House of Paine

meet mistah liu

 here's that guy...liu 

  dollar hegemony gadfly 


lets see what we see...

cracked pots can't hold water
though the leak may be slow
 if the crack is hair line-ish 


==============================


November 27, 2005

Liberating Sovereign Credit 
for Domestic Development
 Part I: The Curse of Dollar Hegemony
by Henry C. K. Liu
 

 
 
Ever since the end of the Cold War,
 which actually began winding down
 with President Nixon's policy of Détente,
 trade has overwhelmed domestic development 
in the global economy, 
as superpower competition 
to win the hearts and minds 
of the world in the form of aid subsided.
 Persistent US fiscal deficits
 forced the abandonment in 1971
 of the Bretton Woods regime 
of fixed exchange rates linked to a gold-back dollar. 

The flawed international finance architecture 
that resulted has since limited 
the global growth engine
 to operating with only the one cylinder
 of international trade,

 leaving all other cylinders 
of domestic development 
in a state of permanent stagnation.

Drawing lessons from the 1930s Great Depression,
 economics thinking prevalent immediately after WWII 
had deemed international capital flow 
undesirable and unnecessary for national development.


 Trade, a relatively small aspect 
of most national economies, 
was to be mediated through fixed exchange rates 
pegged to a gold-backed dollar. 

These fixed exchange rates 
were to be adjusted only gradually and periodically 
to reflect the relative strength
 of the economies participating 
in international trade, 
which was expected to augment
 but not overwhelm the national economies.

 The impact of exchange rates
 was limited to the financing of international trade.
 Exchange rate considerations 
were not expected 
to dictate domestic monetary and fiscal policies,
 the chief function of which was to support
 domestic development 
and regarded as the inviolable province 
of national sovereignty.

The global economy 
is a comprehensive and complex system 
of which trade is only one sector.

 Yet economists and policy-makers 
promoting neoliberal globalization 
tend to view trade 
as the entire global economy itself,
 downplaying the importance 
of non-trade-related domestic development.

 Neoliberals promote market fundamentalism 
as the sole, indispensable path
 for national economic growth,
 despite ample evidence
 in the past two decades 
that trade globalization 
tends to distort balanced domestic development
 in ways that hurt not only the less developed,
 but also the developed economies. 

The distributional consequences 
of global trade liberalization 
frequently work against the poor,
 the unemployed and the financially weak in all economies.

 Reductions in tariffs reduce tax revenues 
for public spending that helps poor people
 and weaken needed protection 
for endangered domestic industries.
 While distributional consequences 
of trade liberalization are complex and country-specific,
 the general trend has been 
to exacerbate income disparity everywhere,
 which in turn leads 
to economic underperformance 
and political instability.

In the United States,
 the Mecca of free-market entrepreneurship,
 the statist sectors
 - public finance, defense, health care, 
social security and public education -
 have kept the economy afloat
 in recurring, protracted recessions,
 while entrepreneurial ventures
 such as corporate finance, insurance,
 high-tech manufacturing, airlines and communication 
languish in extended doldrums.

 Unregulated markets lead naturally 
to monopolistic centralization 
and abuses in corporate governance and finance.

 It is undeniable that "free" markets 
are inherently self-destructive 
of their own freedom. 
Free markets depend on enlightened statist regulations 
to remain free
 and to prevent them from turning into failed markets.

 Government, from monarchy to democracy, 
exists to protect the weak 
from the strong 
and to maintain socio-political stability 
with a just socio-economic order.

The current international finance architecture 
is based on the US dollar 
as the dominant reserve currency,
 which now accounts for 68 percent 
of global currency reserves, 
up from 51 percent a decade ago.

 Some 80 percent of all foreign exchange transactions 
involve dollars.

 In addition, all IMF loans 
are denominated in dollars,
 as are most foreign currency loans. 

Yet in 2003,
 the US share of global exports 
of goods and services was only 11% 
(US$1 trillion 
out of a world total of $9.1 trillion)

 and its share of global imports
 was 13.8% ($1.260 trillion). 

Commodity price and exchange rate changes 
led to a 10.5% rise in world merchandise trade value
 in 2003 above 2002. 

