September 4, 2008 - No. 112

U.S. Dollar Hegemony

Falling Value of U.S. Dollar

The size of the U.S. accumulated deficit in foreign trade in 2006 reached the record value of U.S.$836 billion. The U.S. national debt is around U.S.$9 trillion. Over half of that debt is held by the U.S. federal government itself and put aside in trust accounts for social security payments etc. About $4 trillion is held by others mostly foreign governments and companies. Foreign governments use their allocated currency reserves of around $4.322 trillion to buy U.S. debt in large part U.S. Treasury securities. New batches of these U.S. government-backed IOUs are auctioned off every three months. Recent figures indicate Japan holds the most with $644 billion, followed by China ($350 billion), United Kingdom ($239 billion) and oil exporting countries ($100 billion). Billions of dollars of other U.S. debt issued by private companies such as the mortgage monopolies Fannie Mae and Freddie Mac is routinely bought by non-U.S. companies, governments and individuals. In recent years to keep up with its current account deficit with the rest of the world, new monthly borrowing abroad by the U.S. government and companies is averaging $50 billion per month.

When analyzing the significance of the U.S. trade deficit and debt to foreigners, one has to consider terms of trade and U.S. dollar hegemony. U.S. dollar hegemony is the use of its currency within the imperialist system of states as the main means to settle international accounts, set market prices and hold in reserve. Countries use U.S. dollars and dollar denominated obligations to settle transactions in the basic commodities such as oil, other traded goods and as a reserve currency. To a much lesser extent, this is also practiced by the other currencies of the Triad especially the euro.

The continuing U.S. trade deficit, which forms the major part of its current account deficit, is not an ordinary textbook trade deficit that must be paid from U.S. added-value. The trade deficit in large measure is a U.S. paper transaction covered by borrowing, which becomes part of a nominal national debt. As long as the U.S. Empire dominates the world, and other countries continue buying new U.S. debt and using U.S. dollars as a reserve and to settle international accounts, the U.S. national debt and trade deficit are not a problem for U.S. imperialism. New U.S. debt pays the servicing of old debt and the ongoing trade deficits. The old debt just keeps increasing with more than $50 billion a month flowing into the U.S. as new debt.

Countries within the imperialist system of states such as China accept the U.S. dollar as payment for their exported goods or readily accept U.S. dollars in exchange for their local currency to complete the transaction, which amounts to the same thing. The exporting country ends up holding U.S. dollars. What do they do with their U.S. dollars? They hold them in reserve; they give them back to the U.S. in exchange for U.S. debt instruments such as U.S. Treasury bills or company bonds of the large U.S. banks and lending institutions such as Fannie Mae and Freddie Mac etc.; they use them to buy commodities such as oil or settle accounts with third countries. U.S. dollars and debt instruments (IOUs for billions of dollars) in this way act as an international currency. Many of the U.S. dollars that flow out of the U.S. for payment of goods or in exchange for other currencies either never return to the U.S. to be exchanged for material value or return only to buy this or that form of U.S. debt. This is U.S. dollar hegemony in action.

U.S. borrowing to cover trade deficits, war spending and to pay interest and roll over existing debt is a fraud forcing those countries entrapped within the imperialist system of states to pay tribute to the most dominant imperialist power.

Global Reserves and U.S. Dollar Hegemony

Data from the International Monetary Fund released this past June, which covers about two-thirds of the world's foreign exchange reserves, showed that global central banks' currency reserves rose to U.S.$6.873 trillion at the end of the first quarter 2008.

This is an increase of 7.4 percent from the fourth quarter in 2007.

Total allocated reserves increased 6 percent to $4.322 trillion. Allocated reserves are those whose currency composition has been identified as U.S. dollar, euro, yen, sterling or Swiss Franc holdings.

Identified U.S. dollar reserves (outside the U.S.) were at a record $2.7 trillion, or 63.0 percent of the total allocated reserves. The U.S. dollar's total amount was higher but its share of allocated reserves was down from 64.0 percent in the previous quarter and lower than the 65.1 percent allocation a year earlier.

Reuters writes, the U.S. dollar's share of these holdings declined as the currency's value weakened during the period. Quarterly data are available only as far back as 1999, but the last time the dollar's share fell this low on an annual basis was 1996, when it stood at 62.1 percent.

"The impact of the falling value of the dollar on composition valuations did play a factor in dragging down the dollar's share of FX reserves versus the euro," said Ashraf Laidi, chief currency strategist at CMC Markets U.S. in New York.

