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Thread ID: 6633 | Posts: 4 | Started: 2003-05-13

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PaleoconAvatar [OP]

2003-05-13 17:18 | User Profile

[url=http://www.wsws.org/articles/2003/may2003/defl-m12_prn.shtml]US Fed acknowledges deflation threat[/url] By Nick Beams 12 May 2003

The statement from the Federal Reserve Board last Tuesday announcing its decision to keep its interest rate on hold at 1.25 percent Tuesday was just four paragraphs long but it attracted attention around the world. It wasn’t the decision itself—that had been expected—but the accompanying statement on the economic outlook that sent a tremor through international financial markets.

According to the Fed, over the next few quarters the upside and downside risks to the attainment of economic growth were “roughly equal”. But then an additional assessment was offered: “In contrast, over the same period, the probability of an unwelcome substantial fall in inflation, though minor, exceeds that of a pickup in inflation from its already low level.” Consequently, the “balance of risks” was weighted to the “downside” for the foreseeable future.

What this rather convoluted phrasing added up to was that, after decades of trying to contain price increases, the Fed had offered an official assessment that too-low inflation represented a danger to the US economy. The signs that such a re-orientation in policy was about to be undertaken were clearly visible in the days leading up to the May 6 meeting of the Federal Open Market Committee (FOMC).

On April 30 Fed chairman Alan Greenspan, in testimony to the House of Representatives Financial Services Committee, warned that with price inflation already low, “substantial disinflation would be an unwelcome development, especially to the extent that it put pressure on profit margins and impeded the revival of business spending.”

In March, senior Fed staff member Vincent Reinhart told the National Association of Business Economists that times had changed. “For the first time in 40 years,” he said, “the Federal Open Market Committee is not in a position where it should obviously desire inflation to be lower than its current rate.”

Minutes of the FOMC meeting of March 18, released last week, highlight the growing concern among Fed members over lower price levels. “Members saw further disinflation in core prices as a distinct possibility over the next several quarters,” the minutes noted.

They were also pessimistic about the possibility of increased business investment, which is regarded as crucial for any sustained upturn in the US economy. There were a “variety of factors” likely to induce business firms to continue to hold back on investment decisions in the near term and there was “as yet not persuasive evidence that business fixed investment would provide the needed support for the strengthening in overall economic activity.”

The immediate problem created by lower than normal price increases (disinflation) or outright price declines (deflation) is the setting up of a vicious economic circle. Stagnant or falling prices, reflecting lower profits, increase real interest rates and the debt burden on businesses, prompting them to cut back investment decisions. This leads in turn to a fall in economic growth, reduced profits, further price cutting and higher real interest rates and lower prices as firms try to maintain their share of the market.

Under these conditions, the ability of the Fed to stimulate the economy becomes increasingly restricted because interest rate cuts, aimed at trying to boost business investment, are overshadowed by the fall in prices. According to former Fed governor Laurence Myer, much of the benefit of the Fed’s interest rate cut of half a percentage point last November has already been wiped out by the fall in the inflation rate since then. Real interest rates, he has concluded, after adjustment for inflation, are as high as they were six months ago.

The Fed’s statement that it expected growth to recover, but was nevertheless worried by low inflation, has been interpreted as a commitment that it will not raise interest rates until the threat of deflation has passed. However, it remains to be seen whether the Fed can uphold such a commitment. This is because the sharp fall in the US dollar over the past few weeks is tending to increase American interest rates.

Following the Fed statement last week, the dollar fell to a four-year low of $1.15 against the euro. The euro has been steadily rising against the dollar for the past 10 months, after falling for the first three years of its existence, and on present trends may soon reach, or even exceed, its January 1999 issue level of $1.18.

Global contradictions

The main factor in the fall of the dollar is the shift out of American financial markets by private foreign investors fearful that, with a record balance of payments gap of around $500 billion coupled with rising budget deficits, the value of the dollar is going to drop further, causing them significant losses.

While the general consensus among economists is that the US dollar should start to fall over the longer term, thereby boosting exports and easing deflationary pressures, there are concerns that serious financial consequences could follow if the decline is too rapid.

As the Washington Post’s economic commentator Paul Blustein noted, “[A] tumble in the dollar risks getting out of hand by prompting foreign investors to dump their holdings of US stocks and bonds, which could drive interest rates up and choke off US economic growth.”