For the first time since 1995,
 dollar prices increased
 for both agricultural and manufactured products. 
World merchandise exports
 per capita will amount to $1,562 in 2004,
 or $4.30 per day,
 while 30 percent of the world's population 
of 6.4 billion lives on less than $1 a day,
 less than one-quarter
 of per capita export value.



Since the 1971 collapse 
of the Bretton Woods regime,
 the dollar has been 
a global monetary reserve instrument
 that the US, 
and only the US, can produce by fiat,
 not backed by gold. 

Despite recent corrections, 
the exchange value of the dollar
 is still at an 18-year trade-weighted high,
 notwithstanding record US current-account 
and fiscal deficits and the status 
of the US as the world's leading debtor nation.

 The US national debt as of September 15, 2004 
was $7.38 trillion, 
rising at the rate of $1.69 billion per day,
 against a gross domestic product (GDP) 
of $8.73 trillion for the same period.

World trade is now a game 
in which the US produces fiat dollars
 and the rest of the world produces goods and services
 that fiat dollars can buy. 

The world's interlinked economies 
no longer trade to capture Ricardian comparative advantage;
 they compete in exports 
to capture needed dollars 
to service dollar-denominated foreign debts 
and to accumulate dollar reserves 
to stabilize the value
 of their currencies in world currency markets.

 To prevent speculative and manipulative attacks 
on their currencies, 
central banks of all governments 
must acquire and hold dollar reserves 
in amounts that can withstand market pressure 
on their currencies in circulation. 

The higher the market pressure 
to devalue a particular currency, 
the more dollar reserves its central bank must hold. 

Only the Federal Reserve 
is exempt from this pressure,
 because the US Treasury can print dollars 
at will with relative immunity. 
This creates a built-in support
 for a strong dollar 
that in turn forces the world's central banks 
to acquire and hold more dollar reserves,
 making the dollar even stronger.

 This phenomenon is known as dollar hegemony,
 which is created by a geopolitically-constructed 
peculiarity through which critical commodities,
 among the most notable being oil,
 are denominated in dollars. 

Everyone accepts dollars because
 dollars can buy oil. 
The recycling of petro-dollars 
into other dollar assets 
is the price the US has extracted
 from oil-producing countries
 for US tolerance for the oil-exporting cartel since 1973.

 The trade value of a currency 
is no longer tied to the productivity 
of its issuing economy, 
but to the size of dollar reserves
 held by its central bank.



By definition, dollar reserves 
must be invested in dollar assets,
 creating an automatic capital-accounts surplus
 for the dollar economy.
 Even after a protracted period 
of sharp correction,
 US stock valuation is still at 
a 25-year high and trading
 at a 56% premium compared 
with emerging market averages. 

Between 1996 and 2003,
 the value of US equities rose around 80%
 compared with 60% for European 
and a decline of 30% for Japanese. 

The 1997 Asian financial crisis 
cut Asia equities values by more than half,
 some as much as 80% in dollar terms
 even after drastic devaluation
 of local currencies. 

Even though the US has been
 a net debtor since 1986,
 its net income on the international investment position
 has remained positive,
 as the rate of return on US investments
 abroad continues to exceed 
that on foreign investments in the US.

 This reflects the overall strength 
of the US economy,
and that strength is derived 
from the US being the only nation 
that can enjoy the benefits 
of sovereign credit utilization 
while amassing external debt,
 largely due to dollar hegemony.

Credit drives the economy, not debt. 

Debt is the mirror reflection of credit.
 Even the most accurate mirror 
does violence to the symmetry
 of its reflection.

 Why does a mirror turn 
an image right to left 
and not upside down 
as the lens of a camera does? 

The scientific answer is that
 a mirror image transforms front to back rather
 than left to right
 as commonly assumed.
 Yet we often accept this aberrant mirror distortion 
as uncolored truth 
and we unthinkingly consider
 the distorted reflection 
in the mirror as a perfect representation.

In the language of economics,
 credit and debt are opposites
 but not identical. 

In fact, credit and debt operate 
in reverse relations.

 Credit requires a positive net worth
 and debt does not.

