Will a US dollar collapse end American hegemony?

av Scott Champion, Share International, juli 2003

In the past 24 months, the US dollar has lost 25 per cent of its value relative to a basket of key currencies, including the Japanese yen, euro, Swiss franc, Canadian dollar, Swedish krona and British pound. A drop of this magnitude is not unusual in the cyclic swings of currency markets; however, what has changed is that the Bush administration appears to be actively seeking an even lower dollar. If so, this would be a sharp reversal of the Clinton administration’s strong dollar policy.
The US would like a lower dollar for several reasons. First, a cheaper dollar makes US goods more competitive in foreign markets, thus benefiting US-based multinational corporations. It also makes imports more expensive relative to goods produced in the US. In both cases, American companies would enjoy a distinct advantage.

Secondly, the imperialistic policies of the Bush administration are expensive and must be financed, which means borrowing in international capital markets. The US is currently running a $600 billion current-account deficit (trade deficit adjusted by unilateral transfers such as interest earned abroad). This means the US must borrow more than $1.5 billion per day on a net basis from international lenders. For borrowers such as the US, it is generally easier to pay back loans in a depreciating currency rather than an appreciating one. Due to the large sums involved and a weak domestic economy, a strong dollar would make it more difficult for the US to finance its self-appointed role as the “world’s policeman”.
The US’s increasingly desperate financial condition is not good news for the world. With short-term interest rates near zero, there is little additional economic benefit to be gained from lowering them further. This leaves a cheaper dollar as one of the last levers to stimulate the US economy. As long as lenders are willing to invest in dollar assets, the US can continue to borrow to maintain its current lifestyle. However, if foreign lenders begin to shun US markets because of a falling dollar, it could cause serious problems for the US Government, economy and people.

For many years the US has been the economic engine for the world, standing in as purchaser of last resort for the world’s supply of goods in times of global economic distress. Now the US itself is in trouble. If the US attempts to fight the rapidly gaining forces of deflation by encouraging a depreciating dollar, it will export deflation to the rest of the world because foreign currencies will rise relative to the dollar. This will damage foreign economies and inhibit their ability to buy goods and services, including those from the US. Since the short-term benefit of a weak dollar to US corporations’ earnings will show up quickly, while the long-term damage to the global economy will become apparent only with the passage of time, it is a fair assumption that the US will take the easy route and worry about the global fallout later.
The problem with this approach for the Bush administration is that there are great risks to a weak dollar policy. The world economy is awash in dollars, and when there is too much of something the price or value usually drops, sometimes precipitously. If confidence in the dollar or dollar assets, such as Treasury bonds, declines, the world may, at some point, reconsider its involvement with US assets. The results of such a reappraisal could be anything from mildly damaging to catastrophic. Seventy-five per cent of the world’s central-bank assets are held in US dollars (as Treasury bonds). These bankers do not want their primary asset to suffer a significant decline.

Many nations, like Japan, recycle their trade surpluses into US dollars by purchasing and holding US Treasury bonds. They do this out of self-interest. In the case of Japan, it helps to weaken the yen relative to the dollar. It is hard to imagine the Japanese reversing this policy, as it would harm their own corporations. However Japan, together with the rest of the world, holds nearly a third of total US Treasury debt. If these countries were to stop buying Treasuries, let alone start selling the ones they already own, the US would be in serious trouble. What should concern the US authorities about a weak dollar policy is that the decline could spin out of control.
When the global stock-market crash predicted in this magazine occurs, international support for the dollar will likely evaporate as countries sell dollar assets to shore up their own ailing economies. If this happens, the US will have great difficulty funding its historically large budget and trade deficits. At a most inopportune time, the US may be forced to raise interest rates sharply to attract the capital to meet its obligations. This would be a further blow to an ailing economy. A collapsing US stock market would almost certainly usher in a period of deflation for the American economy. Recent statements by Federal Reserve chairman Alan Greenspan and New York ‘Fed’ governor Bernacke make clear that the Fed is concerned about deflation and stands ready to print an unlimited supply of dollars to fight this eventuality. These statements are unprecedented in the 90-year history of the US Federal Reserve Bank and are tantamount to a declaration that they stand willing to destroy the value of the dollar in the event of a serious crisis.

Today, many forces are coming together that could lead to a collapse of the US dollar. Among these are its oversupply, low interest rates, the need to fight deflation, continuing stock-market declines, and a potential derivatives meltdown [see Share International May 1990] It is highly likely that in the not-too-distant future all of these factors will come into play simultaneously. In addition, many of the world’s financiers, central bankers, and government officials cannot be pleased with the economic and foreign policies of the Bush administration. They well know that the continued recycling of capital into US assets serves, at least in part, to allow the US to dominate the world. If the people who control the world’s capital were to decide, for whatever reason, to cease buying Treasury securities and to liquidate those they own, the dollar would collapse and the US would experience an unprecedented economic shock. Were this to happen, the world would witness the end of American hegemony.