Asad Ismi
Empires collapse usually due to a combination of military overreach and economic weakness, and, judged by these criteria, the U.S. imperial order seems headed for an imminent fall. Washington’s occupation of Iraq has been a disaster. Even after two years, the U.S. military has failed to subdue the Iraqi resistance. A recent report by Knight Ridder Newspapers declared the war “unwinnable.”
Developments on the economic front are even more dangerous for the U.S. Its power rests on two main buttresses: 1) military superiority, and 2) the role of the dollar as the world’s reserve currency. Iraq is making a mockery out of the first, and the second is in jeopardy. The U.S. massive trade and budget deficits ($630 billion and $500 billion, respectively) are driving down the dollar to such an extent that its status as the global reserve currency is imperilled. Since world trade is largely conducted in U.S. currency, most countries have to export goods and services in order to earn these dollars, but all the U.S. has to do is print more dollars. As economist James K. Galbraith explains: “[The U.S. gets] real goods and services, the product of hard labour by people much poorer than ourselves, in return for chits that require no effort to produce.”
The purchase of massive amounts of dollars by the rest of the world allows Washington to borrow cheaply, keep interest rates low, and run up a trade deficit that no other country could get away with. The world thus pays for U.S. overconsumption and underproduction. This arrangement, as economist Andre Gunder Frank puts it, is “a global confidence racket”—a racket that can continue as long as other countries keep on buying dollar assets such as U.S. Treasury bills, thus financing Washington’s enormous deficits.
But, if the value of the dollar keeps going down, why should anyone continue to invest in it? The dollar has dropped by 47% against the euro since 2001, and by 24% against the yen. The greenback hit a record low of $1.37 against the euro in December 2004. There is no end in sight to the dollar’s fall, since the Bush administration is content to let it drop (in the hope of reducing the trade deficit) and has shown no inclination to rein in overall spending. The dollar is expected to shrink by another 30% during the second Bush term, which, according to one observer, “will wipe out anyone holding dollar assets and bury the dollar as a global reserve currency.”
With these dire prospects, surely anyone in possession of a lot of dollars would be inclined to sell. As U.S. Federal Reserve Chairman Alan Greenspan warned in November 2004, “foreigners may tire of financing the record U.S. current account deficit and diversify into other currencies or demand higher U.S. interest rates.” He repeated this warning last March. Currently, Washington needs to borrow $2.6 billion a day —90% of it from foreigners—to finance its trade deficit and to prevent a dollar collapse. The main lenders are Japan and China, whose central banks hold the largest amount of U.S. dollars ($720 billion and $600 billion, respectively). Taiwan owns $235 billion and South Korea $200 billion.
If these countries were to move away from the dollar, the U.S., with its immense borrowing needs, would face bankruptcy. Yet this is precisely what is happening. On January 26, 2005, prominent Chinese economist Fan Gang announced at the World Economic Forum that China had lost faith in the U.S. dollar. “The U.S. dollar is no longer in our opinion…(seen) as a stable currency, and is devaluating all the time, and that’s creating trouble all the time,” Fan said. He added: “So the real issue is how to change the regime from a U.S. dollar pegging …to a more manageable reference, say euros, yen—those kinds of more diversified systems…If you do this, in the beginning you will have some kind of initial shock, you have to deal with some devaluation pressures…Now people understand the dollar will not stop devaluating.”
Fan is director of the state-run National Economic Research Institute in Beijing. He is not a government official, but for traders the connection was close enough and they found “great relevance” in his statement. As Paul Donovan, senior global economist at UBS AG, said, “This in fact is a scenario we consider to be highly likely.” And the dollar promptly dropped. Japan’s Prime Minister, Junichiro Koizumi, also made clear in March that “diversification is necessary” when a parliamentary committee questioned him about the dangers of holding too much of one currency. China and Japan have lost hundreds of billions of dollars during the past two years because of the greenback’s decline.
According to the Financial Times, “Central banks are shifting reserves away from the U.S. and towards the Eurozone in a move that looks set to deepen the Bush administration’s difficulties in financing its ballooning current account deficit.” The Asia Times (Hong Kong) confirms that Asian central banks have been replacing their dollar reserves with regional currencies for the past three years. A report by the Bank of International Settlements states that the ratio of dollar reserves held in Asia declined from 81% in the third quarter of 2001 to 67% in September 2004. China reduced its dollar holdings from 83% to 68%, India from 68% to 43%, and Thailand from 80% to 50%. A January 2005 report sponsored by the Royal Bank of Scotland states that 39 nations out of 65 interviewed were increasing their euro holdings, while 29 were reducing the amount of dollars they owned.
