as a stimulus–it has exhausted those avenues–so they’re going instead for a cheaper dollar. The U.S. economy is weak, but it is stronger than its main rivals, the European Union and the Japanese. And the American ruling class thinks it can impose this on them because it is stronger than they are, because it is the sole superpower, which is one of the reasons why this can get totally out of hand. It can impose this preemptively, unilaterally, but there’s no guarantee that its rivals will accept it.

WHAT CAN Europe or Japan do in response?

THERE COULD be a more concerted attempt on the part of the Europeans, the Japanese, and the Asian countries, to intervene in the world currency markets and prevent the decline of the dollar by buying more dollars. If it took this action with the cooperation of the U.S., it would work. But if the U.S. is going in the opposite direction, which is what the Bush administration is doing, it may not be enough to break the fall of the dollar. The only way it would work, then, is if the U.S. intervened at the same time. But stopping a collapse of the dollar means getting people in the world to agree to buy American debt even after the dollar goes down, which is a difficult thing. That’s one of the dangers in the situation. There’s the possibility that people will shift from dollars to euros or yen as reserve currencies. That has started and if it speeds up, that’s when the threat of a dollar collapse could become real. I’m not arguing here that the euro is going to replace the dollar as the world’s leading currency. That isn’t about to change. But that doesn’t rule out the possibility of a sell off of dollars threatening a dollar collapse. And it is a sign of the weakness of the U.S. that a trend has started to shift some reserves from dollars to other currencies.

WHAT DOES the dollar crisis tell us about the relative strength of the U.S. economy and its position as the world’s superpower?

ALL THOSE people who think that U.S. imperialism is all-powerful, and that the Bush administration is going to go from one victory to the next, are mistaken. It is devaluing the dollar because it sees no way out of its current problems, and it’s gambling that its remedy won’t produce an even worse crisis. The lowering of the dollar’s value is not going to increase U.S. power. It is going to decrease it, either by a modest amount, or by a more significant amount. American capital is now worth 50 percent of what it was three years ago in Europe. If you’re an American capitalist who wants a factory in Europe, you have to pay out 50 percent more. The press may present this as a brilliant stroke by the political representatives of the U.S. capitalist class, but it is not a sign of strength. On the other hand, the U.S. remains the dominant power, and it is on this basis that it assumes that the rest of the world will bail it out. The U.S. ruling class may get this if the dollar collapses, because Europe, Japan, and Asia can’t afford for that to happen. But that won’t enhance U.S. credibility.

The world is still in boom, and the decline of the dollar, unless it becomes a collapse, will not drive the world into immediate recession. American imperialism has great weaknesses in Iraq and economically–but its major rivals are even weaker. World growth may continue for a few more years before another downturn, but this business cycle will likely be weaker and shorter. As world trade and financial policies readjust to America’s problems, there will be sharp, sudden, and unforeseen swings in many economies–as well as other currency crises. Ruling classes everywhere will be carrying out relentless assaults on the living conditions of the working class–in the boom as well as the bust. The class struggle remains at a low level, but the increasing class inequality, polarization, and rollback of reforms in this peculiar economic environment open the prospect for greater struggle and class radicalization internationally.

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