From: Rakesh Bhandari (bhandari@BERKELEY.EDU)
Date: Thu Dec 02 2004 - 19:55:10 EST
More on the consequences of the dollar having replaced the gold
standard. As far as I know, Anwar Shaikh, Fred Moseley and others
have not responded to this kind of analysis. I pointed to this kind
of analysis in the piece I wrote about Mattick for the International
Journal of Political Economy.
rb
The US Current Account Deficit under the Floating Dollar Standard #
Franklin Serrano *
In recent years, the current account deficit of the American economy
has been growing sharply, reaching five per cent of its GDP in 2002.
Along with the deficit, there has also been a marked increase in the
number of heterodox economists who believe that the American foreign
debt ("the biggest in the world") is becoming unsustainable. These
include some Marxists (Giovani Arrighi, Anwar Shaikh, Jayati Ghosh
and several others), Post-Keynesians (Wynne Godley, Robert Blecker,
Jane DŽArista, Dean Baker,Tom Pailley, James Galbraith, among many
others) and also some Latin American structuralists (Arturo O'Connell
and Celso Furtado, to cite only the most notable)[1]. If the American
external deficit is not substantially reduced, they argue, this will
trigger a "speculative attack against the dollar", and consequently,
a serious crisis in the American (and world) economy. With this
crisis, the dollar would probably lose the central role that it plays
in the world economy today.
In fact, what these heterodox critics do not seem to notice is that
the American current account deficits and external liabilities are
very different from those of a country like Brazil and even from
those of the other rich countries. This is due to the fact that the
dollar is nowadays the international currency of the world economy.
The world economy works in practice, at least since 1980, in what we
have been calling the 'floating dollar standard'[2], where the dollar
has a very different role from all other currencies (including the
convertible currencies of the other rich countries). This gives
extraordinarily asymmetric power to the US economy, which simply does
not have any kind of balance of payments constraint.
The position of the American dollar is different from all other
currencies for several reasons. First and most importantly, the
dollar is the international means of payment. This means that,
contrary to other countries, almost all that the US imports are paid
for in dollars. This also implies that virtually the whole of
American external liabilities are also denominated in dollars. Since
the dollar is issued by the FED (American Central Bank), it is
impossible (since American imports are paid for in dollars) for the
US not to have enough resources (dollars) to pay their external
liabilities. Moreover, naturally, it is the FED that determines the
dollar's basic interest rate[3].Therefore, since the American foreign
debt is denominated in dollars, the US is in the peculiar position of
unilaterally determining the interest rate paid on their own foreign
debt.
Further, the American public debt - that pays interest rates set by
FED - is the most liquid dollar financial asset and is also the most
important reserve asset and store of value of the international
financial system. Thus, another consequence of the fact that American
external liabilities are denominated in dollars is that when the
dollar depreciates relative to any other currency, it is the owners
of the American foreign debt of that country who will suffer balance
sheet losses instead of the US.
Another advantage for the US due to the special position of the
dollar is that exchange rate devaluations cause very little inflation
in the US. This is because in a large part of the international
markets, including almost all commodity markets, prices are set
directly in dollars and, as in the case of the oil price, for
instance, do not increase when the dollar is devalued. Recent
econometric estimates show that on average, less than 50% of the
devaluations of the dollar is passed through as increase in the
internal prices of imported products[4]. It is clear that under these
special conditions, the US, unlike Brazil and all other countries of
the world, can have a regime of floating exchange rates and free
short-term capital flows without these creating any problems for its
macroeconomic policies.
Let us consider three recent examples of how things are really
different for the dollar. Our first example is from 2001. In that
year, when the September 11 terrorist attack took place, the American
recession had already started with the decrease of private
investment, due to the excessive productive capacity that had been
rapidly installed in high technology sectors of the "new economy"
during the NASDAQ bubble.
The American policy answer to the crisis was fast and drastic. The
basic interest rate was reduced, there was an enormous coordinated
injection of liquidity into the international financial system by the
FED, together with the central banks of the rich countries. There
were also increases in public spending, tax cuts, and government
financial help for especially jeopardized sectors such as airlines
and insurance companies.
All these measures certainly avoided the deepening of the recession
and the disorganization of the financial system. Just after the
terrorist attack, there was a natural tendency in international
financial markets for "flights to safety", due to the increased
perceptions of risk and uncertainty. This was worsened by the initial
fear that the "war against terrorism" would end up triggering greater
supervision and control of international capital flows, with the aim
of combating money laundering channels and locating the financial
sources of the terrorists' funds.
For our purposes here, what is important to notice is that this
"flight to quality" of the market was a run for the dollar and not
from the dollar, despite interest rate reductions, more than
confirming the role of the dollar as the 'store of value' currency of
the capitalist world economy. It is to the dollar that the market
runs at moments of crisis, even when the crisis, as in this case,
occurs in New York, at the financial centre of the US dollar.
