Why Paulson accepted the Treasury job
It is possible that Henry Paulson sees Goldman Sachs facing an uphill battle in the next few years as the US economy slows. Paulson has made enough money in the good years and may consider it smart to leave Goldman at the peak of the market - it's no fun to run an investment bank in a down market.
Paulson is a banker. Bankers are interested in the state of the market, not the economy per se. In two and a half years, a treasury secretary can, with the full power of the Treasury behind him, have a chance of saving the market from imminent collapse from its current structural imbalances.
The formula is to accelerate the crash in order to gain a fast recovery later. The prospect of Paulson engineering a sharp correction in the equity market right after the mid-term congressional election is almost certain. The strategy is to remove the structural bottlenecks and to weed out the weaknesses and have the market resume its upward path by June 2008. This strategy is doable with a heavy dose of government intervention, but it will require a crash to create a serious enough emergency to make government intervention patriotic, possibly including massive bailouts of several troubled giants such as General Motors, General Electric and Fannie Mae (the Federal National Mortgage Association) and the big money-center banks that are up to their necks with credit-derivative exposures.
Strong dollar is the key
The key is to restore the US dollar's strong exchange rate, despite all the talk of the need for a lower dollar to reduce the trade deficit by predictable free-trade economists such as Fred Bergsten of the Institute of International Economics, whose views are distorted by their seeing trade as the entire economy rather than just one aspect of the global economy.
If China refuses to more quickly revalue the yuan against the dollar in the near term, as it most likely will, Paulson can bring up the dollar along with the yuan against the yen and the euro without adding to the US trade deficit, which is mostly with China, and oil, which is denominated in dollars. The way to strengthen the dollar is to raise the Fed Fund Rate (FFR). Paulson can be expected to apply all the pressure he can muster to force Bernanke to raise the FFR, continuing a gradual pace of 25 basis points on June 25 but more sharply immediately after the November elections to bring on a massive correction in the markets. The FFR can rise to 9% or 10% in the name of national security to save the dollar. The recession will be pre-packaged, and relatively short, from fourth-quarter 2006 to Q1 2008 with a sharp recovery in Q2 2008, providing buying opportunities for those who are smart enough to have cash on hand.
Just like Robert Rubin, treasury secretary under president Bill Clinton, Paulson firmly believes that a strong dollar is in America's national interest. Rubin kept it strong by making the current-account deficit finance the capital-account surplus. Paulson will do it by further erasing national borders in global finance, thus making the US current-account deficit meaningless as long as it is denominated in dollars.
The US has transcended the national economy by operating on the dollar economy that is not location-dependent. The name of the globalization game is making money where money can be made most easily. The United States will prosper as the place where the world's rich will come to spend money made elsewhere, leaving behind the pollution and labor disputes and all the dirty business of making money offshore. Paulson will try to make China an economic colony of the United States (albeit with the full cooperation of the Chinese Communist Party in Beijing, which has designed and promulgated for 28 years an economic policy that leaves China's economy totally dependent on exports to the US) and thus remove bilateral economic conflicts.
Bernanke, not yet a force with confidence, will go along because it is the Fed's duty to support national-security aims and also because a Fed chairman needs a crash to show his wizardry, as Greenspan did in 1987. Besides, no one has opposed Hank "the Hammer" and survived.
Congress and China the wild cards
One wild card is the parochial US Congress. If the Democrats regain the House of Representatives after this year's mid-term election, Paulson will have a tough task ahead.
The other problem is that China is going through a heated debate internally about the wisdom of its economic policy based on exports. Any change in Chinese economic strategy will throw a monkey wrench into Paulson's strategy. Paulson can count on his close links to Tsinghua University in Beijing, where he helped start a business school with several of his Goldman Sachs colleagues. Tsinghua has become in recent decades a hotbed of neo-liberal free-trade market fundamentalism more doctrinaire than Stanford. As a sign of its rejection of progressive policy, the revisionist institution even refused to use the pin-yin romanization (Qinghua) for its name in preference to the Wade-Giles spelling of the Western imperialist era.
There is no guarantee that Paulson will succeed in his possible game plan. The war in Iraq and the pending war over Iran are big uncertainties. In fact, the worst is a gradual, steady worsening of the Iraq quagmire. If the situation in Iraq were to go very badly suddenly, say 3,000 US troops getting killed over one disastrous week, it would be easier for Bush. This slow bleeding in a prolonged occupation is truly deadly for US interests.
Paulson cannot save the economy but he has a chance to create a recovery in time for the 2008 election. After that, whoever rules from the White House will have to face the real music.
Dollar hegemony requires a strong dollar
While I have been pointing out since 2002 (US dollar hegemony has got to go, April 11) the mechanics of how dollar hegemony works, I am not of the opinion that dollar hegemony will die a natural death easily. I coined the term to mean the use of the US trade deficit to finance the US capital-account surplus, both denominated in a fiat currency, thus eliminating any balance-of-payments problem for the United States and depriving the trade-surplus economies of needed domestic capital.