 One can have good credit
 and no debt.
 High debt lowers credit rating.
 When one understands credit,
 one understands the main force
 behind the modern finance economy, 
which is driven by credit 
and stalled by debt.

 Behaviorally, debt distorts
 marginal utility calculations 
and rearranges disposable income.

 Debt turns corporate shares 
into Giffen goods,
 demand for which increases 
when their prices go up, 
and creates what Federal Reserve Board 
Chairman Alan Greenspan calls 
"irrational exuberance", 
the economic man gone mad.

Monetary economists 
view government-issued money 
as a sovereign debt instrument 
with zero maturity,
 historically derived from the bill of exchange
 in free banking. 

This view is valid only for specie money,
 which is a debt certificate 
that can claim on demand 
a prescribed amount of gold or other specie of value. 
But fiat money issued by a sovereign government
 is not a sovereign debt 
but a sovereign credit instrument.

 Sovereign government bonds 
are sovereign debt while local government bonds
 are agency debt but not sovereign debt,
 because local governments, 
while they possess limited power to tax, 
cannot print money,
 which is the exclusive authority 
of the Federal government 
or a central government. 

When money buys bonds, 
the transaction represents sovereign credit 
canceling public or corporate debt.

 This relationship is rather straightforward 
but is of fundamental importance.

Money issued by government fiat 
is now exclusive legal tender 
in all modern national economies. 

The State Theory of Money (Chartalism)
 holds that the general acceptance 
of government-issued fiat currency
 rests fundamentally on government's authority to tax.

 Government's willingness to accept the fiat currency 
it issues for payment of taxes 
gives such issuance currency 
within a national economy. 
That currency is sovereign credit
 for tax liabilities, 
which are dischargeable by credit instruments
 issued by government 
in the form of fiat money.
 When issuing fiat money, 
the government owes no one anything except
 to make good a promise to accept
 its money for tax payment.

 A central banking regime operates
 on the notion of government-issued fiat money
 as sovereign credit. 

A central bank operates essentially
 as a lender of last resort
 to a nation's banking system, 
drawing on sovereign credit.

Thomas Jefferson prophesied:
 "If the American people 
allow the banks to control 
the issuance of their currency,
 first by inflation,
 and then by deflation,
 the banks and corporations 
that will grow up around them 
will deprive people of all property 
until their children will wake up homeless
 on the continent their fathers occupied ... 
The issuing power of money 
should be taken from the banks 
and restored to Congress 
and the people to whom it belongs."



 This warning applies to other peoples 
in the world as well.

Government levies taxes 
not to finance its operations,
 but to give value to its fiat money
 as sovereign credit instruments. 

If it chooses to, 
government can finance its operation entirely
 through user fees, 
as some fiscal conservatives suggest.

 Government needs never be 
indebted to the public.

 It creates a government debt component
 to anchor the private debt market,
 not because it needs money. 

Technically, a sovereign government
 needs never borrow.
 It can issue tax credit 
in the form of fiat money 
to meet all its liabilities.

 And only a sovereign government
 can issue fiat money 
as sovereign credit.

If fiat money is not sovereign debt,
 then the entire conceptual structure 
of finance capitalism is subject to reordering,
 just as physics was subject to reordering 
when man's worldview 
changed with the realization 
that the earth is not stationary 
nor is it the center of the universe. 

The need for capital formation
 to finance socially-useful development
 will be exposed as a cruel hoax,
 as sovereign credit 
can finance all socially-useful development
 without problem.

 Private savings are not necessary 
to finance public socio-economic development,
 since private savings
 are not required for the supply of sovereign credit.

 Thus the relationship
 between national private savings rate
 and public finance is at best indirect.
 Sovereign credit can finance an economy 
in which unemployment is unknown,
 with wages constantly rising 
to provide consumer buying power
 to prevent production overcapacity.

 A vibrant economy 
is one in which there is persistent labor shortages 
that push up wages 
to reduce overcapacity. 
Private savings are needed
 only for private investment 
that has no intrinsic social purpose or value. 