Significantly, the move from the dollar to the euro has spread to the central banks of OPEC countries, which own the most valuable traded resource: oil. The Bank for International Settlements reported in December 2004 that OPEC members’ dollar-denominated deposits fell to 61.5% of their total deposits in the second quarter of 2004, from 75% in 2001. During the same period, euro deposits increased from 12% to 20%. Russia, the biggest non-OPEC oil producer, has switched 25% to 30% of its currency reserves from dollars to euros.
At the end of February, comments by South Korea’s central bank sparked another round of dollar declines. The bank announced its intention to move away from the U.S. dollar and increase holdings of Canadian and Australian dollars. The New York Times described the impact of this “innocuous” statement: “As the Korean comment ping-ponged around the world, all hell broke loose, with currency traders selling dollars for fear that the central banks of Japan and China, which hold immense dollar reserves…might follow suit. That would be the United States’ worst economic nightmare. If it appeared that the flow of investment from abroad was not enough to cover the nation’s gargantuan deficits, interest rates would soar, the dollar would plunge, and the economy would stall.”
Economic Armageddon
The global move away from the dollar portends economic devastation for the U.S. Stephen Roach, chief economist at Morgan Stanley, one of the world’s leading investor firms, has told clients that the U.S. does not have more than a 10% chance of avoiding “economic Armageddon.” He points out that the $2.6 billion the U.S. has to import every day to finance its trade deficit constitutes an incredible 80% of the world’s net savings. Obviously it’s an unsustainable situation. According to Roach, the dollar will keep falling due to the U.S.’s record trade deficit. To attract foreign capital and check inflation, the Federal Reserve’s Greenspan will be forced “to raise interest rates further and faster than he wants.” U.S. consumers, already deep in debt, “will get pounded.” The record U.S. household debt is now equal to 85% of the economy [the U.S. national debt is $7.7 trillion, while total U.S. debt is an unfathomable $43 trillion]. Americans already spend a record proportion of their income on interest payments, and interest rates have not even substantially increased yet. Thus the stage appears set for massive national bankruptcy.
According to the Los Angeles Times, higher interest rates “would be disastrous for a country weaned on cheap credit.” A rise in interest rates would particularly affect a real estate market built on low interest and mortgage rates. This market is now the main engine of U.S. consumption. Millions of Americans have taken out loans against the rising value of their homes and use them (in Roach’s words) as “massive ATM machines.” As André Gunder Frank explains, higher interest rates threaten “a collapse of the housing price bubble [which] with increased interest and mortgage rates would drastically undercut house prices, thereby having a domino effect on their owners’ enormous second and third re-mortgages and credit-card and other debt, their consumption, corporate debt and profit, and investment.”
Echoing Roach, Former Federal Reserve Chairman Paul Volcker puts the likelihood of a financial disaster at 75%, while the U.S. Comptroller-General (head auditor), David Walker, “makes no bones about the fact that the situation is dire.” For Martin Wolf, associate editor of the Financial Times (U.K.), “The U.S. is now on the comfortable path to ruin. It is being driven along a road of ever-rising deficits and debt…that risk destroying the country’s credit and the global role of its currency.”
Paul Krugman, economics professor at Princeton University who writes a column for the New York Times, told Reuters in January: “We’ve become a banana republic…If you ask the question, do we look like Argentina, the answer is a whole lot more than anyone is willing to admit at this point.” Argentina defaulted on a $100 billion debt in 2001, with catastrophic effects: its currency plunged and the economy collapsed, bankrupting thousands of businesses within weeks. National income plummeted by 67%, pushing half the population below the poverty line.
Professor Laurence Kotlikoff, chairman of the economics department at Boston University, agrees with Krugman, saying: “This administration [Bush] and previous administrations have set us up for a major financial crisis on the order of what Argentina experienced a couple of years ago.” Former U.S. Treasury Secretary Robert Rubin similarly warns that “the traditional immunity of advanced countries like America to the Third World-style crisis is not a birthright,” and that the U.S. faces “a day of serious reckoning.”
Peter Schiff, CEO of Euro Pacific Capital, also thinks that the falling dollar could mean major financial disaster. According to him, “This looming dollar crisis cannot be prevented, only delayed, and only at the expense of exacerbating the collapse.” Schiff told Forbes magazine in January that he expects the dollar to drop by 50% against the Chinese and Japanese currencies. This will wreck U.S. consumption. As Schiff states: “Spending on cars, clothing, and electronics will all drop dramatically—perhaps right out of the economy.”