Under dollar hegemony, the exporting economies ship real goods produced with low wages to the United States in exchange for dollars that must by definition be reinvested in dollar assets, not assets denominated in domestic currencies. This is what is hegemonic about the dollar since the emergence of globalization in the late 1990s, not seigniorage, which is not hegemonic by nature because seigniorage is merely a fair fee for services rendered.
Dollar hegemony is the most sophisticated financial regime in history. It is the first time in human financial affairs that currency hegemony is imposed by a fiat currency through floating exchange rates and free convertibility made possible by globalized financial markets. The British Empire was built around the pound sterling, but all local currencies within that vast empire had fixed exchange rates with respect to the pound. After World War II, when the United States took over the British Empire, Bretton Woods was a fixed-exchange-rate regime based on a gold-backed currency - the US dollar, a regime in which cross-border flow of funds were restricted because mainstream economic theory at that time did not consider cross-border flows necessary for trade or desirable for development.
After 1971, when Nixon took the dollar off the gold standard because of the drain of gold from recurring US trade deficits, dollar hegemony still did not arise because cross-border flows of funds were still restricted. After World War II, euro-dollars came into existence because of US military overseas spending, dollar-denominated war debts both from allies and from former enemies paid to offshore US accounts and foreign aid, but the United States was still running a trade surplus and euro-dollars stayed outside the country, mostly in Germany and Japan.
It was during the Vietnam War that the US began to run a recurring trade deficit, at first purposely to prevent Germany and Japan from turning communist. The United States allowed Germany and Japan to build up their automotive and steel sectors for exporting to US markets to keep their economies capitalistic but kept the advanced high-tech sectors for itself. Since it takes several thousand cars to buy one commercial airliner, it was no great loss to lose market share in the auto sector. It did create the Rust Belt in the US Midwest, but domestic political power was shifting to the west and southwest where a new aerospace sector was flourishing.
Dollar hegemony did not come into being until after the end of the Cold War, when the global market was suddenly opened to US companies and financial institutions and cross-border flow of funds became routine with the deregulation of financial markets.
It was through Robert Rubin under Clinton that dollar hegemony became formal US policy in the form of "a strong dollar is in the US national interest" even with a rising and recurring trade deficit. Rubin advanced the notion that the US trade deficit was benign because it was neutralized by the US capital-account surplus.
A trade deficit is never a problem as long as it is denominated in the country's fiat currency. Dollar hegemony is a regime in which a fiat currency issued by one government becomes a supranational currency. Dollar hegemony is the device for globalization of finance to tear down national boundaries and to reduce the authority of sovereign nation states.
Resistance to dollar hegemony
The problem with dollar hegemony is not that it will be resisted by other governments; the US dollar is now a supranational fiat monetary unit accepted by all who own capital, not just US citizens. All other fiat currencies are now derivatives of the dollar.
In every foreign government, from Japan to Germany, from China to Russia, there are powerful forces that see supporting a strong US dollar as serving factional if not national interests. This is because the dollar economy is increasingly detached from US economy, not completely but selectively.
The resistance to dollar hegemony is from a revival of economic nationalism, including US economic nationalism against global trade, particularly in finance, where the game of economic control is being played. This conflict is being waged in the domestic politics of every country, with those who need jobs to make a living pitted against those who make money by the manipulation of capital, known popularly as investing. US big business is allied with foreign state capitalism with US official policy support.
Democracy in Latin America is ushering in a parade of radical socialist leaders against dollar hegemony; and the democratic process in the US is also turning against dollar hegemony. The wars waged by the United States to secure oil for its economy have created $70 oil and $3.50-a-gallon (92-cent-a-liter) gasoline for the US consumer, and the worst is yet to come. The double-digit returns on US pension funds come from investment in companies that ship US jobs overseas and stealth inflation that produced $700 gold. Dollar hegemony to the US economy is turning out to be like the computer HAL in the movie 2001: A Space Odyssey.
Paulson's challenge
The problem Henry Paulson will face is at home in the United States, not in Beijing or Moscow or even Caracas. He will have to explain to an ever increasing number of US voters how globalized financial markets and supranational economic policy have benefited them or will benefit them in the future.
Conflict of interest in policymaking is unavoidable in a complex financial system. It is not surprising nor unreasonable that those who have done well in the private finance sector should be natural candidates to manage the finances of the public sector. And it can be argued that in a system such as the United States', the private and public sectors are two complementary rings of the national economic circus. Conflicts are tolerable if the management of the public sector by private interests produces a strong economy for all of the general public.
When the economy falters, conflict of interest between private and public becomes a critical issue because it is always the general public that bears most of the pain. An economic downturn in the US will produce populist government by representatives of the general public rather than elitist government by the rich and powerful.
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