Financial stability requires balanced trade, says William R. Hawkins
There has been a flood of articles, some quite alarmist, about the coming “collapse” of the dollar as the world’s reserve currency. The last week of October opened with the dollar falling against the euro and yen on a claim in a People’s Bank of China newsletter that Beijing wanted to diversity its massive foreign exchange reserves. The Chinese editorial said that the dollar would still be the principal currency in its hoard, but any hint that there would be a shift to more euros and yen moved the market. The dollar then fell further after the G20 finance ministers meeting in early November.
China (along with Russia), has been making noise at international economic meetings all year about the need to move away from “dollar hegemony” in line with the larger campaign for the world to move away from U.S. “political hegemony.” The desire in Beijing and Moscow for a “multipolar” world of finance is in parallel with their desire for a multipolar balance of power in which they would move up as America moves down. But neither the yuan nor the ruble are used widely enough to replace the dollar. Indeed, the yuan is not convertible, as the Chinese regime will not give up its ability to set its value by fiat as part of its mercantilist trade strategy.
Every U.S. administration, regardless of party, has proclaimed a “strong dollar” policy because the use of the dollar as the leading international currency is a strategic asset. A strong dollar means that in real terms, what America spends overseas, whether to support its military deployments, fund foreign aid projects, or buy raw materials and fuel to power its economy, is less than it otherwise would be. It also means that America can print money when it needs to, and the dollars will be accepted because they can be used for more than just trade with the United States. Huge markets have existed for decades offshore for dollar-denominated finance.
America is the largest importer of oil and manufactured goods in the world. Exporters want to both earn dollars and keep the dollar strong. The problem is that when the U.S. runs the huge trade deficits it has over the last decade, the supply of dollars in the exchange markets exceeds the demand, and the value of the U.S. currency falls. The recent spate of stories about devaluation has come about because the dollar is falling back to its pre-recession level. It actually increased in value during the financial crisis because America was deemed a safe haven for money in a world where economic chaos reigned. Wall Street may not have looked trustworthy, but Treasury securities were still the world’s safest investments. Even a small yield is attractive when everything else is dropping like a stone in the ocean.
Despite the impression given in the media, the dollar was still higher in November 2009 than it had been in March 2008 after falling throughout the decade. According to the Federal Reserve’s major currency index, the dollar hit a low of 69.3 in mid-March 2008, coming off a high of 110 in July 2001 in the wake of the previous recession. The index uses January 2003 as 100. The index at the end of November was around 73, about where it was two years earlier. The dollar’s recent high was 82 in April of this year. Most press stories imply that the devaluation of the last few months is a result of the financial crisis, when it is in fact a return to normalcy.
Unfortunately, what has become normal is the downward pressure on the dollar from trade deficits that totaled $4.8 trillion from 2001-2008, with a merchandize deficit of $5.6 trillion. $1.4 trillion went to China. The American automobile industry, once the vanguard of both the economy and popular culture with its links throughout the industrial sector, suffered trade deficits of $1.1 trillion during these years. The sector had to be bailed out and put through bankruptcy to prevent its collapse. There are similar problems in other sectors. Yet, there is hardly any mention of trade in any of the current news coverage of the devaluation.
The answer to trade deficits in academic theory is devaluation. As the dollar drops in value, imports become too expensive to buy. This can be very inflationary if domestic producers have been driven out of business by the previous flood of imports. Indeed, the tactic of “dumping” used by foreign exporters is aimed at this outcome. Devaluation over the last decade has not reduced the deficit, further undermining the credibility of laissez-faire dogma. And any more dramatic devaluation would jeopardize the strategic role of the dollar as the world’s reserve currency. Rather than gut the dollar to balance trade, trade policy should be changed to save the nation’s finances.
On Oct, 19, Federal Reserve Chairman Ben Bernanke told a conference that trade imbalances played a central role in the worst global financial crisis since the 1930s. “To achieve more balanced and durable economic growth and to reduce the risks of financial instability, we must avoid ever-increasing and unsustainable imbalances in trade and capital flows,” he warned.
Testifying before the Senate Foreign Relations Committee Nov. 17, Treasury Secretary Timothy Geithner repeated what he had said in several international forums: “The financial crisis also showed clearly that previous global economic patterns were unsustainable. To establish a more global foundation for growth and avert future crises of this nature, we must rebalance global demand….emerging markets and economies with large and sustained surpluses will need to shift their growth towards domestic demand and reduce their reliance on exports. Governments around the world will need to accept this basic reality or we will all face slower growth.” The emphasis in both statements on government policy implies a move away from the “free trade” faith in private markets. The forces that generated the imbalances cannot correct them.
Unfortunately, neither Bernanke nor Geithner have presented a plan to change unsustainable modes of global behavior. Bernanke’s sole policy prescription was to reduce Federal budget deficits, but even if accomplished, this would not be sufficient to balance trade. Congress attempted to constrain the transmission of Federal spending into increased imports with “Buy America” provisions in the stimulus bill, but President Barack Obama raised objections to this as a general policy.
The ideal way to reduce the trade deficit is by increasing exports. Getting other nations to buy more American-produced goods was a theme of President Obama’s trip to Asia. Foreign governments will not, however, allow their markets to be overrun in emulation of Washington’s blunder. Instead of cooperation, Obama was met with demands that America avoid “protectionism,” thus indicating the desire of others to continue their export-led surpluses. Even with less foreign intransigence, U.S. exports would have to increase by more than 50 percent to balance the trade account, and no one sees any scenario that would accomplish such a feat.
America will have to rely on its own national policy to achieve balance. The process of placing restrictions on U.S. imports will evolve slowly, but is inevitable. There will be more energetic enforcement of trade laws against dumping and other predatory behavior, and less emphasis on broad trade liberalization efforts like the Doha Round. Green tariffs are provided for in Congressional “cap and trade” legislation as a necessary counter to the refusal of developing countries to accept pollution standards. The government’s tardy intervention in the auto industry will require further action to protect its investment and ensure the success of its industrial policy.
America’s trading partners see what is coming, though they will protest any revival of protectionism in Washington even as they continue their own. At the East Asia Summit Oct. 25, the talk was of increased regional trade and less reliance on exporting to the United States. Bernanke in his Federal Reserve conference remarks had noted that the larger Asian countries, China, India and Indonesia, have been recovering faster because of their large internal markets. These markets are largely shielded from imports. Their industrial sectors are now growing faster than their exports.
As the United States rebalances its economy, domestic demand will also have to be channeled to support home production of goods and services and to take back the massive market shares that have been lost to overseas rivals. A secure market, stronger dollar, and more stable finances will attract the capital needed to boost economic growth and job creation.
William R. Hawkins is a consultant specializing in international economic and national security issues. He is a former economics professor, Congressional staff member and think tank scholar who has authored three books and hundreds of academic and editorial articles.