An abrupt drop in the dollar could cause a stock market crash and make the real estate market dive. “When the dollar collapses,” says Professor Immanuel Wallerstein, “everything will change geopolitically…it will be a vastly different U.S—no longer able to live far beyond its means, to consume at the rest of the world’s expense. Americans may begin to feel what countries in the Third World feel when faced with IMF-imposed structural readjustment: a sharp downward thrust of their standard of living.”
Paper Empire
The weakness of the dollar and the huge deficits are symptoms of the decline of U.S. manufacturing. “Americans don’t produce enough and don’t save enough,” says Schiff. U.S. manufacturing is only 13% of GDP and, according to Roach, “Manufacturing employment currently stands at only about 13% of the U.S.’ private non-farm workforce—down sharply from 23%…in the mid-1980s.” Since 2000, the U.S. has lost close to three million manufacturing jobs. Between 1989 and 2004, the U.S. savings rate fell from 6% to 1%. Foreigners now produce most of the goods Americans are consuming and lend Washington the money to buy these goods, leading to skyrocketing deficits.
An important factor behind the manufacturing decline is the abandonment of the U.S. by its own corporations, many of which have relocated operations to Asia from where they export to the U.S. John Chambers, Chairman of Cisco, said recently: “What we’re trying to do is outline an entire strategy of becoming a Chinese company.” Cisco is the leading U.S. supplier of networking equipment for the Internet. The company manufactures $5 billion worth of products in China, where it employs 10,000 people.
In fact, the U.S. economy has been in decline for more than three decades, accounting for a plummeting share of world economic output. The first dollar crisis occurred at the end of the 1960s when U.S. President Lyndon Johnson’s escalation of the Vietnam war led to increasing public deficits. This coincided with the rise of Western Europe and Asia as strong exporters, to whom Washington lost its manufacturing lead. To retain its global domination, the U.S. then depended on its military superiority and the dollar’s role as the world’s reserve currency. As the U.S. deficits rose due to the Vietnam war, France demanded gold in exchange for the dollars it held, since at the time the greenback was backed by Washington’s gold reserves. Other countries followed suit and, as U.S. gold reserves were drained, President Richard Nixon delinked the dollar from gold and floated it against other currencies.
This coincided with the oil crisis of the 1970s, when crude prices shot up 400%. Suddenly, oil became the most important traded resource, and Nixon linked the dollar to it. In June 1974, U.S. Secretary of State Henry Kissinger made a deal with Saudi Arabia (the biggest OPEC oil producer) stipulating that oil could only be bought in dollars. In return, the U.S. agreed to militarily protect the Saudi regime. In 1975, OPEC (following the Saudi lead) officially agreed to sell oil only in dollars. The age of the petrodollar was thus born. As long as oil was traded in dollars, so would other goods, and the dollar would remain the world’s reserve currency. This arrangement allowed the U.S. to continue its dominant imperial role despite its crucial economic weakness: the inability to compete with the European and Asian countries in manufacturing and export capacity. But now the U.S. position became highly vulnerable to the whims of the oil-producing countries and to the fate of the resource itself.
The first challenge to the petrodollar system came with the Third World debt crisis. Awash in petrodollars, Western banks loaned hundreds of billions of these to developing countries, which could not repay the loans when Washington raised interest rates to nearly 20% in 1979 to save the falling dollar. It was crucial for the future of the petrodollar system that this money be recycled back to the West, and so the U.S. used the World Bank and IMF to ensure this would happen. The loans were repaid several times over (the payments continue), and the petrodollar system was saved—but at the cost of decimating Third World economies with structural adjustment programs that devastated their industry, employment, and health and education sectors. As F. William Engdahl perceptively points out, the U.S.’s petrodollar hegemony “was based on ever-worsening economic decline in living standards across the world as IMF policies destroyed national economic growth.”
The second challenge to the petrodollar system came from Iraq when it started trading oil in euros in November 2000. If other OPEC countries followed suit, that would be the end of the reserve role of the dollar. The 2003 U.S. invasion of Iraq was partly aimed at staving off this possibility by forcibly returning Iraq to the dollar, warning other OPEC members not to switch to the euro, and starting the process of physically controlling Iraqi and Middle Eastern oil in order to gain leverage over European countries.
