Neville Bennett - $US

The US provides the largest global market for goods and services. It performs extremely efficiently in providing employment not only for its own citizens, but also for the rest of the world. Its influence sways the fortunes of New Zealand farmers, Pakistani weavers, Japanese automakers and French vintners, to name only a few. Their exports to the USA are funded largely by debt creation.

The financial manipulation to fund these imports, especially a burgeoning trade deficit has attained bubble dimensions. As we have observed in past columns, Arthur Greenspan keeps turning the han-dle of the printing press, lowering interest rates, and taking every other measure necessary to deliver easier credit. The bubble has extended to every corner of the financial world, but is prominent in housing. This credit creation, partly motivated to support the equity market, is naturally affecting the $US. Its depreciation is rapidly be-coming a rout.

It is important that the USA plays the linchpin role in credit creation. As the largest economy, and the global lender of last resort, the US must provide adequate international liquidity. But it has an-other important role, that of providing a reserve currency and a store of value. These roles are in conflict, as a weak dollar, is a poor re-serve and inadequate store of value. Conversely a strong dollar, while being good for reserves, inhibits trade. The balance between these roles is admittedly difficult to attain. The current Bush admini-stration seems unable to cope with its financial responsibilities.

The burden is shared. International investors have played their part by purchasing American debt. But again an imbalance is appar-ent. The USA has become the world’s largest borrower, and its chances of moving to an equilibrium position are negated by its lack of domestic savings. The USA depends on foreign capital, and its over-dependence is being signaled in the market by a declining dollar and a surging gold price.

In the last 12 months, the dollar has depreciated against the $NZ by 23.6%, the $AU by 13.3%, the Yen by 10.75%, the Pound by 11.3% and the euro 17.4%. The trend appears to be accelerating. This is partly motivated by political events, especially the Iraq situa-tion.

Certainly war worries have driven the currency down every day since December. But this is an insufficient explanation for the dollar reaching a three year low against the Euro, and persistent weakness against other currencies.

The weakness of US equity markets is obviously a concern. When the Dow or NASDAQ appreciate, trading screens light up indi-cating a flow of foreign funds into equities. But equities are in the dol-drums, especially as such important indicators as Intel and Microsoft report weak prospects.

Capital flows are the most significant driver of the dollar. The flows are affected by equity prices but more by fundamentals, such as interest rates and the trade deficit. The dollar was rocked by the release of data which showed that the trade gap widened to a record $US 40 billion for December. This huge deficit subtracts from GDP but weakens the dollar by purchasing credit, in the form of capital in-flows, to fund the US’s enormous current account deficit. The dollar noticeable weakened too on news that industrial production and ca-pacity utilization fell in December. Record low interest rates also make dollar securities relative unattractive.

The funding of American debt is a disaster waiting to happen. The US current account deficit was minus $ 445 billion in 2000, -$447 billion in 2001 and -$435 in 2002. This deficit can only be funded by foreigners as US saving is often negative or inconsequential, its ex-ternal investments are negative two trillion dollars, and its fiscal posi-tion has deteriorated owing to tax cuts and rocketing security expen-ditures. The current spike in oil prices adds to these pressures, and may be enough to tip the economy into deeper recession.

Japan has been the main source of funding US requirements, but this stream of money may diminish as Japan’s population ages (and repatriates savings) and its Government struggles with indebt-edness. The Euro area exported $347 billion 1999-2001, but this flood will diminish as the community invests more in Eastern Europe and increases social spending.

The USA was fortunate until recently, but its luck is changing. It attracted $424 in bond sales alone in 2001(which helped to keep in-terest rates low) but is unlike to retain as much respect as yields fall and economic growth falters. The country has reaped the benefits of providing the major global currency, and capital inflows have encour-aged continuing prosperity. It has been largely spared the contraction that is evident in Japan, Germany, and Hong Kong.

Nevertheless, the advantages to foreign investors depositing money in the USA have diminished and some reversal of capital flows is possible. If this is the case, the dollar will continue to weaken and there will be pressure to raise interest rates. Moreover, there are competitors to the dollar as a reserve currency, the yen and euro re-main attractive, and there are plans for a gold-based international currency. Thus, the dollar is not invulnerable in the longer term. Some quite dramatic changes in the economic international order are not beyond the impossible.

Neville Bennett
Christchurch, New Zealand
n.bennett@hist.canterbury.ac.nz.

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