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The
dollar is to decline in value, and an exclusive currency
peg to it, as in the Gulf Cooperation Council (GCC)
countries, is unwise. Given the accumulated US deficits
and imbalances in international trade, this analysis is
such a no-brainer that reiterations of it, including
those by my humble self, have become a bit boring. Thus,
at this stage let us ask the contrarian question: why
has the dollar – although stumbling – still held its
ground as a worldwide reserve currency instead of
falling like a stone, and why have the Gulf countries so
far paid only lip service to a necessary diversification
of their currency holdings?
Total US debt, including that of households and public
agencies, has been ballooning since the 1980s. It now
amounts to $44 trillion – 350 percent higher than the
US' GDP. To make matters worse, most of that money is
spent on consumption, while investments and jobs are
moving to China and elsewhere. Thus, with a dwindling
economic base, this debt has effectively become too high
to be repaid. Either there will be a default in payments
or, more likely, the dollar will be devalued by
inflationary policies to such extent that it will not
hurt to 'pay' it back. Currently, five dollars of
additional debt buy only one dollar of GDP growth, the
net asset position of the US has been increasingly
negative since 1985, and the trade deficit has spiraled
out of control. There is no doubt that the US dollar is
financial radioactive waste, and it is not really clear
why anybody would like to hold it or tie their fate to
this doomed currency. And yet, the US, which needs to
attract 80 percent of worldwide savings to finance its
current account deficit, still manages to do so. Rather
than worldwide investors being suicidal, this is a
problem of size and a lack of alternatives. When you
have a debt of one million, you have a problem, but when
you have a debt of one billion, your bank has a problem
– the latter does not want to write off its assets, and
will continue to throw good money after bad, just to
keep you afloat. That is the position of the US, which
is well aware of it; John Conolly,
treasury secretary in the Nixon Administration,
put
it bluntly in 1971 when the US decoupled the dollar from
gold: “The dollar is our currency but their problem.”
After the oil shock of the 1970s, the OPEC countries
were awash with cash and were obvious candidates to
balance the US deficit. Saudi Arabia, in particular, was
courted by the US administration to buy US securities,
and was given special trenches
of treasury bills that did not go through the normal
competitive auctioning process. In the 1980s, low oil
prices made the current account surpluses of OPEC
countries a thing of the past and Germany and Japan
stepped into the gap, with the latter obtaining the
special trenches that Saudi Arabia had received in the
1970s. With German reunification and Japan’s recession,
the US’ financiers changed once again, as the role was
partly taken up by China and other emerging markets.
Recently, with the resurgence in oil prices, OPEC
countries have come into the spotlight again, as they
have current account surpluses of approximately 35
percent of the US deficit, while the corresponding
figure for Asia is 49 percent.
Recently it has indeed been the oil-exporting countries
that have kept the US dollar afloat, despite occasional
announcements to the contrary. Between September 2005
and April 2006, the treasury holdings of the biggest
holder, Japan, declined from $672 billion to $639
billion, while the number two, China, continued to
increase its holdings from $306 billion to $323 billion,
but did so reluctantly, amidst calls by senior officials
for currency diversification. The oil-exporting
countries and the UK, however, increased their holdings
massively from $66 billion to $99 billion and from $96
billion to $167 billion respectively. The increase in UK
holdings has been attributed largely to Arab buying out
of London.
In light of these plain numbers, GCC announcements of
currency diversification appear to be mere rhetoric. The
1 percent change in Kuwait's currency peg last month was
rather modest, and other GCC countries, like Saudi
Arabia, Oman, and Bahrain, were quick to deny that they
would follow suit in making changes to the status quo.
The plan of the UAE central bank to increase its share
of euros from a meager 2 percent to only 10 percent of
overall currency reserves has been postponed repeatedly,
and has not yet been implemented. As its announcement on
the matter came shortly after the US refused to let
Dubai Ports World handle the management of American
ports in the wake of the P&O takeover, the announcement
might have been no more than a warning of retribution.
Qatar’s position – holding up to 40 percent of currency
reserves in euros and up to 90 percent in dollars –
seems to have been the most courageous one so far, but
in general, one can attest that the special relationship
between the US and the Gulf countries is still intact.
