Another look at the coming US crisis of 2008

Oscar Ugarteche

23/01/2008

Opinión

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Thomas Palley, a moderate and a critic of orthodoxy, has recently written an article entitled "Don’t Bet Against the Dollar" http://www.thomaspalley.com/?p=92#more-92. Founder of Economics for Open and Democratic Societies, Palley opens his article with a defense of the dollar’s role as international reserve currency, and argues that the dollar’s position is not about to change. On January 17^th, 2008, the New York Stock Exchange fell 306 points, with the Dow Jones Industrial Average registering 12.159 points. This data confirms the downward trajectory of the US economy. In this article, I will respond to my colleague Palley from a Latin American perspective.

Perhaps Palley has not followed the discussions around the Asian Monetary Unit, the redenomination of Arab reserves in Euros and their petroleum business in a currency basket, and the Russian proposal to create a common currency reserve with

China

. Perhaps he has not noticed the expansion and fortification of Africa’s rand zone and that business within MERCOSUR is increasingly undertaken in the currencies of those countries. South America needs its own monetary unit to complete its financial regionalization project. This unit should be designed in 2008. In this sense we are in effect witnessing a change in the currency of international reserves.

The cause of this change is that the dollar’s value has fallen as a result of the immense

deficit and the loss of confidence in the economy’s stability. The best economic indicator is the price of gold. In January 2003, it was less than 350 dollars an ounce and by January 2008 was more than 900 dollars an ounce. The tripling of the price of gold and the loss of confidence in the US dollar are two sides of the same coin. The projections are that over the next few years, an ounce could reach 1,600 dollars. Nobody believes, therefore, that the weakness of the dollar is recoverable in the near or distant future, and even less so after the massive New York stock market crisis.

The

United States

dollar is the lifeblood of the international system, but this system is undergoing major regional changes in an effort to follow the euro’s lead. Most important are the Asians, who hold 67% of the world’s international reserves and are increasingly more reluctant to finance a war that they do not believe in. In general, the central banks keep international reserves in dollars as United States treasury bonds. In other words, the reserves constitute credits of the US external debt. The creditors obviously are not impressed by the invasion of Iraq or by the bloody performance in the Middle East. Let’s remember that the United States’ creditors are now all of us, the rest of the world. We also should not forget that the petroleum exporters are for the most part Islamic countries and that financing war is against their beliefs. All the more so if that war is against other Muslims.

There is a way out for the dollar. It will have an inflationary impact on the US economy along with an economic stagnation that is beginning to resemble the stagflation of 1973-74. After all, if the rest of the world, in currencies unconnected to the dollar, experiences a 40% or 100% increase in the price of petroleum, for the

United States

and countries anchored to the dollar it will be an increase of 178%.

Secondly, Palley correctly notes that a decline in the demand for assets denominated in dollars could lead to a fall in prices for those assets and a rise in the interest rate. We see this in the mortgage market, which is experiencing a two-year drop, and with stock market values that, after arriving at a record of 14,000 for a year, have been now nearing the 12,000 mark and are on their way down. The Federal Reserve (FED) will not raise the interest rate because it is aiming for a countercyclical financial policy. Japan followed a similar policy in the 1990s after the fall of their real estate and stock markets, although as the US should remember, it did not manage to reactivate the economy. The free market does not control the

United States

interest rate, the FED does.

Palley obliquely declares that analysts see the "depreciation of the dollar against euro" as the end of the dollar standard. One should remember that it is Treasury Secretary Henry M. Paulson, Jr., who insists that the Asians allow the dollar to be devalued against the Asian currencies and in particular, the Chinese. Also it is necessary to remember that those of us whose currencies are not based on the euro have seen the devaluation of the dollar, becoming a cheap asset that lowers the price of imports from the US. For Palley, this is healthy. For the rest of the world, that is to say, for all of us who are not from the US, that do not use the dollar as a payment currency, it is a problem. The global measuring stick of the financial system was established in dollars in the 1940s, when the United States was the creditor of the world. Today it is the world’s largest debtor and yet the dollar continues to be the common international unit of measure.

