Dumping of US dollar could trigger 'economic September 11'
The Australian | August 29, 2005
There is a potentially fatal flaw at the heart of the global economy: the
strong possibility of financial meltdown following a collapse of confidence
in the greenback, Clyde Prestowitz tells Bruce Stannard
THE nightmare scenario that haunts global strategist Clyde Prestowitz is an
economic September 11 -- a worldwide financial panic triggered by a sudden
massive sell-off of US dollars that would lead inexorably to the collapse
of economies around the world.
If that happens, Prestowitz predicts: "It would make the Great Depression
of the 1930s look like a walk in the park."
Australia would be sucked into the vortex of such a recession, which would
cause great hardship throughout the world, he warns.
Prestowitz is not a doomsayer, neither is he alone in his views. As
president of the Economic Strategy Institute, a Washington think tank, he
is in regular contact with the most influential US business leaders,
several of whom -- Warren Buffet and George Soros included -- have taken
steps to hedge their currency positions against the possibility of a
cataclysmic plunge in the greenback.
"Right now," he says, "we have a situation in which the US is running huge
trade deficits -- about $US650 billion ($766 billion) in 2004 -- which are
financed by borrowings from the central banks of Asia -- mainly the Chinese
and the Japanese. All the world's central banks are chock-full of US
dollars -- they're holding many more dollars than they really want. They're
holding those dollars because at the moment there's no great alternative
and also because the global economy depends on US consumption. If they dump
the dollar and the dollar collapses, then the whole global economy is in
trouble.
"However, some countries have a bigger stake than others in maintaining the
status quo. China and Japan have a big stake in maintaining the flow of
their exports to the US and keeping the US economy humming. Russia, on the
other hand, does not export much to the US. India doesn't export much to
the US. Yet Russia and India are also big dollar-holders. They hold many
more dollars than they really want or need.
"It doesn't take any great stretch of the imagination to see what could
happen if one of these central bank managers decides to dump dollars. We
had a situation recently when a mid-level official at the Central Bank of
Korea used the word 'diversification'. It was a throwaway remark at some
obscure lunch, but there was instantaneous overreaction. The US stock
market fell by 100 points in 15 minutes because the implication was that
South Korea might be shifting out of US dollars.
"So picture this: you have a quiet day in the market and maybe some smart
MBA at the Central Bank of Chile or someplace looks at his portfolio and
says, 'I got too many dollars here. I'm gonna dump $10 billion'. So he
dumps his dollars and suddenly the market thinks, 'My god, this is it!' Of
course, the first guy out is OK, but you sure as hell can't afford to be
the last guy out.
"You would then see an immediate cascade effect -- a world financial panic
on a scale that would dwarf the Great Depression of the 1930s."
Prestowitz says the panic could be started by something as simple as a
hedge-fund miscalculation.
"We had exactly that scenario in the US recently," he points out, "when a
big hedge fund called Long Term Capital Management went belly-up. These
guys were pros. They had two Nobel prize-winning economists writing their
trading algorithms, and their traders were the creme de la creme among New
York bond traders.
"They made a big bet -- a trillion dollars leveraged 20 to one, and they
blew it. They went belly-up. That threatened to bring down the whole system
so US Federal Reserve chairman Alan Greenspan had to organise a bail-out
through the Federal Reserve Bank of New York.
"Now consider this: there are currently 8000 hedge funds in the US alone.
Every day $6 trillion of derivative instruments trade on international
markets. If there are four people in the world who understand those trades,
I'd be surprised. So the potential for another disaster is not
insignificant. This is why Warren Buffet, chairman of investment giant
Berkshire Hathaway, is betting $US21 billion against the dollar. This is
why currency speculator and hedge fund manager George Soros has also made a
big bet against the dollar.
"Soros is one of the greatest currency speculators of all time. He was the
guy who broke the British pound in the early 1990s by betting $US10 billion
it would fall. He made a quick billion when it did. In 2002, he warned that
the greenback was in danger of losing a third of its value. Of course, it
could be argued that Soros is a professional hedge fund manager whose job
is to play the ups and downs of currencies and his remarks could be seen
more as manipulation than prophecy. And yet, in conversations with me,
Soros has expressed concern about the market fundamentalist view that
prevails in Washington and parts of Wall Street.
"This is the belief that markets are self-correcting and best left alone.
Soros calls this a dangerous siren song. Far from being self-correcting, he
emphasises, markets tend to excess. They over-shoot. Anyone with any
experience of markets knows this.
"When markets are going down, all the weaknesses get concentrated, and you
need intervention at the right time to stop things from getting out of
control. If the dollar started to melt down, the results could be really
nasty. A 1930s-style global depression is not out of the question."
To underscore the point that he is not alone in this, Prestowitz cites Paul
Volcker, head of the Federal Reserve before Greenspan, who has said
publicly there is a 75 per cent chance of a dollar crash in the next five
years.
"No wonder people look at this and say, 'Holy cow!'," he says. "No one
knows for sure what will happen, but clearly the global markets could
implode very quickly. The lack of an alternative to the dollar is the only
reason it hasn't taken a big fall already."
Prestowitz, formerly a trade adviser and negotiator for former US president
Ronald Reagan, believes the US will continue to be the world's most
powerful economy for the foreseeable future. But he foreshadows an
inexorable decline, a trend that is likely to continue "depending on the
way we play our cards".
"Right now, we're playing them just about as badly as it's possible to play
them, and that has geo-political implications." he says. "We've outsourced
trying to deal with North Korea to China, we really can't deal with Iran,
so we've outsourced that to the EU, which is struggling, and Iran is
cozying up to China. Other bad actors like Zimbabwe's Robert Mugabe and
Sudan are cozying up to China.
"America's global hegemony is already under challenge, and that challenge
is going to become more and more evident as the extent of the relative US
economic decline becomes evident. Right now, the US dollar is probably 40
per cent overvalued versus the Japanese yen or the Chinese renminbi. How's
the US going to look as a global power when the dollar is at 50 per cent of
its current value?"
Three Billion New Capitalists by Clyde Prestowitz is published by Basic
Books at $US39.95
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