Savings without full employment 
are deflationary,
 as savings reduces current consumption 
to provide investment to increase future supply, 
which is not needed in an economy 
with overcapacity created by lack of demand,
 which in turn has been created 
by low wages and unemployment

. Say's Law of supply creating
 its own demand is a very special situation 
that is operative only under full employment 
with high wages. 

Say's Law ignores a critical time lag 
between supply and demand 
that can be fatally problematic
 to the cash-flow needs 
in a fast-moving modern economy. 
Savings require interest payments,
 the compounding of which will regressively make
 any financial scheme unsustainable.

 The religions forbade
 usury for very practical reasons.

The relationship between assets
 and liabilities is expressed as credit and debt,
 with the designation determined 
by the flow of obligation.

 A flow from asset to liability 
is known as credit,
 the reverse is known as debt.
 A creditor is one who reduces
 his liability to increase his assets,
 which include the right of collection
 on the liabilities of his debtors.
 Sovereign debt is a pretend game 
to make private monetary debts
 denominated in fiat money tradable.

The sovereign state, representing the people, owns all assets of a nation not assigned to the private sector. This is true regardless whether the state operates on socialist or capitalist principles. Thus the state's assets is the national wealth less that portion of private sector wealth after tax liabilities, plus all other claims on the private sector by sovereign right. High wages are the key determinant of national wealth. Privatization generally reduces state assets while it may increase tax revenue. As long as a sovereign state exists, its credit is limited only by the national wealth. If sovereign credit is used to increase national wealth, then sovereign credit is limitless as long as the growth of national wealth keeps pace with the growth of sovereign credit.

When a sovereign state issues money as legal tender, it issues a monetary instrument backed by its sovereign rights, which includes taxation. A sovereign state never owes domestic debts except by design voluntarily. When a sovereign state borrows in order to avoid levying or raising taxes, it is a political expedience, not a financial necessity. When a sovereign state borrows, through the selling of sovereign bonds denominated in its own currency, it is withdrawing previously-issued sovereign credit from the financial system. When a sovereign state borrows foreign currency, it forfeits its sovereign credit privilege and reduces itself to an ordinary debtor because no sovereign state can issue foreign currency.

Government bonds act as absorbers of sovereign credit from the private sector. US Government bonds, through dollar hegemony, enjoy the highest credit rating, topping a credit risk pyramid in international sovereign and institutional debt markets. Dollar hegemony is a geopolitical phenomenon in which the US dollar, a fiat currency, assumes the status of primary reserve currency in the international finance architecture. Architecture is an art the aesthetics of which is based on moral goodness, of which the current international finance architecture is visibly deficient. Thus dollar hegemony is objectionable not only because the dollar, as a fiat currency, usurps a role it does not deserve, but also because its effect on the world community is devoid of moral goodness, because it destroys the ability of sovereign governments beside the US to use sovereign credit to finance the development their domestic economies, and forces them to export to earn dollar reserves to maintain the exchange value of their own currencies.

Money issued by sovereign government fiat is a sovereign monopoly while debt is not. Anyone with acceptable credit rating can borrow or lend, but only sovereign government can issue fiat money as legal tender. When sovereign government issues fiat money, it issues certificates of its sovereign credit good for discharging tax liabilities imposed by sovereign government on its citizens. Privately-issued money can exist only with the grace and permission of the sovereign, and is different from sovereign government-issued money in that privately issued money is an IOU from the issuer, with the issuer owing the holder the content of the money's backing. But sovereign government-issued fiat money is not a debt from the government because the money is backed by a potential debt from the holder in the form of tax liabilities. Money issued by sovereign government by fiat as legal tender is good by law for settling all debts, private and public. Anyone refusing to accept dollars in the US for payment of debt is in violation of US law. Instruments used for settling debts are credit instruments.

Buying up sovereign bonds with government-issued fiat money is one of the ways government releases more sovereign credit into the economy. By logic, the money supply in an economy is not government debt because, if increasing the money supply means increasing the national debt, then monetary easing would contract credit from the economy. But empirical evidence suggests otherwise: monetary ease increases the supply of credit. Thus if fiat money creation by sovereign government increases credit, money issued by sovereign government fiat is a credit instrument.

