----- Original Message ----- From: "Michael Perelman" <[EMAIL PROTECTED]> To: <[EMAIL PROTECTED]> Sent: Saturday, May 04, 2002 1:23 PM Subject: [PEN-L:25676] Re: day of reckoning for the dollar?
> That was Jane D's argument. Michael Pollack posted the transcript of her > discussion with Doug Henwood either here or at LBO. > ======================== On Fri, 24 Aug 2001, Michael Perelman wrote: > Regarding the thread on exchange rates, yesterday Doug interviewed > Jane regarding exchange rates, posing Ellen Frank's analysis to her. http://csf.colorado.edu/pen-l/2001III/msg02118.html Doug Henwood: Welcome to WBAI, Jane D'Arista Jane D'Arista: Thank you. DH: As I said in the introduction, after many years of being the world's strongest currency, the United States, after being the target of foreign investors' capital flows, seems to be having a wobbly time of it. What's your analysis? What's going on with the dollar, and what are the underlying reasons for it? JDA: The slowdown is certainly a factor in what is going on with the dollar. But the problem is that it is the trade balance that is at the heart of this issue. The US has been not really the target of investors except as a by-product. Really what it is is the target of exporters. All the world exports except the US and we are the importer of last resort. As a result, and because of the fact that the dollar is the key reserve and transactions currency, we pay our bills in dollars, and those dollars then go out and are returned to our financial markets. So it's not so much the idea of a strong dollar policy per se, or that the US is the preferred locus of investment, so much as that those by-products are inevitable, if the dollar is going to be the key currency, and if the US is going to be the importer of last resort. Now the fact that the US economy is slowing, and those imports are dropping, is very much affecting the dollar. DH: Let's go over some basic concepts here. You mentioned the phrase "reserve currency." What does that mean? JDA: That means that countries who have to keep a reserve in order to protect their own position keep those reserves in dollars. It used to be gold, under the gold standard. Now that they hold dollar reserves, they need dollars to keep them up. They need them in order to be able to import to keep their own economies going, to repay debt, and to build additional reserves. The reserves are out there because markets for most currencies other than those of a few countries (Europe of course, Japan and the US) are very thin. So people cannot -- Mexico, for example, although it's in a very strong position at the moment, tends to use dollars as well its own currency in its export/import industries. So the dollar has become the key currency, both for holding reserves and for transactions. That has a very large implication for the United States and for US financial markets. It means that, increasingly, investment has to be in the US. Over a third of all US treasury securities are owned by foreigners, a very large share of that by foreign central banks, who hold their reserves in dollars. Now they don't hold dollar bills. They invest those reserves in a US financial asset. And they are looking for the safest asset, and that tends to be the treasury bill. They have also moved now into the Fannie Mae and Freddie Mac paper, the government-sponsored enterprises that appear to be the next-safest financial asset in the US market. DH: This is subtle point, and I guess a pretty obscure one to most Americans, namely that other countries do a lot of business, including financial business, or paying for imports, in currencies other than their own. JDA: That is correct. DH: India can't pay for oil imports in dollars, it needs dollars, and Argentina can't pay its debts in pesos, it needs dollars. JDA: That's correct. DH: But the United States is unique, in that we pay for oil imports, and pay our foreign creditors, in the currency that we print. How big a benefit is this for the United States, in your estimation? JDA: Well, certainly during the 90s it was an enormous benefit because it jump-started our economy and kept it running in 5th gear. That was a lot money pouring in. Throughout the 90s, between 10 and 20 percent of the flows into US financial markets were flows from foreign investors. So the foreign sector made a real contribution to US financial markets. This meant that the saving rates could fall and not push up interest rates and not constrain credit because credit was gushing in. But the result was . . well, when you read about a developing country, they say if the capital flow is over 10 percent of GDP, then you have a problem. Well, it's been pretty high in the US, and I think we have a problem as well. What this has done is create a debt bubble. Everybody focuses on the stock market bubble, the real bubble is debt. And in particular consumer debt. DH: Let's get back to this in just a second. But let's talk a moment about the basics of international accounting. You mentioned trade deficits and capital inflows, and these things are related. If we import more than we export, we have to finance the difference, and that becomes debt we owe to foreign creditors. JDA: That's correct. DH: Now, there are a lot of optimists who say we've been hearing about this for a long long time. The United States has been running a significant trade deficit since the early 80s, our foreign debts have been increasing since the early 80s, but it's just because we're so mighty, and so productive, the world loves us, so