The New York Board of Trade's U.S. dollar index for trading purposes dropped 6.4 percent in the first quarter of the year. Specifically against the euro, the U.S. dollar was down about 8 percent in the same period.

The euro's share of allocated reserves marginally rose to 26.8 percent in the first quarter, a record high, from 26.4 percent in the fourth quarter. The fourth quarter figure was up from 25.0 percent a year ago.

"The rise in the euro's weighting (as allocated currency reserves) in Q1 mostly reflected the fact that the euro appreciated sharply in that quarter -- hence raising the value in dollar terms of existing euro assets," said Michael Saunders, an analyst at Citigroup in London.

Analysts said, though, that the rise in euro reserves was relatively modest given how sharp the single currency's rise had been against the dollar in that period.

CMC's Laidi said the value of the currency does not usually play a role in determining the share of the reserves.

For instance, he said, the euro's composition rose in 2000 and 2001 at a time when the euro dropped 6 percent against the dollar in both years. And, at the current pace, Laidi reckoned that the euro may not attain a 50-50 percent composition (versus the U.S. dollar) before 2020.

Sterling's (British Pound) allocation in the first quarter was at 4.7 percent, little changed from the previous quarter. Central banks also increased their allocation of yen to $134 billion, or 3.1 percent, from $117 billion the previous quarter, or 2.8 percent, while allocating 0.1 percent to the Swiss franc.

Reuters writes, global reserves have increased every quarter since the first quarter of 2001, and the pace of accumulation has gained over the last five years. The accumulation of reserves, much of which is invested in U.S. debt markets, has mirrored rising current account deficits in the United States. The IMF data is closely monitored since speculation has mounted in recent years that central banks may be looking to trim the heavy weight of the dollar in their currency holdings and therefore minimize exposure to the greenback's declines. So far, however, the evidence of a significant shift has been erratic. Although the dollar's share has dropped from around 71 percent in 1999, the year the euro was launched, it has remained generally steady over the past four years. Alan Ruskin, chief international strategist at RBS Greenwich Capital said,

"The best explanation for this apparent lack of diversification is that the investment arm of central banks selling dollars ... has ... been offset by the wing of the central bank that has a foreign exchange objective (through a quasi/loose dollar peg) that has been buying dollars back in a weak dollar environment."

(Source: Reuters)

For Your Information
Dollars and Sense Internet Magazine January/February 2005
(excerpts)

The value of the U.S. dollar is falling. It's what lies behind the slide of the dollar that has even many mainstream economists spooked: an unprecedented current account deficit the difference between the country's income and its consumption and investment spending. The current account deficit, which primarily reflects the huge gap between the amount the United States imports and the amount it exports, is the best indicator of where the country stands in its financial relationship with the rest of the world.

At an estimated $670 billion, or 5.7% of gross domestic product (GDP), the 2004 current account deficit is the largest ever. An already huge trade deficit (the amount of exports falls short of imports) made worse by high oil prices, along with rock bottom private savings and a gaping federal budget deficit, have helped push the U.S. current account deficit into uncharted territory. The last time it was above 4% of GDP was in 1816, and no other country has ever run a current account deficit that equals nearly 1% of the world's GDP.

Most of the current account deficit stems from the U.S. trade deficit (about $610 billion). The rest reflects the remittances immigrants send home to their families plus U.S. foreign aid (together another $80 billion) less net investment income (a positive $20 billion because the United States still earns more from investments abroad than it pays out in interest on its borrowing from abroad).

The current account deficit represents the amount of money the United States must attract from abroad each year. Money comes from overseas in two ways: foreign investors can buy stock in U.S. corporations, or they can lend money to corporations or to the government by buying bonds. Currently, almost all of the money must come from loans because European and Japanese investors are no longer buying U.S. stocks. U.S. equity returns have been trivial since 2000 in dollar terms and actually negative in euro terms since the dollar has lost ground against the euro.

In essence, the U.S. economy racks up record current account deficits by spending more than its national income to feed its appetite for imports that are now half again exports. That increases the supply of dollars in foreign hands.

At the same time, the demand for dollars has diminished. Foreign investors are less interested in purchasing dollar-dominated assets as they hold more of them (and as the self-fulfilling expectation that the value of the dollar is likely to fall sets in). In October 2004 (the most recent data available), net foreign purchases of U.S. securities -- stocks and bonds -- dipped to their lowest level in a year and below what was necessary to offset the current account deficit. In addition, global investors' stock and bond portfolios are now overloaded with dollar-denominated assets, up to 50% from 30% in the early '90s.

