Drowning together in dollars
SCMP March 1
Last year, foreigners bought a net US$700 billion of American assets,
mostly government, agency and corporate debt. Is this not utter folly?
When, I ask, do they expect to get their money back?
The players in the international money game mostly seem to believe
that this is a "pass the parcel" where the music never actually
stops. Or, if is does, it is because of one-off commercial accidents,
which leave only a limited number of participants holding the likes
of Enron debt.
What is not being asked is whether the galloping buildup of US debt
is going to cripple the whole system; the dollar-based world which has
existed since America unilaterally trashed the Bretton Woods agreement
History should teach us to be wary of central bankers as well as governments.
Yet the horizons of those who make the bulk of portfolio management
decisions, be they investment banks, monetary authorities or fund managers,
seldom look beyond 30 weeks, let alone 30 months. As for 30 years, forget
But given the state of payment imbalances, any sensible discussion
of the future needs to start with a look backwards to at least 30 years
ago. It should include an understanding of the psychology of the deeply
America's net debt to the rest of the world is approaching US$2 trillion.
The buildup has been apparently cheap and painless because of the dominant
role of the dollar in the global system. But the persistence of gigantic
deficits is not just raising the question of how long and at what price
this can be financed. It is beginning to cast a shadow over the whole
system, which hinges on confidence in the ability of the US to meet
its obligations. It looks increasingly unlikely that it can do so, even
assuming that either a major US recession or drastic Asian currency
revaluations come soon enough to halt the debt buildup.
Two groups of people are responsible for the impending crisis in international
finance, which could prove at least as damaging as that of 1971. First,
there is Federal Reserve chairman Alan Greenspan and the ranks of media
and political courtiers who surround him. His response to every problem
has been ever easier monetary conditions. It was his response to the
supposed Millennium bug, the collapse of the Nasdaq in 2000, the failure
of the Wall Street insiders' scam know as long-term credit management,
September 11, Enron and the mini-recession of 2002, for example.
Easy money naturally leads to debt buildups and bubbles as households
are positively encouraged to go out and buy petrol-guzzling sports utility
vehicles with 0 per cent finance, or extract equity from their inflated
house prices. Meanwhile, President George W. Bush is borrowing hundreds
of billions of dollars from the next generation to buy votes and illusions
of national security. The other group consists of those who allow this
process to continue, the mostly Asian central banks who buy all this
debt and the US investment banks with a huge vested interest in selling
mountains of dubious debt, and related instruments, to gullible foreigners.
Those foolish enough to believe that US government debt is really that
safe should examine the record. Foreign investors who believed in the
word of the State of Mississippi are still waiting for the redemption
of an issue made in 1833.
All right, so that was a state matter not a federal one and preceded
the civil war. But fast forward to the 1930s, when president Franklin
D. Roosevelt was searching for ways out of the depression. He not only
devalued the dollar and took the US off the gold standard, but repudiated
all contracts, public or private, which were denominated in gold.
Again, in 1971, president Richard Nixon ended the Bretton Woods system
by stopping the exchangeability of dollars into gold. Gold was becoming
attractive simply because of lack of faith in a US which was printing
money to finance war and a prosperous peace. The net result was a decade
or more of high inflation.
I am not suggesting that high inflation will return. But one must assume
either a period of artificially low interest rates to enable households
and the US government to manage its debt at the expense of the foreign
suckers who bought it. Or there is going to be an upsurge in US protectionism
as the great promoters of free trade and globalisation find it is not
working out as planned. The success of John Edwards' campaign for the
Democratic nomination shows the way the wind is blowing. Republicans
may in principle be more free-trade oriented, but it is hard to imagine
the Bush administration, with its contempt for foreign views, defending
The third possibility is that there will be some form of dollar crisis
which will lead the US to freeze the dollar balances held by foreign
central banks, and even private institutions. Perhaps they would continue
to earn interest, but the principal would be subject to controls on
how and when it could be spent. The world needs the dollar as it premier
trading currency. It cannot be replaced, except over many years. But
it is possible to imagine a two tier-exchange system which separated
the dollar's trading role from that of the disastrous state of the US
foreign asset-liability balance.
Some Hongkongers may remember the problems caused by its membership
of the sterling area when Britain's own overseas position became too
weak to sustain its reserve currency role. Hong Kong kept its fiscal
reserves in sterling but following the devaluation in 1967 had to be
offered guarantees to ensure it did not switch to dollars, further draining
The dollar problem is different. There is no alternative to the dollar.
But the size of the US foreign-debt overhang relative to the economy
is vastly greater than it was for Britain.
The crisis may be avoided. But as long as Asian governments continue
to bury their heads, fail to look at the facts or history, they will
contribute to the demise of a system they claim to be supporting. They
are underwriting the Greenspan hubris and in the process leading US
households into deep water, and America itself into a debt position
which will have dire consequences for its own influence and for the
system over which it has presided.
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