Economist Hyman Minsky rightly noted that whenever credit is issued, money is created. The issuing of credit creates debt on the part of the counterparty; but debt is not money, credit is. Debt is negative money, a form of financial antimatter. Physicists understand the relationship between matter and antimatter. Einstein theorized that matter results from concentration of energy and Paul Dirac conceptualized the by-product creation of antimatter through the creation of matter out of energy. The collision of matter and antimatter produces annihilation that returns matter and antimatter to pure energy. The same is true with credit and debt, which are related but opposite. They are created in separate forms out of financial energy to produce matter (credit) and antimatter (debt). The collision of credit and debt will produce annihilation and return the resultant union to pure financial energy un-harnessed for human benefit. The paying off of debt terminates financial interaction.

Monetary debt is repayable with money. Sovereign government does not become a debtor by issuing fiat money, which, in the US, takes the form of a Federal Reserve note, not an ordinary bank note. The word "bank" does not appear on US dollars. Zero maturity money (ZMM) in the dollar economy, which grew from $550 billion in 1971 when President Nixon took the dollar off a gold standard, to $6.6 trillion as of June 2004, is not a federal debt. It amounts to about 65% of US GDP of $11.64 trillion, slightly below the national debt of $7.38 trillion at the same point in time. Sovereign credit is what gives the US economy its inherent strength.

A holder of fiat money is a holder of sovereign credit. The holder of fiat money is not a creditor to the state, as some monetary economists mistakenly claim. Fiat money only entitles its holder a replacement of the same money from government, nothing more. The dollar, being a Federal Reserve note, entitles the holder to exchange the note to another identical note at a Federal Reserve Bank, and nothing else. The holder of fiat money is acting as a state agent, with the full faith and credit of the state behind the instrument, which is good for paying taxes and is legal tender for all debt public and private. Fiat money, like a passport, entitles the holder to the protection of the state in enforcing sovereign credit. It is a certificate of state financial power inherent in sovereignty.

The Chartalist theory of money claims that government, by virtual of its power to levy taxes payable with government-designated legal tender, does not need external financing. Accordingly, sovereign credit enables the government to finance a full-employment economy even in a regulated market economy. The logic of Chartalism reasons that an excessively low tax rate will result in a low demand for currency and that a chronic government fiscal surplus is economically counterproductive and unsustainable because it drains credit from the economy continuously. The colonial administration in British Africa used land taxes to induce the carefree natives to use its currency and engage in financial productivity.

Thus, according to Chartalist theory, an economy can finance with sovereign credit its domestic developmental needs, to achieve full employment and maximize balanced growth with prosperity without any need for sovereign debt or foreign loans or investment, and without the penalty of hyperinflation. But Chartalist theory is operative only in predominantly closed domestic monetary regimes. Countries participating in neo-liberal international "free trade" under the aegis of unregulated global financial and currency markets cannot operate on Chartalist principles because of the foreign-exchange dilemma. Any government printing its own currency to finance legitimate domestic needs beyond the size of its foreign-exchange reserves will soon find its convertible currency under attack in the foreign-exchange markets, regardless of whether the currency is pegged at a fixed exchanged rate to another currency, or is free-floating. Thus all non-dollar economies are forced to attract foreign capital denominated in dollars even to meet domestic needs. But non-dollar economies must accumulate dollars reserves before they can attract foreign capital. Even with capital control, foreign capital will only invest in the export sector where dollar revenue can be earned. But the dollars that exporting economies accumulate from trade surpluses can only be invested in dollar assets, depriving the non-dollar economies of needed capital in domestic sectors. The only protection from such attacks on domestic currency is to suspend full convertibility, which then will keep foreign investment away. Thus dollar hegemony, the subjugation of all other fiat currencies to the dollar as the key reserve currency, starves non-dollar economies of needed capital by depriving their governments of the power to issue sovereign credit for domestic development.

Under principles of Chartalism, foreign capital serves no useful domestic purpose outside of an imperialistic agenda. Dollar hegemony essentially taxes away the ability of the trading partners of the US to finance their own domestic development in their own currencies, and forces them to seek foreign loans and investment denominated in dollars, which the US, and only the US, can print at will with relative immunity.

