|The Dollar Crisis: Causes, Consequences, Cures by Richard |
Reviewed by David Peters
The US economy is on the verge of collapse, and the whole world is going down with it. Or so Richard Duncan would have us believe. His new book The Dollar Crisis: Causes, Consequences, Cures offers an unabashedly alarmist view of the imminent unraveling of the global economy - an outcome he argues has now become unavoidable.
And as a longtime financial analyst in Asia who predicted the impending collapse of the Thai economy as early as 1993 and worked as a consultant for the International Monetary Fund (IMF) during the height of the Asian crisis, he knows a thing or two about financial crashes.
Duncan traces the current "crisis" to the end of the Bretton Woods monetary system in 1973. With the global monetary base indirectly tied to gold, the total volume of reserve assets worldwide grew by just 55 percent between 1949 and 1969 - an average of 2.2 percent per year. Since then, reserve assets have mushroomed by almost 1,900 percent, or about 9.7 percent annually.
The system that replaced Bretton Woods saw major foreign currencies floating against the dollar. Because the world's reserve currencies were pure fiat money, the author argues, this system had no built-in check on the growth of the global money supply. As long as the world's central banks were willing to hold US-dollar- denominated debt as reserves, the United States could run an almost endless series of large trade deficits without paying the monetary consequences in terms of a collapse of the dollar.
But having sown the wind for 30 years, the US is now about to reap the whirlwind.
Duncan argues that the current international monetary system has three fatal flaws that make it inherently unstable: "First, it allows certain countries to sustain large current account and capital or financial account surpluses over long periods, but it causes those countries to experience extraordinary economic boom-and-bust cycles that wreck their banks and undermine the fiscal health of their governments. Its second flaw is that this system has made the well-being of the global economy dependent on a steady acceleration in the indebtedness of the United States, a state of affairs that is obviously not sustainable. The third flaw is that it generates deflation."
Duncan explains, for example, that Japan's large trade deficits with the US in the 1970s and 1980s caused a rapid and inordinate rise in Japan's total reserve assets. Those reserves entered the Japanese economy as high-powered money, causing a huge monetary expansion and credit spree. Asset prices rose until the over- indebtedness of the business sector caused the bubble to burst. Because of over-investment during the boom relative to increases in people's purchasing power, the market had excess supply. Deflation set in, which further hurt the business sector, but because of the lack of good investment opportunities, the banks were ultimately caught in a liquidity trap.
Like most countries that run a current account surplus with the US, Japan plows most of it back into US-dollar assets. Duncan contends that this massive capital flow in turn prompted a credit spree in the US during the 1990s, fueling a parallel asset-price bubble.
Time is running out on this cycle, he argues. The first stage of the US bust - marked by the collapse of creditworthiness in the corporate sector - was mitigated by a continuing consumption orgy led by households drunk on low mortgage rates. But that bubble is also bursting, as consumer debt surges to dangerous levels. Many assets, especially stocks and real estate, remain overpriced, and over-investment has made the economy vulnerable to deflation. When the second bust comes, monetary policy will be to no avail, since interest rates are already at their lowest point since the era of US president Dwight Eisenhower.
To make matters worse, few US securities are generating positive returns these days. And if the rest of the world stops buying US assets, how will the United States fund its US$500-billion-a-year trade deficit? The dollar will have to collapse, turning an incipient depression into a global crisis of monumental proportions.
Duncan argues his position forcefully and clearly. If anything, the reader gets the point all too early in the book, and ultimately tires of having the same argument beaten into his or her head again and again. The Dollar Crisis contains 177 tables and graphs, which apart from some troubling typographical errors (were total US credit market assets really only US$25 billion by the third quarter of 2001?) are helpful in amplifying the author's points.
But in the end, what is most frustrating about Duncan's work is the single-minded way he ignores any nuances that might detract from his argument. For instance, he describes how China's large trade surpluses with the US have led to a credit boom, without ever mentioning that China's state-owned banking sector allocates credit based on non-market criteria.
He repeatedly stresses that the post-Bretton Woods monetary system has no in-built adjustment mechanism, when in fact the adjustment is supposed to come from the free floating of currencies. It's not that there was no adjustment mechanism, countries just chose to circumvent it by intervening in the foreign-exchange markets, because they had other policy priorities. A central bank may simply place more value on fighting inflation or on keeping exchange rates stable to facilitate foreign investment than on retaining the option to use monetary policy to smooth out the business cycle.
But such concerns do not register on Duncan's radar. The world he describes is one in which inexorable macroeconomic forces operate in a policy void, and with no microeconomic complications.
He argues that Thailand's credit boom was due simply to the presence of a capital account surplus. But would that surplus have wreaked the same havoc had the country not been pressured to liberalize its capital account before its central bank could provide adequate prudential oversight? And what if the banks had not been allowed to take short-term deposits in the international interbank market with no reserve requirements and lend long-term at home?
Policy matters, and that is precisely why the path from the author's observations to his specific predictions may not follow as straight a line as he tries to make it seem.
Duncan has little faith in markets. He asserts, "If all trade barriers were removed in 2003, practically nothing would be manufactured in the 'industrialized', advanced countries by 2010." Free trade, in his view, does little more than create a structural imbalance in the global economy that is highly deflationary, due to the low wages of workers in the developing world.
Even ignoring the proposition that a group of countries could have no comparative advantage whatsoever, Duncan still neglects to mention that wages are, to some extent at least, governed by productivity differences. The average worker in a Thai factory is considerably less productive than her counterpart in the United States, because she is probably working in a less capital-intensive environment.
The first of his two policy suggestions to mitigate the coming collapse touches on this issue, advocating a global minimum wage, enforced by international treaty. But since labor productivity varies widely among developing countries, creating an artificial price floor would have disastrous effects on some nations' competitiveness. Yet he blithely asserts, "The only conceivable reason that any government would object to a plan designed to raise the wages of its people in a deflationary age is for fear that other countries could cheat by paying their workforce less."
Countries don't pay workers, companies do, and one group that would certainly object is those who foot the bill, who undoubtedly wield some political influence. In fact, the truly big winners from such a policy would be factory owners in industrialized countries, who would suddenly find themselves more competitive without having to invest in increasing their productivity.
Duncan's other policy suggestion is to create a global central bank (he nominates the International Monetary Fund for the job), which could engineer a controlled increase in the global money supply by allocating new reserves according to criteria that could include development priorities. However, many countries world be wary of entrusting such responsibility to a largely unaccountable organization whose policymaking system is structurally dominated by the industrialized countries.
The Dollar Crisis: Causes, Consequences, Cures, by Richard Duncan, John Wiley & Sons (Asia) Pte Ltd, Singapore, 2003. ISBN: 0-470-82102-7. Price: US$29.95, 269 pages.