there's nothing to worry about. How do you answer the pollyanna point of view? JDA: By looking at the stock of debt in the US domestic economy relative to GDP, which has reached historically high levels. If you took the entire economy, all the sectors, the federal, the private, etc., including the financial, you're over 200% of GDP. It's never been that high. We're up considerably from where we were in the 80s. And that stock of debt has to be maintained. Somebody's got to keep putting money in there just to keep it where it is, just to maintain the level, so that people are not forced to repay immediately or institutions don't go bankrupt because they can't support, on the liability side, their assets, which are our debts. Now the foreign sector has done that for us. Will it continue to do so? My answer is: it can't. If we can't buy those imports, they can't give us back dollars that will support the existing stock of financial assets in the US. DH: I think the pollyannas would respond with two question: first of all, why should they stop? And secondly, if they do, where can they put their money instead? The pollyanna response is that they're kind of stuck here, there's no place else to put their money. JDA: That is such a fallacy. The point is that these people have to earn money. They have to earn the dollars. They don't print them. We do. And the way they earn them is by exporting to us. So if they are not able to earn additional funds -- take the Asian countries at the moment, or Latin American countries, you name 'em. As their exports fall, they have to use their reserves, their dollar reserves, in order to pay for imports. They also have use them to pay debt, because they're not earning what they need to service the outstanding dollar debt. So as they pull out funds denominated in dollars from the US financial markets, well, you can see what happens. DH: Well, what does happen? Play out the scenario a little bit for us. JDA: The problem is what we're seeing now in the treasury bill market. The price falls, the interest rate is rising. DH: But at the same time, the Federal Reserve has been rather aggressively pushing down interest rates, short term interest rates, since the beginning of the year in an effort to revive a flagging economy. Can foreigners reverse what the Fed is trying to do in policy terms? JDA: Yes, they can, because their holdings are so enormous. It's a very substantial amount that they hold as a stock of the total outstanding debt. I mentioned treasury securities. Also 20% of all corporate bonds are owned by foreigners. So my point is that if it simply stops coming in, that's an immediate problem. People assume it has to flow out to be problem. But that's not true, and doesn't have to happen. Now as far as Europe is concerned, if you look at the imbalances with the US, there's been more money coming in than we needed to finance that deficit, and there's been more money coming out of Europe than they can allow to come out given that they have a slight deficit themselves these days. So there's been a net outflow of funds from Europe, which has pushed down the value of the Euro. Now, people don't have to move money, necessarily. It may simply be that new investment out of Europe won't come to the US. Certainly it's not coming in foreign direct investment. They're not buying plant and equipment anymore. And it will stop coming in portfolio. The money will stay home, in other words. So what you have is like musical chairs when the music stops. DH: You scrutinize the domestic flow of funds as well as the international flow of funds, and you've said several times that we've got very high domestic debt. Now pollyannas will say that people have been investing this productively, and we've had a productivity miracle over the last five years. So the debts are not really a problem because the capacity of the US economy to grow has been so much improved, and once we get through this little rough patch everything will grow like gangbusters. So there's really nothing to worry about. How do you respond to that line of pollyanna thinking? JDA: Well, I think you look at it from the perspective both of the household sector and of the business sector. In terms of the household sector, people are very alarmed now, because the debt relative to disposable income is at historically high levels. Debt service, as a proportion of disposable income, is at high levels. We've not seen these levels before. What we do know, from the previous recession, is that when this kind of racheting up occurs, and it did occur last time -- and at a lower level, mind you: it was about 89% of disposable income during the last recession, and now, depending on the figures you use, some people put it at between 110 and a 120 percent -- it means that people have to stop buying at a certain point. They can't service the debt. If employment falls significantly, and people lose jobs, bankruptcies result. They lose their houses, etc. This is a terrible future that the household sector is facing. The Fed has done a very good job of bringing down interest rates and allowing people to refinance mortgages and pay off debt. That's been very helpful. I don't know how long that can continue, or how much more help we can give the household sector. That will also depend on whether or not there is investment enough in the financial sector buying the Fannie and Freddie bonds to keep that housing game going for the domestic household sector. Now on the business side, what has been astonishing is that we've