The Mundell-Fleming thesis, for which Robert Mundell won the 1999 Nobel Prize, states that in international finance, a government has the choice among (1) stable exchange rates, (2) international capital mobility and (3) domestic policy autonomy (full employment, interest rate policies, counter-cyclical fiscal spending, etc). With unregulated global financial markets, a government can have only two of the three options.

Through dollar hegemony, the United States is the only country that can defy the Mundell-Fleming thesis. For more than a decade since the end of the Cold War, the US has kept the fiat dollar significantly above its real economic value, attracted capital account surpluses and exercised unilateral policy autonomy within a globalized financial system dictated by dollar hegemony. The reasons for this are complex but the single most important reason is that all major commodities, most notably oil, are denominated in dollars, mostly as an extension of superpower geopolitics. This fact is the anchor for dollar hegemony which makes possible US finance hegemony, which makes possible US exceptionism and unilateralism.

Foreign investors held $1.61 trillion,
 or 24.3 percent, 
of the $6.63 trillion of outstanding corporate bonds
 at the end of the first quarter of 2004,
 up from 22.1 percent in the first quarter of 2003,
 13.5 percent on average throughout
 the 1990s and 11.9 percent in the 1980s. 
US life insurance companies
 held a slim lead as the largest owners of corporate debt,
 with $1.62 trillion, or 24.4 percent of the market,
 but that lead is expected to be overtaken soon by foreigners.

 The rising US trade deficits 
will continue to increase foreign ownership 
of all types of US securities. 

The dollar-denominated trade surplus
 for foreign economies
 is invested in US government and agency securities 
and corporate stocks and bonds.

 The jump in the US trade deficit
 to a record high of $55.8 billion 
for June 2004 has once again refocused 
the spotlight on the rising external indebtedness
 of the US economy. 

Despite the recent fall of some 20 percent 
in the exchange value of the dollar 
against other major currencies, 
the US trade gap increased to $55.8 billion
 in June 2004 from $42.7 billion in December 2003.

 The current account deficit trend,

 which measures the rate 
at which the US is going into external debt,
 continues to rise.
 The payments gap was $542 billion for 2003,
 easily eclipsing the previous high
 of $481 billion recorded in 2002. 
At current rate,
 the trade gap for 2004 will exceed $600 billion,
 an unsettling level of 5.2% of GDP.

The 9.7% annual decline 
in the real value of the U.S. dollar 
since the first quarter of 2002 
has little effect in reducing the trade deficit.
 The dollar fell much more against 
the Euro (38% in nominal terms) 
than other currencies. 
The U.S. deficit with Western Europe
 rose 16.9% in the first half of 2004.
 Asian nations engaged in heavy intervention
 in foreign exchange markets 
in order to prevent the dollar
 from falling against their currencies. 

China and Hong Kong peg their currencies
 to the dollar at a fixed rate.

Federal Reserve Board chairman Alan Greenspan 
has expressed the view that the weaker dollar
 should eventually help narrow 
the trade deficit, 
with a warning that "creeping protectionism" 
could endanger the flexibility
 of the global financial system. 

Greenspan feels that global financial markets 
will be able to finance the US payments gap 
with a daily capital inflow 
of between $1.5 - 2 billion,
 provided trade and finance restrictions 
are not imposed by government measures.

 The national debt 
is rising at the rate of $1.69 billion per day.
 Net capital inflow requirement
 adds up to $730 billion annually.
 If and when this inflow of funds
 should reverse for any number of reasons,
 a major financial crisis could erupt.

 Flow of Funds data
 released by the Federal Reserve 
shows that US financial markets 
are becoming ever more dependent
 on inflows of foreign capital.
 This foreign capital has essentially
 been created by recycling US external debt,
 not savings. 

Foreign governments provided 
86% of total capital inflows
 in the first quarter of 2004,
 94% of which from Asia.

Greenspan has also denied 
the existence of a housing bubble,
 by noting that the US housing market
 is disaggregated.
 Yet the residential mortgage market 
is non-placed related. 
Fanny Mae, created by Congress 
during the New Deal decades ago
 to make home mortgages available 
to middle and low income buyers,
 and current under inquiry on violation 
of generally accepted accounting principles
 from supervisory authorities,
 markets its mortgage-backed securities
 worldwide and engages in large scale
 interest rate derivative trading.

