Jay:
Actually I agree with your critique of Levy. His analysis makes the implicit assumption tha the dollar will remain strong as far as the eye can see. But we must ask the question "how long will the rest of the world allow itself to be crucified on a cross of greenbacks"? Argentina is merely the latest victim of the "strong dollar policy" that has done so much to enrich the US and impoverish many overseas.
AMERICA’S ‘STRONG DOLLAR’ POLICY AND ARGENTINA’S DEFAULT: A ROOT
CAUSE THAT DARE NOT SPEAK ITS NAME
28 December 2001
by Marshall Auerbach
Argentina has been a habitual problem throughout 2001, so it is perhaps appropriate that the
country’s new government has ended the year by announcing the largest sovereign debt
default in history. So much for former Citibank Chairman Walter Wriston’s belief that only
companies go bust, not countries.
Needless to say, the blame game has already started as to who or what caused this fiasco with
the usual suspects now being lined up in front of us: the IMF, former Presidents Menem and
De La Rua, former Economics Minister Domingo Cavallo, the currency peg system itself,
Argentina’s fiscally irresponsible provincial governments, the list goes on. Curiously, there
has been very little attempt to look at the problem from another perspective, namely the
consequences of Argentina being yet another in a string of international casualties emanating
from America’s strong dollar policy. As was the case in emerging Asia, Argentina’s decision
to retain a link with a manifestly overvalued currency must surely rank as one of the leading
root causes of the default. While this is not the sole cause of Argentina’s current woes,
retaining the peso-dollar convertibility peg ultimately did a huge amount to undercut the
competitiveness of the country’s external sector, consequently rendering its debt servicing
requirements untenable.
Even when it was becoming clear that Washington’s economic policy makers were adhering to
a strong dollar policy solely as a means of appeasing the increasingly large foreign
constituency financing America’s huge and growing private sector financial deficit, the
Treasury and the IMF continued to insist that Argentina retain its convertibility system (with
no modifications) as a quid pro quo for receiving continued assistance. This left Argentina in
an economic cul-de-sac, with virtually no policy options left to alleviate the country’s 4-year
long recession. They were forced to operate under conditions that no American politician
would dare advocate for the US – cutting public expenditure in the midst of a fully blown
recession, raising interest rates – in short, the exact opposite of what American policy makers
have been doing since the US economy began to descend into recession. Yet the multifold
adverse effects from these policies have thus far occasioned little analysis within the context of
Argentina’s current plight.
It is one thing to say that the US should not allow its policy on the dollar to be subject to an
international veto (as Washington and others seem to be urging on Tokyo in regard to the
yen). It is quite another to ignore the international implications of such a policy, whilst
simultaneously seeking to assert global dollar hegemony. It is also perverse to continue to
advocate a strong dollar policy independent of any considerations relating to trade
competitiveness in the US itself and the corresponding threat posed by debt trap dynamics in
the event of a substantial current account deficit.
Under Treasury Secretary Rubin and his two successors who have slavishly continued his
policy, short run speculative trend following capital inflows which buoy domestic stock and
bond markets and keep domestic interest rates low have been deemed to be consistently more
important even as the strong dollar policy has wreaked havoc domestically in America’s
manufacturing heartland and created huge external imbalances in the current account. It has
also propelled asset markets ever higher with unstable fuel from inflows of short term global
speculative capital. In the case of the US it is now hurtling the world's largest net debtor
nation toward a record current account deficit as a share of GDP, whilst concomitantly
drawing desperately needed capital funding requirements away from the emerging world
(thereby helping to create the kind of underdeveloped gangster states that we now recognize
pose formidable risks to American domestic security). Finally, the strong dollar policy has
helped to perpetuate a high tech bubble rife with capital expenditure excesses, and a stock
market and real estate bubble, all of which are symptoms of a credit system run amok in the
US itself. Washington’s attempts to deal with the aftermath of these excesses has already
begun to exert a powerful deflationary toll on the global economy, thereby further
exacerbating the problems of a country like Argentina, as it seeks to export its way out of its
current financing crisis.
It didn’t used to be like this. From the early 1970's onward, American industrialists have been
concerned about competitive inroads from lower wage countries on a rapid path toward
modernization. In the 1980's the focus was on Japan and its successful takeover of a long
succession of consumer durable goods markets (autos, TV's, etc.) and some high tech markets
(semiconductors) that were developed initially by US firms. By the 1990's and the early part
of this century concerns have intensified that imports of an ever widening range of goods from
lower wage countries, particularly in the Far East, have "hollowed out" America's industrial
base, destroying the country’s export capability and rendering the United States hostage to the
fickle forces of speculative foreign capital inflows.