Our second example is from 2002. The damage control and expansionary
measures described above were already beginning to work in 2002.
However, the scandals of Enron and other big companies caught
falsifying their balance sheets exacerbated the bursting of the stock
market bubble. Until then, with the FED's help, the overall stock
market bubble had survived not only the collapse of the NASDAQ
bubble, but also the terrorist attack.
Since the dollar was mainly being kept strong by foreign demand for
papers negotiated in the American stock market and the FED was
already quickly reducing the American interest rate (by much more
than in the other rich countries), it is only natural that the dollar
started to depreciate.
However, the result of this recent foreign capital outflow from the
US and of the devaluation of the dollar, contrary to what many
heterodox economists mentioned above had foreseen, has been the
continuous reduction (instead of increase) of American interest
rates. These interest rate decreases have lowered the financial
losses of heavily dollar-indebted American firms and workers and has
also been helping to keep demand growing, both in the markets for
real estate and for durable consumption goods.
This shows that the US simply does not need those external capital
flows to finance its external current account deficit. The American
external deficit continues to be automatically financed, at the very
moment the transactions that generate this deficit are denominated
and paid in the American national currency. Which other country that
has a stock market crash and an outflow of external capital, answers
these by reducing its interest rate?
Our third example is from 2003. Although the dollar is tending to
devalue, some countries - especially in Asia, as Japan and China
among others - have been doing everything possible to avoid or
contain the appreciation of their currencies relative to the dollar.
On the one hand, these countries do not want the increased costs (in
dollars) of their exports to cause either lower profitability or
lower market share for their products in the international markets.
Moreover, the appreciation of the currencies of these "surplus"
countries that hold a great amount of financial assets in dollars
would bring big balance sheet losses for the local companies and
financial systems. Hence, the central banks of these countries are
actively intervening to buy dollars, and are continually accumulating
their external reserves in dollars, in order to avoid appreciation of
their exchange rates. By now, Japan already holds more than US$600
billion of dollar reserves, while China has already passed the US$350
billion mark. Similarly, South Korea has more than US$100 billion
(built up quickly in recent years after the crisis), Taiwan has more
than US$180 billion, and even Indonesia has more than US$30
billion[5].
f the heterodox critics cited above were correct, the American
government should be noting the fact that although private agents
have "run away from the dollar" in recent times, the governments of
the Asian countries are helping to minimize the devaluation of the
dollar and to finance the enormous American current account deficit,
thus avoiding a "dollar crisis".
But, what is occurring in reality is exactly the opposite of this.
There has been a growing and not very subtle American diplomatic
offensive pressuring the Asian countries to let their currencies
appreciate. The pressure on China to abandon the fixed exchange rate
and to revalue the Yuan, in particular, has been very strong and
there are growing official American accusations that the Asian
countries are "protectionist", follow "mercantilist" policies and
practice "unfair competition". The reason for this pressure seems to
be very simple: at the moment, the American priority is to revive the
domestic economy. The devaluation of the dollar is in the American
interest, in order to increase exports and to reduce American imports
to help domestic economic recovery. The Asians are seen as going
against this plan when they avoid appreciation of their currencies.
This last example shows how the American government is not worried
about the depreciation of the dollar causing any problem, let alone a
"crisis". One reason for this is that (as recent official figures
point out) about a third of the American current account deficit with
"foreign residents" is in fact due to imports from branches of
American multinationals abroad. The main reason, however, is simply
that the American government knows very well that, given its current
condition of being the world's only superpower, it will certainly not
have any difficulty in finding sellers in international markets
willing to accept dollars as payment for its imports.
References
SERRANO, Franklin L. P. (2003). From 'Static' Gold to the Floating
Dollar. Contributions to Political Economy, 22, 87-102 (forthcoming).
BOMFIM, Antulio N. (2003). Monetary Policy and the Yield Curve.
Federal Reserve Board, mimeo, New York
BEDDOES, Zanny M. (2003). Flying on One Engine - a survey of the
world economy. The Economist, September, 20.
SAMUELSON, Robert (2003). A Crackup for World Trade. Newsweek, August, 25.
October 14, 2003.
# I would like to thank, but not implicate, Prof. Paul Davidson for
his comments on an earlier version of this note.
* Associate Professor at the Instituto de Economia, UFRJ, Brazil.
[1] In fact, this view is so widespread nowadays that it is easier to
mention the few exceptions such as Prabhat Patnaik and Paul Davidson
(and curiously enough, Ronald Mckinnon in his new incarnation).
[2] See Serrano (2003).
[3] Besides directly determining the basic short run dollar interest
rate, the FED has a lot of power to influence the determination of
the longer dollar rates of interest set by the market. Because of
arbitrage, these longer rates depend fundamentally on the market
participants' expectations of the future course of the short rates
set by the FED. See Bomfim (2003).
[4] See Beddoes (2003).
[5] See Samuelson (2003).
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© International Development Economics Associates 2003
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