 The stratospheric rise 
in home prices in recent years 
has been largely financed by low-cost,
 high debt-to-equity ratio mortgages 
sourced from foreign creditors.

During the fourth quarter of 2003,
 foreign creditors loaned US borrowers 
an unprecedented $848 billion annualized,
 an amount equal to one-third of all credit market lending.
 For 2003 as a whole, 
foreign investors accounted for 22.6 percent 
of net new lending in US markets 
and raised their share
 of outstanding credit market debt 
by a percentage point to 10.9 percent. 
Between 2000 and 2003, 
the volume of credit market instruments 
(US government securities, agency debt,
 corporate bonds and commercial papers) 
owned by foreign investors expanded 
by more than half.
 Mainly as a result of purchases 
of corporate and Treasury debt, 
foreign acquisitions of US credit market instruments 
soared to a record 
$611.2 billion in 2003,
 more than acquisitions in the previous 
two years combined.
 Between October and December of 2003,
 foreign investors bought 89 percent 
of net new securities issued
by the US Treasury
 and 40 percent of bonds issued by US corporations.
 In a bid to stabilize 
their own currencies against a falling dollar,
 Asian central banks have been purchasing dollars 
to keep their currencies from rising,
with which they then use to buy 
US sovereign and private debt.
 Largely as a result of this process,
 central banks and other foreign public agencies
 accounted for two thirds 
of the acquisitions of US Treasury securities 
during the fourth quarter of 2003.

 The trend is expected to increase for 2004.

The rising US external debt
, fuelled by a $600 billion trade deficit coupled with record federal budget deficit of more than $500 billion, has prompted concerns that, at some point, foreign investors are going to lose confidence and begin withdrawing funds or at least slowing the inflow. There is also the nagging risk that ever-growing current account deficits would lead to US protectionist measures and an overdue questioning of the role of the dollar as a primary reserve currency. World economic growth as a whole continues to depend critically on expansion of the US economy, but this expansion is dependent on and continues to generate ever-increasing levels of domestic and external debt. The US economy is vacuuming up the world's surplus capital to finance its rising debt, depraving other economies of needed capital for domestic development, while dollar hegemony prevent non-dollar economies from utilizing sovereign credit. China's strong manufacturing sector attracted foreign direct investment (FDI) worth $53.5 billion in 2003, compared with US$52.7 billion in 2002. The US, traditionally the largest recipient of FDI, saw such investment plunge by 53% in 2003 to reach $30 billion - the lowest in 12 years. But while FDI in the US supports the dollar economy, almost all of China's fast rising FDI is concentrated in the export sector, which operates to support the dollar economy, not China's domestic development or the yuan economy.

Interest rates, at least short term rate controlled by the Fed Funds rate (FFR) target, are not predictable by merely observing market trends since the FFR is determined not by market fundamentals but by Federal Reserve ideology of sound money as dictated by the Fed's institutional role of fighting inflation, modified by its judgment on the need for counter-cyclical monetary stimulation. The only way to predict FFR level is to get into the mind of Greenspan, or whoever happens to be Chairman of the Fed.

But low interest rates does not stop foreigners from investing in the US, it only pushes foreigners from low-yield US Treasuries into higher-yield corporate bond markets. If foreigners should stop funding US debts, the Fed can make up the slack by printing more dollars, as Fed Vice Chairman Ben S. Bernanke has publicly suggested, killing the two birds of high oil price and massive debts with one inflationary stone. But the dollars that foreigners have accumulated from trade surpluses from the US cannot be converted back into their own currencies without causing their own currencies to appreciate against the dollar, thus reducing foreign exporters' trade surplus in dollars. This is part of the circular trap of dollar hegemony. Also, foreign exporters selling the dollars they have accumulated from trade will only cause the dollar to fall further, causing these foreigners to lose more than they gain as their remaining dollar holdings will lose foreign exchange value against their own currencies.