Under the weight of the massive current account deficit, the dollar has already begun to give way. Since January 2002, the value of the dollar has fallen more than 20%, with much of that drop-off happening since August 2004. The greenback now stands at multiyear lows against the euro, the yen, and an index of major currencies.

Should foreign investors stop buying U.S. securities, then the dollar will crash, stock values plummet, and an economic downturn surely follow. But even if foreigners continue to purchase U.S. bonds -- and they already hold 47% of U.S Treasury bonds -- a current account deficit of this magnitude will be a costly drag on the economy. The Fed will have to boost interest rates, which determine the rate of return on U.S. bonds, to compensate for their lost value as the dollar slips in value and to keep foreigners coming back for more. In addition, a falling dollar makes imports cost more, pushing up U.S inflation rates. The Fed will either tolerate the uptick in inflation or attempt to counteract it by raising interest rates yet higher. Even in this more orderly scenario of decline, the current expansion will slow or perhaps come to a halt.

Imperial Finance

You can still find those who claim none of this is a problem. Recently, for example, the editors of the Wall Street Journal offered worried readers the following relaxation technique -- a version of what former Treasury Secretary Larry Summers says is the sharpest argument you typically hear from a finance minister whose country is saddled with a large current account deficit.

First, recall that a large trade deficit requires a large surplus of capital flowing into your country to cover it. Then ask yourself, would you rather live in a country that continues to attract investment, or one that capital is trying to get out of? Finally, remind yourself that the monetary authorities control the value of currencies and are fully capable of halting the decline.

If the United States Were an Emerging Market

If the United States were a small or less-developed country, financial alarm bells would already be ringing. The U.S. current account deficit is well above the 5%-of-GDP standard the IMF and others use to pronounce economies in the developing world vulnerable to financial crisis.

Just how crisis-prone depends on how the current account deficit affects the economy's spending. If the foreign funds flowing into the country are being invested in export-producing sectors of the economy, or the tradable goods sectors, such as manufacturing and some services, they are likely over time to generate revenues necessary to pay back the rest of the world. In that case, the shortfall is less of a problem. If those monies go to consumption or speculative investment in non-tradable (i.e., non-export producing) sectors such as real estate, then they surely will be a problem.

By that standard, the U.S. current account deficit is highly problematic. Economists assess the impact of a current account deficit by comparing it to the difference between net national investment and net national savings. (Net here means less the money set aside to cover depreciation.) In the U.S. case, that difference has widened because saving has plummeted, not because investment has picked up. Last year, the United States registered its lowest net national savings rate ever, 1.5%, due to the return of large federal budget deficits and anaemic personal savings. In addition, U.S. investment has shifted substantially away from tradable goods as manufacturing has come under heavy foreign competition toward the non-traded goods sector, such as residential real estate whose prices have soared in and around most major American cities.

Capital inflows that cover a decline in savings instead of a surge in investment are not a sign of economic health nor cause to stop worrying about the current account deficit.

Feel better? You shouldn't. Arguments like these are unconvincing, a bravado borne of old-fashioned, unilateral financial imperialism that underlies the muscular U.S. foreign policy we see today.

True, so far foreigners have purchased the gobs of debt issued by the U.S. Treasury and corporate America to cover the current account deficit. And that has kept U.S. interest rates low. If not for the flood of foreign money, Morgan Stanley economist Stephen Roach figures, U.S. long-term interest rates would be between one and 1.5 percentage points higher today.

The ability to borrow without pushing up interest rates has paid off handsomely for the Bush administration. Now when the government spends more than it takes in to prosecute the war in Iraq and bestow tax cuts on the rich, savers from foreign shores finance those deficits at reduced rates. And cash-strapped U.S. consumers are more ready to swallow an upside-down economic recovery that has pushed up profit but neither created jobs nor lifted wages when they can borrow at low interest rates.

How can the United States get away with running up debt at low rates? Are other countries' central banks and private savers really the co-dependent "global enablers" Roach and others call them, who happily hold loads of low-yielding U.S. assets? The truth is, the United States has taken advantage of the status of the dollar as the currency of the global economy to make others adjust to its spending patterns. Foreign central banks hold their reserves in dollars, and countries are billed in dollars for their oil imports, which requires them to buy dollars. That sustains the demand for the dollar and protects its value even as the current account imbalance widens.