According to International Monetary Fund chief economist, Kenneth Rogoff, while a moderate fall in the dollar would be a “welcome correction”, a sudden decline “might lay bare weaknesses in the financial system” by causing huge losses for financial operators who had banked on the US dollar remaining stable or declining at a gradual rate.

The situation is further complicated by the contradictions besetting the world economy as a whole, some of which were elaborated by Morgan Stanley chief economist Stephen Roach in an article published in the Japanese newspaper Nihon Keizai Shimbun on May 1.

Roach began by pointing out that the threat of deflation reflects “the inherent tensions of an increasingly dysfunctional global economy.” Since 1995, demand in the US has increased on average by 4 percent a year, double the 2 percent annual increase in the rest of the world. This has meant that the US accounted for 64 percent of the cumulative increase in world gross domestic product in the period 1994-2001—double its share of the world economy.

This imbalance has expressed itself in the growing US balance of payments gap which, if it continues, could reach the equivalent of 7 percent of gross domestic product (GDP), requiring a foreign capital inflow of $3 billion every business day. “The world,” as Roach noted, “has never before faced an external financing burden of that magnitude.”

The other major problem to which he pointed is the growth of excess capacity in key industries, a legacy of the collapse of the financial bubble of the late 1990s. In this respect “the American disease bears an eerie resemblance to the Japanese strain.”

A so-called “rebalancing” of the world economy would require a fall in the value of the US dollar and a consequent appreciation of the yen and the euro. But this would lead in turn to cuts in demand for both eurozone and Japanese exports, under conditions where both these economic regions have relied on external demand to promote growth.

If rising currency values led to falling growth rates via a reduction in export demand, this could bring financial complications as well. The consequences of low growth and deflation are already visible in Japan, where the bad loan problems of the banks and major financial institutions have steadily worsened over the past decade. Now there is a danger that the same process could afflict the German financial system as well.

Examining each component of the world economy in this way reveals a series of interconnected contradictions.

The US economy needs a fall in the value of the dollar to increase exports and cut its balance of payments deficit but without too rapid a decline which would precipitate a capital outflow, interest rate hikes and recession. Europe and Japan, however, do not want to see appreciation of their currencies and a consequent reduction in markets. On the other hand, however, the process which has seen them finance the US deficit, thereby maintaining a “strong” dollar, cannot continue indefinitely.

While it is not possible to predict exactly how these contradictions will unfold, the fact that they have emerged with such sharpness points to the development of a major financial crisis of which deflation is a harbinger.

Copyright 1998-2003. World Socialist Web Site. All rights reserved.

Bill White also picked this story up at [url=http://www.overthrow.com/lsn/news.asp?articleID=4993]Overthrow.com[/url]

PaleoconAvatar

2003-05-13 17:24 | User Profile

The megacapitalists are going to be on the receiving end of the old adage, "live by the sword, die by the sword."

The preceding article was from the World Socialist Web Site. In a classic pincer maneuver, I now give you more bad news about the dollar from the Right, specifically Chronicles Magazine. Clearly, the Center cannot hold....

[url=http://www.chroniclesmagazine.org/News/Trifkovic/NewsST043003.html]http://www.chroniclesmagazine.org/News/Tri...wsST043003.html[/url]

April 30, 2003

DOLLAR, ACHILLES HEEL OF THE EMPIRE by Srdja Trifkovic

With the victory in Iraq the United States appears more powerful than ever in its history, indeed mightier than any power in the whole of history. For better or worse the Bush Administration proved that it was able to do what it had set its mind on doing many months ago. It has stepped on many toes in the process, humiliating the Old Europe (which was avoidable and regrettable), embittering the Arab world (inevitable), and rendering the United Nations irrelevant (excellent). The aftermath of the victory creates an excellent basis for a creative American role in the Israeli-Palestinian conflict and for a gradual rapprochement with the Europeans and Russians from the position of statesmanlike strength devoid of arrogance.

