John Rapley - Foreign FocusLARGELY HIDDEN by the turmoil in global stock markets in recent weeks has been one of the big unfolding stories of the global economy, the falling value of the US dollar. Against a weighted basket of the currencies of its major trading partners, the "greenback" has lost some ten per cent of its value in the last few months. Against the euro, the slide has been a good deal more precipitous.
So far, the decline has been orderly, and so may not pose too much of a threat to the world economy. Some analysts worry that the drop could turn sharper, though. A correction in the value of the dollar had been expected for some time, simply because its value had become unsustainable. During the 1990s, the US began running huge balance-of-payments deficits with its trading partners. Foreigners were happy to accept payment for their exports to the US in dollars, since the booming American economy was then a good place to park their funds.
But the dollar, like the US stock market, became something of a pyramid scheme. The booming economy attracted foreign investment, and foreign investment continued the boom.
This was because the US savings rate declined throughout the 1990s, and by some measures dropped below zero by decade's end. Americans were thus spending more than they earned. In any other economy, the lack of saving would have choked investment, and thereby economic growth. But since foreigners were willing to pick up the slack, the US continued growing.
However, when the stock-market bubble that was driving the boom burst, the foreign money began flowing out. This both exacerbated the stock market's decline and drove down the value of the dollar. Is a rush for the exits, of the sort seen during the 1997-98 Asian Crisis, possible? Could the dollar, and with it the US economy, crash?
It is about that which economists now fret. The US has become more exposed than ever before to the vagaries of global financial markets. Of course, its capital stock is huge, and so the economy is less vulnerable to the sort of capital flight that Thailand or South Korea suffered. Still, the central bankers of the industrial economies are watching the value of the US dollar very closely, because if it sinks quickly, the world economy will get dragged in its wake.
Underlying the currency movements are some deeper trends which may have profound implications for the American economy's future. Since World War II, the US dollar has been the principal reserve currency used by the world's central banks. Most countries accept payments for their exports in US dollars, since it is a virtually universal currency. Thus, whatever reserves the world's governments have built up are lodged in US accounts, giving the American economy access to a large pool of investment capital.
This has placed the US in a uniquely privileged position. Unlike any other government in the world, the US can effectively print money to pay its bills (any other country must earn its dollars through exports). This has enabled the US to live beyond its means and still grow, just as it did in the 1990s. In layman's terms, the world has effectively subsidised the American standard of living.
The role of the US dollar as the world's reserve currency actually grew in the 1990s, as central banks, for various reasons, liquidated some of their gold stocks. However, with the advent of the euro, US dollar hegemony may have reached its peak. This is because the eurozone, which is expanding, is starting to rival the US economy in size. In its share of global trade, it will even surpass the US. As a result, more governments may start to use the euro for at least part of their reserves.
A wholesale shift to the euro would cause the US economy to implode; not surprisingly, therefore, Venezuela and Iraq thorns in the US side recently began requiring payment in euros for their oil exports. Still, confidence in the US dollar remains high, and for the foreseeable future, it will remain the world's favoured reserve currency. All the same, the days of easy money for the US may now be passing.
John Rapley is a Senior Lecturer in the Department of Government, UWI, Mona.