had net negative issuance since 1994 in the stock market. Meaning that more issues are pulled from the market by corporations over a given period of time (quarterly, annually, etc.) than new issues are put in. So you've been contracting the number of stocks in the market. Even with all this IPO stuff from the tech sector. There's still been a contraction in the number of stocks on the market. Companies have done that, in part, in order to create pools of stock for the stock options that they've been issuing to employees. They also do it to prevent takeovers, etc. So they've been using money to buy back their own stock. In many cases, in most cases it look like, they been doing it by issuing corporate debt. DH: And they've been buying each other, too. JDA: Yeah. And corporate debt has been a hot thing, and it's certainly been hot with the foreign sector. They just love it. And now, it may not be such a hot sector. We saw this before in the 80s. The story was different -- it was the takeover mania of the 80s -- but you got a revival of the stock market in that recession, towards the end of the recession in the 90s that allowed companies to rush out and issue stock and pay back debt. When that will be possible for the business sector, I don't know. And in the meantime, debt is something that is contractual, you gotta pay it, you gotta service it, pay interest and principal on it, and that constrains profits. And profits is what is driving down the market, or rather the lack thereof. DH: I remember almost 10 years ago, 1989 into the early 90s, we had a very flat economy. The US economy barely grew for two, three, four years -- in fact, almost coterminous with the term of the first President Bush. And I remember thinking and writing at the time that the American economy can't live with prudence. I mean, that was a time when companies stopped being so aggressive with debt, consumers stopped borrowing so aggressively, and as people tried to work off the old debts, the economy was pretty flat. It really didn't start taking off again until 1993-94 when people started borrowing again? Are we in a similar situation now, only at higher levels? JDA: Yes, and I think there an enormous number of mainstream economists who will agree to that, and who see that as problem. DH: How can we get out of it then? JDA: Well, again, it's a question of being able to repay debt. And what do you need for that? Well, you need employment. And so where is the employment going to come from? One good scenario is that if that if the dollar does fall in value, manufacturing may pick up. It may pick up not only because the US can then compete in foreign markets, but it can compete at home, it can sell at home more, competing with foreign imports. And that could have a positive effect on jobs. That would be great. So ideally what we want is, yes, a fall in the value of the dollar. But not too much. And no panic please. But if it could just wind its way a little bit lower, that would be a very good thing for the US economy. DH: The Clinton administration, especially in the persons of Larry Summers and his predecessor, Robert Rubin, were really big on a strong dollar. They kept saying a strong dollar is in the interest of the United States. Of course, not very much interest of manufacturers, but they didn't care too much about that. The Bush administration, and its treasury secretary O'Neill, have been a little less enthusiastic, it seems, about their commitment to a strong dollar policy. First of all, what's the significance of this possible policy shift? And why the interest in the first place in a strong dollar, which the Clinton people were so obsessed with? JDA: Well, the Clinton treasury really reflected the interests of the financial sector, not the manufacturing sector. A strong dollar, of course, keeps American financial institutions very profitable, very much in the forefront of all the business that is conducted in the international markets, etc. So you want a strong dollar for that if you see that as a positive gain for the US economy. I don't, of course, because I don't think it provides that much employment, nor that much value added to the US economy. I think it's a disaster. It has been a disastrous policy. When O'Neill came in -- I have lots of caveats about O'Neill, increasingly so as I listen to what he's saying now -- but one did assume at first that he had more of a sense of the importance of the health of the business and manufacturing sector. I mean, they got crushed under Reagan. And they said, Well, if we can't lick 'em, we'll join 'em. We'll join the financial sector by going overseas, and they did, increasingly putting manufacturing capacity offshore. But it seemed that they were beginning to realize that this was not ideal for them, and that they might swing in a different direction. One hopes they will, because those jobs are needed at home as well as abroad. There are other ways to conduct a good development policy other than putting US factories offshore. DH: And finally, you are with the Financial Markets Center. Who is the Financial Markets Center? And you've got a website, I presume, that people can check out if they want to know more. JDA: Yes we do. We're a small, non-profit organization engaged in research and analysis about financial markets and in particular about the Federal Reserve and monetary policy. We are very small, not too many of us. And our website is www.fmcenter.org. DH: Okay, thank you for joining us, Jane D'Arista. JDA: Thank you very much for having me.