There is a problem, however. The ideologues of global dominance in Washington have always looked upon the war against Iraq merely as a stepping-stone to their stunningly ambitious global agenda. The Project for a New American Century, conceived and staffed by people destined to become key players in President Bushs administration and their neoconservative friends and allies, was created specifically to advocate a world order completely dominated by unrestrained American power. Their tool of choice, the theory of pre-emption, was inaugurated in the new strategic doctrine in September 2002 and tested this spring. Its advocates will call the initial result an unqualified success, and they will clamor for more of the same.

The global-imperial scheme has a weak spot: the dollar. The U.S. currency is increasingly seen at home and abroad, by proponents and opponents of the New American Century alike as the potential Achilles heel of the project. When the war in Iraq was launched last month, many voices all over the Arab world demanded that OPEC countries start selling oil for euros, not US dollars. The threat is not new: a generation ago it backfired when oil producers demands for payments in gold briefly drove its price to over $900 per ounce. Today an alternative to gold exists, however, and it is called the euro. Saddam Hussein made the switch last fall and reaped considerable benefits from it in the few remaining months of his rule: the $10 billion Iraqi oil-for-food fund at the UN gained a hefty billion thanks to the conversion. The decision will no doubt be reversed by his U.S.-influenced successors, but the option will be considered seriously by the House of Saud, in Iran, and along the coast of the Gulf.

The benefits of current arrangements to the United States are considerable. For as long as oil is traded in dollars, central banks around the world have to prevent speculative attacks on their currencies by holding huge dollar reserves. According to Henry C.K. Liu of the New York-based Liu Investment Group, the higher the market pressure to devalue a particular currency, the more dollar reserves its central bank must hold:

This creates a built-in support for a strong dollar that in turn forces the worlds central banks to acquire and hold more dollar reserves, making it stronger. This phenomenon is known as dollar hegemony, which is created by the geopolitically constructed peculiarity that critical commodities, most notably oil, are denominated in dollars. Everyone accepts dollars because dollars can buy oil. The recycling of petro-dollars is the price the US has extracted from oil-producing countries for US tolerance of the oil-exporting cartel since 1973.

Other countries dollar reserves must be invested in American assets, creating an artificial capital-accounts surplus for the US economy. Even after a sharp drop the Dow is still at a 25-year high, and trading at a 56 percent premium, compared with the emerging markets. It is therefore hugely significant that the euro now the joint currency of most European Union member-states (including the Old Europes Franco-German axis) has appreciated by one third against the dollar since early 2002, when it traded at 84 cents. This is a truly astonishing gain for the euro, in view of the fact that the economy of the European Union is neither booming nor absorbing huge investment funds from around the world. It demonstrates the underlying weakness of the dollar even now, while it is still the worlds reserve currency. (Dollars account for 68 percent of global currency reserves.) If the petro-euro threat were carried out, global demand for dollars would slacken and throw exchange rates into turmoil. Some analysts predict that something like two dollars for one euro would be the likely result within a year.

The consequences for the global economy would be incalculable, and for the United States literally cataclysmic. World trade would cease being a game in which the US produces dollars and the rest of the world produces things that dollars can buy. The American economy would no longer enjoy the benefits of a gigantic subsidy provided by the goods and services of countries holding their reserves in dollars, notably by Japan, which imports four-fifths of its oil from the Middle East. The fewer dollars circulating outside the U.S. would soon translate into fewer goods and services that this country will be able to obtain from abroad on what amounts to interest-free credit. American consumers would no longer be able to buy cheap imports, and the most obvious result would be at the pump: the price of euro-discounted oil would soon exceed 40 dollars per barrel, pushing the gallon of unleaded above $3. Spiraling energy costs would turn current recovery sluggish and uncertain as it is into a slump unseen since Hoovers presidency. Current account deficits half a trillion dollars last year alone would no longer be financed by foreign capital because its influx would simply cease. Global demand for shares of American companies and U.S. Treasury bonds, already weak compared to the heady days of the nineties, would collapse altogether if oil producers stop unloading their petrodollars in the American market. The Dow would drop below five thousand within weeks, and property markets would collapse within months. Without foreign investors, interest rates would zoom into double digits and the Fed would find inflationary pressures simply irresistible. Mr. Greenspan would excuse himself from another term on the grounds of age and poor health.