Prior to Robert Rubin, Secretaries of the Treasury in the United States conducted economic
policy partly with an eye toward preventing a loss of US competitiveness. Faced with calls for
protectionism from firms and workers whose industries and jobs were at risk, these former
Treasury regimes were biased toward a low dollar exchange rate which would enhance the
position of US industries in world trade without running the risk of trade wars posed by
protectionist solutions. This was the rationale behind the Louvre Accord, for example. Most of
these Treasury Secretaries remembered an earlier era when the US ran current account
surpluses and was the world's largest creditor nation. From this perspective, US current
account deficits were a source of weakness they wished to rectify. It was only 8 years ago at
100 yen to the dollar that Mickey Cantor and Lloyd Bentsen were fighting to improve US
competitiveness in global tradeables markets with, among other weapons, a threat of dollar
devaluation.
The Rubin Treasury developed policies that marked a conspicuous break from this trend in
that it followed a very strong dollar policy, an orientation that has been continued by his
successors, even as the American current account went into record deficit as a percentage of
GDP earlier this year. Secretaries Rubin, Summers and O’Neil have been quite consistent in
their respective focuses: trade competitiveness is seldom cited as an issue; instead, all have
emphasized the support a strong dollar gives to domestic capital markets (indeed, in the case
of Mr. O’Neil, he went as far as to dismiss the current account deficit as nothing more than an
outdated accounting anomaly). We see the preference clearly expressed as early as September,
1996 in an interview Mr. Rubin granted to the New York Times.
Mexico was still boiling when Rubin faced his second potential political disaster,
the fall of the dollar to below 80 yen.
For Rubin, this was more familiar territory: he had supervised the currency traders
at Goldman, and he knew both the fiscal and political risks. "These kinds of
occurrences are not without consequences," Rubin said.
A declining dollar tends to drive investors out of American stocks, bonds and
Treasury debt, putting pressure on the federal government to raise interest
rates. "It would take a while to show up, but I'm certain it would have
happened," he said.
Encouraging strength in a dollar that is too low is constructive in that it reverses the flow of
speculative short term capital in a fashion that restores long run equilibrium to the exchange
rate. This is what coordinated intervention is all about when it is on the "right side of the
fundamentals". This may have been appropriate on the dollar's rise from its 1995 low at 79
yen. However, once a currency has risen appreciably, continuing to encourage trend following
speculative short term capital becomes questionable. It eventually can become destabilizing,
causing a speculative overshoot in the direction of extreme overvaluation. But the persistence
with which the strong dollar policy has been pursued suggests that Rubin, Summers and
O’Neil have all been oblivious to these dangers, or simply chose to ignore them to great
international cost.
For these gentlemen, a loss of competitiveness, a rising current account deficit, and a growing
net debtor position, all associated with a very strong dollar, appear to always be outweighed
by any potential risks from destabilizing capital flows out of US stocks and bonds. As we
have noted about Rubin in the past, this would appear to be symptomatic of the "US
short-termism" that one would expect from a trader from Wall Street, but not from leading
policy makers within the US government. Yet somehow a policy designed to deal with a
short-term problem of the dollar bloc’s external competitiveness, gradually metamorphosed
into something akin to holy writ, as America’s capital markets became increasingly captive to
foreign capital to sustain the unsustainable. Certainly, this policy kept the US markets
buoyed for a much longer period of time, but at the cost of drawing away badly needed capital
for countries with large external financing requirements, such as Argentina.
To give some indication of the scale of this capital misallocation, in the mid-1990s, net private
capital flows to the emerging world peaked at $225bn. Western investors pushed money
abroad in the search for yield; debt costs dropped while equities soared. In 1994, publicly
quoted emerging market companies were relatively even more expensive, on a price to book
basis, than their developed country peers, according to Merrill Lynch estimates. This hungry
search for yield led Western portfolio managers into markets where they had little
understanding, and virtually ignored pre-existing prudential requirements that they would
have applied to companies in their home markets. Greedy foreign lenders lent to Asia's
highly indebted firms, for example, because they did not want to miss a party. Based on their
Western prudential limits and guidelines, they should never have lent to Korean firms who
were leveraged 4 to 1, but they did. When the environment soured, they looked at these
companies for the first time in terms of their prudential limits and guidelines and decided
that they wanted out.
(Parenthetically, it is worth noting that the behaviour of Western portfolio managers during
the 1990s was in marked contrast to earlier debt crises in the emerging world. When banks
lent to Brazilian or Argentine firms in the 1970's, for example, these firms had conservative
balance sheets. When balance of payment crises occurred, the banks were able to justify their
loans on the basis of corporate credit worthiness criteria even if country credit worthiness
criteria were not met, and they rolled over their loans.)
In any event, the bubble comprehensively burst during the emerging markets financial crisis
of 1997/98. Capital flows now stand at less than a quarter of their peak, bond spreads have
ballooned, and equities are now worth less than half, on the same relative basis, than their US
and European peers. There has clearly been a huge cost both from the perspective of the US
and the emerging world: The outflow of short-term capital from the emerging world into the
US has created financial and economic crises in these economies which further weaken global
markets for US industries; the resultant inflows into the US created huge capital expenditure
excesses in the American economy, which will likely take years to work through, as well as
exerting a powerful global deflationary undertow.