Most importantly, plans are still in place to peg the
unified GCC currency to the US dollar in 2010. Even
neighboring Iran, an outspoken advocate of diversifying
in favor of the euro, and a country hardly known for its
endorsement of US foreign policy, recently shunned Hugo
Chavez’s proposal at the OPEC summit in Caracas to price
oil in euros, instead announcing that it would stick to
pricing oil in dollars at its planned oil exchange on
Kish island.
Only 10 percent of GCC imports come from the US, while
roughly one-third apiece comes from Europe and Asia
respectively. At the same time, two-thirds of the
region's energy exports go to Asia. Thus, from a
trade-weighted perspective, an exclusive currency peg to
the dollar does not make sense, and one could speculate
about whether the GCC countries’ dollar allegiance is
not economic in nature, but politically motivated, as
the GCC states depend heavily on the US for security in
an unstable region. There are, of course, a number of
economic reasons to hold on to the dollar, although they
are quite different from the ones suggested by the
textbook wisdom of mainstream economics. The first is
that the dollar may be in bad shape, but that other
currencies do not look much better. Compared to their
GDPs, budget deficits in the EU are on average
comparable to that of the US; Japan's is actually much
higher. The only difference is the more balanced foreign
trade position that the two have.
As
the GDP and the number of inhabitants of Euroland are
comparable to those of the US, or even surpass it, the
dollar is facing real competition for the first time, in
terms of transaction domain. Formerly, the thinness of
markets for hard currencies like the yen, the Swiss
franc, the deutsche mark, and gold limited movements out
of the dollar because of the lack of sizable
alternatives. However, apart from the limited political
and military power of Euroland, the euro is not yet
sizable enough to be an alternative – the market
capitalizations of its bond and equity markets still lag
far behind those of the US. It thus remains to be seen
whether the euro can acquire a status as an
international reserve currency on equal footing with the
dollar by 2010, as expected by Nobel economic laureate
Robert Mundell. This is all the more true for China – if
it can avoid a hard landing for its overheated economy
and develops the political and military clout to solve
its growing energy problem, it might be able to become a
second competitor to the dollar in 10 or 20 years.
However, so far the Chinese yuan is not even fully
convertible, and China’s opaque capital markets are only
a tiny fraction of the size of their American
counterparts.
Thus, the dollar is illiquid because there are so many
of it. For countries that want to diversify, there are
simply not enough assets denominated in other
currencies, and the gravity of established contractual
obligations and trading platforms denominated in dollars
is causing a dollar attraction, which is completely
independent of the US economy and its abysmal deficit.
To grasp what is going on with the dollar, one has to
look at it as a world currency that is fuelling global
commerce, not as the currency of an isolated
nation-state. Since its beginning in the 16th
century, capitalism has always had a hegemonic power
that has acted as the central banker of the world and
has supplied it with the liquidity it has needed. First
this was the Spaniards, then it was the Dutch, and next
it was the British, once they rid themselves of
Napoleon. The demise of the British pound began with
World War I, and after World War II, the dollar finally
took over within the framework of the Bretton Woods
system. At that time, the US was by far the biggest oil
producer in the world, and accounted for more than 50
percent of global industrial production. Aside from the
military might of a superpower, the dollar was backed by
US current account surpluses and by gold. Today, only
military might is left. Since 1971, the US has
essentially been paying for its imports with printed
paper, without a need to export goods and earn foreign
currency or gold to pay for this. No other nation has
this privilege.
Nevertheless, the dollar debt juggernaut fuels the world
economy, and everybody is happy with it. It goes without
saying that the US housing and consumer markets benefit,
but the Japanese love it as well – the yen carry trade
has enabled them to stabilize their shaky financial
system with a zero interest rate policy and without
inflation. China and Southeast Asia still have not
developed domestic alternatives for their
export-oriented industrialization, and the Europeans are
content to sail in the geopolitical and economic wake of
the US.
Thus, with no clear alternative in sight, the financial
health of other countries and currencies is heavily
dependent on the US dollar Ponzi scheme. If the dollar
goes down, they go with it, and as with the prisoner's
dilemma, everybody is afraid to make the first move –
the first one to abandon the dollar could set off a
chain reaction that would backfire and affect them as
well. Thus, the dollar's demise might take a bit longer
than common sense would suggest, as everybody is trying
to evade the unpopular repercussions. Nevertheless, it
is inevitable, and that is why the GCC countries need to
contemplate a diversification into other currencies and
gold sooner rather than later. |