In Washington the threat is currently regarded as remote because any significant decline in the value of the dollar would hurt major oil producers. The Saudis and others cannot afford to see the value of their U.S. currency reserves and Treasury bonds depleted, the argument goes, and the resulting economic downturn in the U.S. would be felt around the world and additionally hurt their oil revenues by reducing demand. The additional, unspoken assumption is that the U.S. will assume control, by whatever means, of the Iraqi oil, and that it will be again traded in dollars come what may. Yes, the oil belongs to the people of Iraq as we are repeatedly assured, but whoever is eventually recognized in Washington as the peoples legitimate representative will be expected to use a sizeable chunk of those dollars for the rebuilding of Iraq by Bechtel et al.

There is a problem, however. Quite apart from politics, the economic argument for the switch seems compelling. It would mean that whatever you can get for dollars you can get for euros and your euro-reserves would be safer in the long term. The Eurozone does not run huge trade deficit like the United States. It is not heavily indebted to the rest of the world, and it is not subjected to the political will of a single national decision-making structure. Europe is the Middle Easts biggest trading partner, it imports more oil and petroleum derivates than the United States, and it has a bigger share of global trade. Even short-term prospect may be inciting: if oil producers play their hand right and convert their dollar assets to euro assets first, and only then start demanding payment for oil in euros, those assets would immediately increase in value.

The political argument is even more compelling. In the aftermath of the war in Iraq its most determined advocates demand that the United States proceed with its mission of bringing democracy to the Middle East Syria today, Iran tomorrow, Libya in-between, and even such friendly states such as Saudi Arabia and the Emirates in the longer term. Former CIA Director James Woolsey states that the United States is engaged in fighting an open-ended campaign for democracy in the Middle East. Norman Podhoretz dubbed the project World War IV: it is aimed at regime changes all over the Middle East, and winnable provided that America has the stomach to impose a new political culture on the defeated parties. Arab oil producers and Iran quite rightly see all this as a threat, and may conclude that the monetary weapon is the only one they can effectively use. Unlike the neoconservative-dominated U.S. administration, the Eurozone countries do not threaten them. Quite the contrary, as the French foreign minister de Villepins current Middle Eastern tour demonstrates, the powers of Old Europe are busy staking its claim as the best friend the Arabs have in the Western world.

Paradoxically this may be the argument for speeding up the liberation of the Middle East. As British analyst Michael Stenton says, If the neocons don't do Saudi Arabia, the US might lose the Saudis at just the point in time that Iraq becomes most difficult. Their case must be We cant stop now! because only by marching on can they protect the dollar the greatest weapon the U.S. has. They know that if it goes, the project of global hegemony goes with it. The ultimate corollary of this argument is that only an American-ruled world will be safe for the dollar. The notion is pleasing to the neocons, but it is insane and certain to result in Americas destruction more thorough and irreversible than any dislocation resulting from the war of the currencies.

The short-to-medium-term defense of the dollar demands the emergence of a realist and prudent approach to Middle Eastern affairs. Yes, a strong-dollar policy is in the U.S. national interest because it keeps inflation low through low-cost imports and it makes American assets costly to foreign investors. It is therefore necessary to remove political incentives for the regions oil producers to switch to the euro as a defensive ploy against what they rightly perceive as unrestrained U.S. interventionism. Scrupulously even-handed and creative American approach to the Israeli-Palestinian problem would be a visible litmus test of a more benevolent regional intent. It makes a lot of sense on geopolitical and moral grounds, and it can be made conditional on the retention of the financial status quo by the key players such as Saudi Arabia. The looming danger to the dollar, with all its incalculable consequences, makes moral and geopolitical sense, but it also necessitates a new start in the Middle East on the grounds of enlightened American self-interest.

Copyright 2003, www.ChroniclesMagazine.org

Zoroaster

2003-05-13 19:07 | User Profile

The Anglo/American/Zionist Alliance has dominated Western Civilization since World War One. The beginning of the end for this ignoble, if not criminal force will come when the Euro replaces the dollar as the preferred form of international currency.

PaleoconAvatar

2003-05-13 19:25 | User Profile

Originally posted by Zoroaster@May 13 2003, 15:07 ** The Anglo/American/Zionist Alliance has dominated Western Civilization since World War One. The beginning of the end for this ignoble, if not criminal force will come when the Euro replaces the dollar as the preferred form of international currency. **

Agreed, that's a fine benchmark that I look forward to seeing come about.