As far as the immediate effects of the strong dollar policy on Argentina, it is clear that the late
1990s tech boom, combined with high US economic growth, drained Buenos Aires of available
capital. True, mere words cannot in themselves engender a “strong dollar policy”. It is
indicative of the high confidence that the markets reposed in Messrs. Rubin and Summers
(after successfully turning up the dollar against the yen in 1995) that the two were able to
perpetuate the myth that American government officials by force of words alone could
maintain this policy objective for as long as they wished, irrespective of fundamentals. Both
were clearly loath to address the growing problem of the current account deficit for fear of
driving investors out of American stocks, bonds and Treasury debt and destroying the
illusion of America’s formidable new economy. Argentina became an indirect casualty of this
policy preference.
Alan Greenspan’s incessant discussion of a high-tech led productivity miracle also helped to
foster the belief in a “new economy”, supposedly making the US a much more attractive
repository for overseas’ capital than beat up emerging markets, rife with crony capitalists, or
an economic bloc, such as the European Union, with a brand new relatively untested currency
(as Washington policy makers implied on numerous occasions in regard to both Asia and the
EU). Collective cognitive dissonance on the part of global investors also played a role, but this
was undoubtedly encouraged by the persistent cheerleading of Messrs. Rubin, Summers,
O’Neil, and Greenspan.
Whatever the cause of the strong dollar policy, American policy makers have been uniformly
successful in sustaining it, even as the US external position has become more unbalanced,
thereby drawing away funds for the rest of the world. Simply put, the money Argentina
needed to service its $95bn of traded debt was misallocated to fibre optic cable networks that
will never be built, dotcoms that went spectacularly bust, or cell phone handsets and personal
computers now sitting in factories as unsold inventory.
Deflationary pressures intensified as consequence of the IMF’s conditionalities for further
loans. After years of throwing good money after bad, the IMF has acquired religion all of a
sudden by refusing to extend any further credit to Argentina. But this comes at the worst
possible time and in a manner which simply makes a bad situation in Argentina much
worse. The Fund is unwilling to disburse a tranche of its already approved loan to Argentina
in the absence of further fiscal tightening. Yet highly restrictive fiscal policies have already
done much to contribute to further depressed aggregate demand, causing more deterioration
in corporate cash flows, thereby aggravating the domestic debt problem. The country has
been in recession for the past 42 months, with the most recent GDP figures indicating an
annualized contraction of -4 per cent. The same mistakes committed in Asia are being
repeated again, doing little to enhance the IMF’s long-term credibility.
The Fund is no longer seen as a disinterested financial intermediary in much of the emerging
world, but as Uncle Sam’s enforcer. But to attack the IMF as the sole cause of Argentina’s
collapse misses the broader point. Argentina is, above all else, a casualty of America’s strong
dollar policy. Trade competitiveness has eroded as a consequence of retaining a peg to an
overvalued currency, whose external value the Argentines had no means of controlling. As the
current account deteriorated ever greater offsetting capital flows were required to support the
peg. At the same time, returns to investments in tradeables fell. After all, why would anyone
build a plant in such an economy when factor endowments and relative prices made it more
profitable to build it elsewhere? The IMF’s policy prescriptions simply intensified a
pre-existing deflationary dynamic, but were not the proximate cause.
A major benefit of the gold standard was the fact that it was unencumbered by nationality
and therefore could not be operated in a capricious, irresponsible manner; America’s policy
on the dollar policy clearly is. If a US dollar-based reserve currency system is to be upheld
internationally in a credible manner, its success must be predicated on America’s financial
and monetary authorities conducting themselves in a manner which does not engender further
global instability. We have long discussed America’s increasingly growing financial
imbalances and its consequent vulnerability to third world-style debt trap dynamics. The
country’s perpetuation of a strong dollar policy has contributed to this vulnerability, as well
as having the consequence of hollowing out American domestic manufacturing industries and
leading to a corresponding dependence on finance capitalism in which the country’s
manufacturing and industrial interests are generally subservient to those of finance and
banking. This is fine as far as it goes; America’s policy makers are perfectly entitled to make
decisions they view to be in the best interests of their country, however irresponsible others
may think these decisions are. But if Washington is to insist that the dollar continue to retain
a major international role, surely it behooves policy makers to incorporate into their
deliberations the international implications of their currency policy.
When such policies themselves become a source of major global financial instability, it
ultimately undermines the greenback’s international status, thereby undercutting the strong
dollar policy that has been the hallmark of the last 3 Treasury Secretaries. Moreover, it is
perverse to insist that countries such as Argentina (which have no control over the dollar’s
fate) are forced to retain a monetary system predicated on a link to this overvalued currency as
a quid pro quo for receiving further financial support and assistance, only to be dropped like
a hot potato when the consequences of religiously adhering to this advice become too adverse.
Unfortunately, this is precisely what has happened over the past 5 years during a time when
Argentina’s problems have continued to build. Paul O’Neil and his fellow policy makers in
Washington may indeed wish to wash themselves of the embarrassment now being caused by
Argentina’s default, but they cannot evade their responsibility in helping to create the mess in
the first place. |