This strategy has clearly failed, and it now appears that in the military arena, too, the U.S. cannot prevail, not even against lightly armed Iraqis. The petrodollar system is falling apart as the world rejects a U.S. imperialism in which it expects other countries to not only supply it with a massive amount of consumer goods in exchange for increasingly worthless bits of paper, but also wants them to pay for its gigantic military machine with which it attacks or threatens them. As American journalist Seymour Hersh said in a recent interview: “The minute the rest of the world gets tired of our belligerence, they can turn us off economically as easily as flicking a light switch.”
A New World
The collapse of the dollar and that of the U.S. economy will end American superpower status as Washington becomes incapable of financing a colossal military machine that currently occupies 725 bases around the world with 446,000 troops. Economic power will centre around the European Union, China and India, which are already creating new global structures that exclude the U.S. These endeavours show that the U.S. is already, to some extent, a “has-been” global power whose desperate military aggression only makes it weaker on the world stage.
The Financial Times explains: “A new world order is indeed emerging—but its architecture is being drafted in Asia and Europe at meetings to which the Americans have not been invited.” In contrast to Washington’s endless military ventures, Europe and China emphasize economic might as the main instrument of foreign policy. As Newsweek points out, “the strongest tool for both is access to huge markets.”
In April 2004, 10 new countries joined the European Union and six more are expected to in the near future. Newsweek lauded this development by emphasizing that “no single policy has contributed as much to Western peace and security.” This is a highly important statement. It recognizes that Europe has changed the very definition of security. After two world wars, the Europeans appear to have realized that the best guarantor of security is economic inclusion, not mass murder. And now the EU is considering Turkey’s membership, which would actually make Europe part of the Middle East, and vice versa. According to Newsweek, “When historians look back, they may see this policy as being the truly epochal event of our time, dwarfing in effectiveness the crude power of America.”
Similarly, China and the Association of South East Asian Nations (ASEAN) are creating an Asian trade bloc to rival the EU. The ASEAN Plus Three (China, Japan, and South Korea) summit meeting in December 2004 laid the groundwork for an East Asian Community (EAC) that “should build a free trade area, cooperate on finance, and sign a security pact…that will transform East Asia into a cohesive economic block.” This is a significant defeat for the U.S., which scuttled a similar intiative in 1990. The Asian agreement creates a market zone of two billion people, the largest global trading bloc “dwarfing the EU and NAFTA.” India has also become an ASEAN summit partner and wants an economic zone stretching from its borders to Japan.
No single country has posed more of a challenge to Washington than China, which recently replaced the U.S. as the leading consumer market in the world. Beijing has economically displaced the U.S. all over Asia and is now doing so in the latter’s so-called back-yard, Latin America. China is now Chile’s largest export market and Brazil’s second biggest trading partner. In November 2004, Chinese President Hu Jintao went on a tour of Latin America and agreed to invest $30 billion in the region. Most importantly, China and Venezuela signed a bilateral energy pact in December 2004, under which the latter agreed to supply Beijing with 120,000 barrels of fuel oil a month. China pledged to invest in 15 Venezuelan oil-fields. China has become the world’s second largest importer of oil after the U.S. Venezuela is the U.S.’s fourth largest oil supplier, and the deal with China cuts into one of Washington’s “few remaining relatively stable sources of crude.” China intends to make a similar move towards Canada, the U.S.’s biggest oil supplier. What can Washington do about such incursions into its “vital interests”? Not much, since Beijing could cripple the U.S. economy simply by stopping its purchase of American Treasury bills.
The demise of the United States as a superpower will be particularly beneficial for the Third World—the 80% of humanity that has suffered most under Washington’s economic and military heel. Since 1945, the U.S. has unleashed a reign of death, destruction and plunder on developing countries, killing more than 20 million people through wars, coups, bombings, assassinations, massacres, embargoes, and economic destabilization. The purpose was to ensure that 80% of the world’s wealth was owned by 20% of its people. Third World countries have fought back, inflicting significant defeats on Washington. It was the Vietnam war that started the U.S.’s economic downslide, and today Iraq is an important nail in Washington’s financial coffin.
Third World resistance has made it impossible for the U.S. to continue dominating the world economically and militarily. Without U.S. muscle behind them, Washington’s client states all over the South will have to give way to nationalist regimes that want to use their countries’ resources for the benefit of their own people: A wave of Venezuelas is likely, leading to a redistribution of global wealth in the developing world’s favour. The European Union will have to come to a new arrangement with a resurgent South, and the result could lay the basis for an egalitarian world.
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Published in the Canadian Centre for Policy Alternatives Monitor, May 2005
Asad Ismi is the CCPA Monitor’s international affairs correspondent and has written extensively on global economic and political issues.