The U.S. strong dollar policy in the face of its yawning current account deficit imposes a "shadow tax" on the rest of the world, at least in part to pay for its cost of empire. "But payment," as Robert Skidelsky, the British biographer of Keynes, reminds us, "is voluntary and depends at minimum on acquiescence in U.S. foreign policy." The geopolitical reason for the rest of the capitalist world to accept the "seignorage of the dollar" in other words, the advantage the United States enjoys by virtue of minting the reserve currency of the international economy became less compelling when the United States substituted a "puny war on terrorism" for the Cold War, Skidelsky adds.

The tax does not fall only on other industrialized countries. The U.S. economy has not just become a giant vacuum cleaner that sucks up "all the world's spare investible cash," in the words of University of California, Berkeley economist Brad DeLong, but about one-third of that money comes from the developing world. To put this contribution in perspective: DeLong calculates that $90 billion a year, or one-third of the average U.S. current account deficit over the last two decades, is equal to the income of the poorest 500 million people in India.

Global Uprising

Not surprisingly, old Europe and newly industrializing Asia have grown weary from all their heavy lifting of U.S. securities. And while they have yet to throw them overboard, a revolt is brewing.

Those cranky French are especially indignant about the unfairness of it all. The editors of Le Monde, the French daily, complain that "The United States considers itself innocent: it refuses to admit that it lives beyond its means through weak savings and excessive consumption." On top of that, the drop of the dollar has led to a brutal rise in the value of the euro that is wiping out the demand for euro-zone exports and slowing their already sluggish economic recoveries.

Even in Blair's Britain the Economist ran an unusually tough-minded editorial warning: "The dollar's role as the leading international currency can no longer be taken for granted. Imagine if you could write checks that were accepted as payment but never cashed. That is what [the privileged position of the dollar] amounts to. If you had been granted that ability, you might take care to hang to it. America is taking no such care. And may come to regret it."

But the real threat comes from Asia, especially Japan and China, the two largest holders of U.S. Treasury bonds. Asian central banks already hold most of their reserves in dollar-denominated assets, an enormous financial risk given that the value of the dollar will likely continue to fall at current low interest rates.

In late November, just the rumour that China's Central Bank threatened to reduce its purchases of U.S. Treasury bonds was enough to send the dollar tumbling.

No less than Alan Greenspan, chair of the Fed, seems to have come down with a case of dollar anxiety. In his November remarks to the European Banking Community, Greenspan warned of a "diminished appetite for adding to dollar balances" even if the current account deficit stops increasing. Greenspan believes that foreign investors are likely to realize they have put too many of their eggs in the dollar basket and will either unload their dollar-denominated investments or demand higher interest rates. After Greenspan spoke, the dollar fell to its lowest level against the Japanese yen in more than four years.

A Rough Ride from Here

The question that divides economists at this point is not whether the dollar will decline more, but whether the descent will be slow and orderly or quick and panicky. Either way, there is real reason to believe it will be a rough ride.

First, a controlled devaluation of the dollar won't be easy to accomplish. Several major Asian currencies are formally or informally pegged to the dollar, including the Chinese yuan. The United States faces a $160 billion trade deficit with China alone.

A fall in the dollar sufficient to close the current account deficit will slaughter large amounts of capital. The Economist warns that "[i]f the dollar falls by another 30%, as some predict, it would amount to the biggest default in history: not a conventional default on debt service, but default by stealth, wiping trillions off the value of foreigners' dollar assets."

Even a gradual decline in the value of dollar will bring tough economic consequences. Inflation will pick up, as imports cost more in this bid to make U.S. exports cheaper. The Fed will surely raise interest rates to counteract that inflationary pressure, slowing consumer borrowing and investment. Also, closing the current account deficit would require smaller government deficits. (Although not politically likely, repealing Bush's pro-rich tax cuts would help.)

What will happen is anyone's guess given the unprecedented size of the U.S. current account deficit. But there is a real possibility that the dollar's slide will be anything but slow or orderly. Should Asian central banks stop intervening on the scale needed to finance the U.S. deficit, then a crisis surely would follow. The dollar would drop through the floor; U.S. interest rates would skyrocket (on everything from Treasury bonds to mortgages to credit cards); the stock market and home values would collapse; consumer and investment spending would plunge; and a sharp recession would take hold here and abroad.

The Bush administration seems determined to make things worse. Should the Bush crew push through their plan to privatize Social Security and pay the trillion-dollar transition cost with massive borrowing, the consequences could be disastrous. The example of Argentina is instructive. Privatizing the country's retirement program, as economist Paul Krugman has pointed out, was a major source of the debt that brought on Argentina's crisis in 2001. Dismantling the U.S. welfare state's most successful program just might push the dollar-based financial system over the edge.

