The Fate Of The Dollar

Jayati Ghosh

IT is amazing how long the fortunes of the capitalist world economy have been bound up with the US dollar. Ever since the dollar emerged as the world’s reserve currency after the Second World War, it has maintained its pre-eminence despite periodic threats to its supremacy and doubts about its future prospects.

The US dollar is not only the favoured currency of world trade, it is also the currency in which the most desired financial assets in the world are held. And therefore it has become the only currency for which none of the standard rules have seemed to apply. That is, whether interest rates in the US are high or low, whether the US government deficit is large or small, the rest of the world’s appetite for US assets appears to be undiminished.

IRRESPONSIBLE POLICIES 

Because of this, the US government can also get away with “irresponsible” behaviour of a kind which no other government in any other country can dare to even dream of. Macroeconomic indicators in the US are at levels which would imply a financial crisis in any other country. The household sector consumes more than it earns, and its debt is at an all-time high. Government deficits are large and rising. The current account deficit is already more than 5 per cent of GDP. Net investment income (interest plus dividend payments) in the US is negative, because foreigners now own more assets in the US than Americans own in the rest of the world.

 Despite all this, the US administration can continue to engage in macroeconomic policies that are supposed to reduce the pain of economic recessions, and can try to reverse the business cycle downturn by expansionary fiscal policies and lower interest rates, without affecting investors’ faith in its currency. By contrast, even other developed country governments in Europe and Japan would not dare to undertake such measures for fear of capital flight.

Most of this is of course because of the geopolitical strength of the US as the world’s only superpower. After all, money is all about power, and international money is about international power. This is why the ongoing war in Iraq (like the previous war in Afghanistan) is not only about controlling oil resources and the like. It is also about the US government’s need to show the rest of the world that it is the strongest and is willing to use that strength, and that it will put down opposition to its rule. This is necessary to ensure its economic and financial supremacy, without which the dollar would just be one more of the many currencies flooding international markets.

But there are signs that the relatively easy ride the dollar has had so far may become rougher and more unpredictable. One of the reasons is the US government’s own confusion about how to improve the economic recovery. Despite large increases in military expenditure and spending on “homeland security”, as well as tax cuts that have greatly benefited the American rich, the economic recovery remains slow, halting and has hardly generated any additional jobs.

So the US administration is now thinking of using a falling dollar to boost exports and reduce the pressure of import competition. It is encouraging the shift to European assets which is pushing up the euro, and pressurising countries like China to revalue their currencies upwards.

SERIOUS IMPLICATIONS

But allowing the dollar to fall in international currency markets (as it has been doing in the past months) is a process with complicated effects. A weak dollar would export deflation to the rest of the world, and would supposedly allow the US economy to expand at the expense of the European and Asian economies. At the same time, though, a weak dollar would also bring down the values of US financial assets, and reduce the effect of the private consumption boom which is supposed to fuel the recovery.

At the same time, the fact is that as long as export-led growth is the name of the game and the United States remains the engine of world growth and the importer of last resort, no one wants the dollar to lose its value significantly. The Europeans and especially the Japanese have been trying hard to keep the value of the dollar from falling any further against their currencies. In the meantime, China has been resisting international pressure to revalue the renminbi.

So we have what seems to be an impasse, stemming primarily from the apparent reality that the US economy will not be able to continue to be the primary source of world demand and therefore the engine of world growth. At the same time, the US dollar remains the central pivot for international finance, and too many agents around the world have their stakes in it.

This impasse is likely to lead not only to worldwide stagnation, but also growing instability. The instability can only be accentuated by the growing perception that the US is not just an unfair and selfish ruler of the world, but also an inefficient imperialist. So the continuing tragedy of a relatively small country, straining against US colonial occupation, may become the trigger for a more general economic revulsion against US assets. If that happens, then the dollar’s future might well indicate the volatile and insecure future of international capitalism as well.