Thus if China which as of September 2004 holds over $485 billion in foreign reserves sells $10 billion for yuan, or euro, or yen to try prevent loss from a falling dollar, the remaining $475 billion will be worth less than the gain (or stop-loss) from the $10 billion sale, which adds downward pressure on the dollar. Thus foreign-owned dollars are trapped with nowhere to go except to stay in the dollar economy. It does not mean however, that these dollars will all return to the US geographically; some will remain as euro-dollars (which has nothing to do with euros, but is a term meaning offshore dollars). The expansion of euro-dollars, mostly in Asia, will mean that the dollar economy is swallowing up Asia, turning it into a financial colony of the dollar which the US can print at will with relative immunity.

Dollar hegemony may be good for the dollar economy, but it is not necessarily good even for the US economy. Those who still have jobs or income in the US that earn more than their counterparts outside of the US will fall victim to outsourcing brought about by corporate arbitrage on cross-border wage disparity. Worker pension funds, in search of highest return on investment from transnational corporations that maximize their profit from cross-border wage arbitrage, are unwittingly depriving the future pensioners of their high-wage jobs, pushing them into early involuntary retirement with reduced annuity. Unemployment in the US will continue to rise to support transnational corporate profit maximization from outsourcing. First textile, than manufacturing, then high-tech and next will be financial services, beyond back office outsourcing, but hungry 25-year-old investment bankers and traders overseas who will settle happily for $1 million a year instead of the $3 million demanded by bankers and traders in New York. Cross-border wage disparity will not moderate until cross-border purchasing power parity (PPP) gap moderates, and PPP gap is mostly a dysfunctionality of the exchange rate regime under dollar hegemony.

US interest rates will stay below market for the foreseeable future, until dollar hegemony ends. Whether dollar hegemony ends depends on whether China has enough foresight to kick start a new international finance architecture. So far, there is no sign that China has the wits to do much, except complacently counting the dollars China accumulates while not realizing the more dollars China holds, the more the Chinese economy loses by exporting real wealth from the yuan economy to the dollar economy, as Japan has done since the end of the Cold War. Hopefully the new generation of Chinese leaders will be better advised about the curse of dollar hegemony. On the other side, the US is getting to be like Saudi Arabia, which has been ruined by its oil riches denominated in dollars, saddling the country with a whole generation of citizens with no marketable skills at competitive wages. The only difference is that while Saudi Arabia pumps oil, the US prints dollars.

Dollar hegemony is reducing the US 
to a country whose workers are overpaid 
across the board by international standards.
 While Greenspan justifies US high wages 
by citing continuous rise in productivity,
 such rise is achieved essentially 
by foreign workers doing most of the producing.

 Ultimately, productivity cannot 
be increased by not working.

 The only jobs that will not be outsourced 
will be those that are location-tied,
 such as cooking and serving meals,
 caring for the sick, the young and the aged, 
vacuuming carpets, cleaning toilets and picking fruits.

 Such jobs do not pay a living wage 
in the US turbo economy, 
and to fill them the US imports illegal immigrants.
 Greenspan's warning about creeping US trade protectionism
 amounts to a trade-off 
between losing high-pay jobs
 and defaulting on
 low-interest foreign debts.

Foreigners are buying US corporate debt, 
not equities.
 To fund its twin deficits
, the US economy continues
to rely on sustained foreign funding.
 Foreigners purchased net public debt 
of $61.33 billion and $21.3 billion
 of corporate bonds in February 2004, 
but practically no equities,
 only $100 million. 

Even then, private investor purchases
 of public debt fell by half to $10 billion, 
the rest bought by foreign central banks
 which are constrained by policy
 on high-risk investment.

 The lack of interest in equity suggests 
that foreigners have little faith 
in the continuing growth of the US economy
 and are aware that the US bankruptcy regime
 grants preference to debt before equity.

Net portfolio inflows 
into the US of $83.4 billion
 in February 2004,
 although slightly lower than $92.3 billion in January,
 were almost double the $45 billion 
a month required to fund the US current account deficit.
 This validates Greenspan's assertion
 that the US has no trouble funding 
its external deficit.
 US workers, however,
 will have trouble holding 
on to their high-paying jobs.

 


Henry C. K. Liu