The U.S. economy is in a precarious situation held together so far by imperial privilege. Its prospects appear to fall into one of three categories: a dollar crisis; a long, slow, excruciating decline in value of the dollar; or a dollar propped up through repeated interest rates hikes. That's real reason to worry.

Dollars & Sense Internet Magazine March/April2004
(excerpts)

If Americans collectively import more goods and services from foreigners than we export, we are said to have a trade deficit. Paying for the things we import accounts for most of the flow of dollars out of the United States. However, money flows out of the country for other reasons as well. The U.S. government supports overseas military bases; immigrants to the United States send dollars back to their families; foreigners who own U.S. businesses or financial assets take income out of the country.

When these factors are added to the trade deficit, the net outflow of dollars is called the current account deficit. In 2002, the U.S. trade deficit amounted to $418 billion, and the current account deficit totalled $480 billion. Preliminary data for 2003 indicate the current account deficit will be at least $550 billion.

Once the dollars leave the country, three things can happen.

First, foreigners can use dollars to purchase U.S. assets: stocks, bonds, bank deposits, government debt, real estate, businesses. When Toyota buys land and equipment for a factory in the United States, when a British investment fund buys stock in a U.S. corporation, when a German bank purchases U.S. Treasury bonds, then the United States is said to be "financing" its current account deficit by selling assets. In 2002, foreigners acquired $612 billion in U.S. assets.

The United States has run persistent and increasing current account deficits since the 1980s, and foreigners have used the dollars to stake significant claims on U.S. assets. At the end of 2002, the value of U.S. assets owned by foreigners exceeded the value of foreign assets owned by U.S. residents by $2.4 trillion. This is the reason the United States is often said to be a debtor nation, with a net debt to the rest of the world of $2.4 trillion. But this "debt" is denominated in our own currency. For that reason, it does not pose the same risks for the United States as developing countries with large debts face because their debt must be repaid in dollars or euros.

Foreign central banks provide a second outlet for dollars that leave the United States. The dollar is the most widely used international currency, and many less-developed countries have sizable dollar-denominated debts. Governments sometimes hang on to whatever dollars fall into their hands, parking them in liquid assets like U.S. bank accounts or U.S. government bonds to earn interest. In 2002, foreign governments held almost $95 billion in dollar reserves.

In 2002, on balance, more dollars flowed back into the United States to purchase assets then flowed out. This allowed U.S. companies to buy assets overseas, almost $200 billion worth.

As long as the country's large current account deficit is financed by these capital inflows, it is not necessarily a problem. But a third possible consequence of the massive U.S. current account deficit is that foreigners will lose confidence in the U.S. economy and stop purchasing U.S. assets. If this happens, the supply of dollars in the global banking system will exceed demand and the exchange value of the dollar will fall.

Over the past few years, the dollar lost about one-third of its value relative to the euro. This could signify that foreigners are shifting from U.S. to euro-based assets. If the era of dollar supremacy is indeed coming to a close, the value of the dollar will continue to fall.

(If the value of the dollar continues to fall) imports would grow more expensive. With less foreign demand for U.S. assets, stock prices might tumble and interest rates rise. United States-based banks and corporations would find it harder to buy foreign assets and expand overseas. The dollar has been in trouble before and, in the past, the U.S. government pressured other countries to buy or hold dollars and prop up its value.

***

Other pertinent facts:

The U.S. Commerce Department reported the May 2008 deficit on trade in goods and services was $59.8 billion. This was not much changed from the April deficit of $60.5 billion in April.

Petroleum products accounted for $33.2 billion of the monthly trade gap, on a seasonally adjusted basis. Since December 2001, net petroleum imports have increased $27.7 billion, as the average price of a barrel of imported oil has risen from $15.46 to $106.28., and monthly imports of oil and refined products have increased from 353 million to 373 million barrels.

In 2007, the Chinese government purchased $462 billion in U.S. and other foreign currency and securities. This comes to about 14 percent of China GDP and about 35 percent of its exports of goods and services. These purchases provide foreign consumers with 3.5 trillion Yuan to purchase Chinese exports.

Trade deficits must be financed by foreigners investing in the U.S. economy or Americans borrowing money abroad. Direct investments in the United States provide only about a tenth of the needed funds, while Americans borrow abroad about $50 billion each month.

Since December 2007, the U.S. economy has lost 438,000 jobs 235,000 jobs in manufacturing and 261,000 in construction.

The U.S. manufacturing sector has lost 3.8 million jobs since 2000.

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