I will explain the distortions this creates with the following example:

Between January 2003 and December 2007, the price of petroleum rose 178% per barrel in US dollars: from 32 to 92; in Brazilian reais it varied 40%: from 116 to 162 reais a barrel; in Peruvian soles it grew by 137%: from 115 soles a barrel to 274 soles; in Colombian pesos it rose 102%, in rands 118%. Would a reference in dollars be useful? The price of the dollar in reais dropped from 3.53 to 1.77, in soles it went from 3.46 to 2.98, in Colombian pesos from 2778 to 2014 and in rands from 8.69 to 6.93. The price of the dollar also dropped in euros, and in Canadian and Australian dollars, yens, etc. Hopefully the problem was the dollar – euro relation. The problem for the rest of the world is the uselessness of the US dollar as a measure of international prices. For that reason, the euro has been expanding to more countries, including recently to Malta and

Cyprus

, and they are working towards an Asian monetary unit and a South American unit like the rand zone, to name a few examples of the dollar being replaced as the international reserve and monetary reference.

Palley does not understand the rest of the world’s fears. Our fears are well placed because US economic problems are always exported. In 1971, Nixon put an end to fixed parities and the Bretton Woods system; in 1981 Reagan with his Reaganomics created a debt crisis in the rest of the world by pressing for an expansive fiscal policy, while at the same time maintaining a tight monetary policy. Yes, we are scared because global responsibility has not been Washington’s strong suit, especially not for Republican administrations. We should also remember the 1920s. The problem today of the United States looks like that of developing countries then: it consumes more than it produces, by spending borrowed money. The serious thing is that Bush and his partisans have managed turn the greatest economy in the world into the most indebted one, without having gone through a war that destroyed its productive base, as happened to the European countries.

Palley trusts, in an act of personal confidence, that the

United States

’ role as buyer of last resort will cause the rest of the world to lend it money. What we are seeing is a restructuring of international markets. Washington’s propaganda up until now has been that China is the world’s driving force. But everything seems to indicate that the world’s driving force is in the war and in managing the US budget deficit caused by the war. Can they sustain this war and this economic logic for much longer? Bush just returned from selling arms in the Middle East. He will have to sell them to the whole world, and not just the Middle East, if he wants to cover the external deficit.

I invite you to read the rest of Palley’s text because you will appreciate his peculiar interpretation of export policies and how these policies became imported to our countries. It is an example of the peculiar way in which progressive US academics understand what happens in Latin America. The IMF’s death throes and the World Bank’s weakness are part of the problem that Palley ignores: that these multilateral institutions did nothing to prevent this problem and that they are not part of the solution either. What are they good for, then? These multilateral losses are a product of the US government’s fiscal irresponsibility and of the Washington-based institutions' inability to deal with them. The IMF was created so that a global crisis would not be repeated, and the concept was invented by the Treasury in 1935-36. Perhaps the US government has Alzheimer’s and forgot what it created and what it was for. Or maybe, in these fundamentalist times, the Republicans think that all Democratic inventions are demonic.

Meanwhile, the rest of us are preparing for a post dollar standard world. A world with regional monetary units, regional financial institutions and with a trade system that is much less dependent on a single buyer with a dual norm—one for itself and another for the rest of the world. There is no doubt that there will be a recession and more inflation. The question is if it will be like 1974-75 or post-1990 Japan. Either way, we should fear the dollar and continue to work for regional autonomy. (Translation: ALAI).

- Oscar Ugarteche, Peruvian economist, works in the Institute of Economic Investigations at the UNAM,

Mexico

, and is a member of the Latin American Network on Debt, Development and Rights (Latindadd). He is the president of ALAI.

https://www.alainet.org/es/node/125289