FT: Martin Wolf sounding a little like Peter Gowan

[Michael Pollak <mpollak@xxxxxxxxx>]

[At least for the first couple of paragraphs]

Financial Times; September 30, 2003
A very dangerous game
By Martin Wolf

<snip>

One might, if one were cynical, view what has happened as a brilliant US
conspiracy. In the 1980s and 1990s, its policymakers persuaded a host of
economies to liberalise their financial markets. Such liberalisations
generally ended with financial crises, currency crises, or a combination
of the two. These disasters lowered domestic investment in the afflicted
countries, instilled deep fear of current account deficits and engendered
a strong desire to accumulate foreign exchange reserves. The safest way
was to invest surplus funds in the country with the world's biggest
economy and most liquid capital markets.

When gullible foreigners can no longer be persuaded to finance the US, the
dollar will decline. Since US liabilities are dollar-denominated, the
bigger the decline, the smaller net US liabilities to the rest of the
world will then turn out to be. In this way, the last stage of the
"conspiracy" will be partial default through dollar depreciation.

How long can such a game go on? Not indefinitely, must be the answer. One
can envisage three alternative developments: adjustment postponed; brutal
and immediate adjustment; and smooth adjustment. The world needs the last.
We cannot assume it is what it will get.

Under adjustment postponed, US domestic demand would pick up rapidly to
reach annual growth of over 4 per cent a year, in real terms. This would
pull GDP growth along at its sustainable rate and generate a still bigger
current account deficit, probably rising to well above 6 per cent of GDP.
The dollar is also assumed to stabilise. While this would represent a
depreciation from its peak, it would leave the currency, on a
trade-weighted basis, at much the same average level as between 1997 and
2000 (see chart). Since the US current account deficit would not fall,
under this scenario, the rest of the world would, by definition, be
willing to accumulate claims on the US at an increasing rate.

As Andrew Smithers of London-based Smithers & Co notes (Profits and Cash
Flow Problems for US Companies, September 22 2003), if the current account
deficit is to increase, net borrowing by the aggregate of the US
government, corporations and households must rise as a share of GDP. But
household savings are far more likely to rise than fall, given their
already extraordinarily low level. So either the fiscal deficit, corporate
cash flow, or both, would have to worsen. A further increase in the fiscal
deficit is likely to undermine confidence in the US. A deterioration in
corporate cash flow is likely to do the same, unless it reflects a surge
in investment that seems much more likely to yield good returns than did
the doomed surge of the late 1990s.

This scenario looks implausible. It would also merely postpone the day of
reckoning. But no less undesirable would be a dollar rout. The communiqué
of the finance ministers of the Group of Seven leading high-income
countries in Dubai has, however, created some risk of such a rout. It
stated, in particular, "that more flexibility in exchange rates is
desirable in major countries or economic areas to promote smooth and
widespread adjustment in the financial system, based on market
mechanisms". Already the yen has risen to ¥111 to the dollar, from ¥117 in
mid-September. Any substantial further appreciation would threaten Japan's
fragile recovery. A big rise in the euro would also be dangerous for the
eurozone. Moreover, a collapsing dollar would undermine foreign
willingness to buy US bonds. The resulting jump in long- term US interest
rates would threaten the US recovery.

That leaves the third outcome: a smooth global adjustment. This would
require a sizeable strengthening of demand, in relation to potential
output, in all the world's significant economies, including, not least,
Asia, outside Japan. Instead of continuing to lend more money to the US
Treasury, Asian governments, including China, would accept joint
appreciation against the US dollar, combined with greater spending at
home. Stronger growth of demand is no less an imperative in the eurozone,
particularly Germany.

Both the providers and the users of the funds have, hitherto, been happy
with the world of exploding US foreign liabilities. But the game has to
stop. Another cycle similar to the last is neither plausible nor
desirable. If the G7 has indeed triggered a widely shared process of
adjustment, that is welcome. But that adjustment has also to be smooth,
not brutally abrupt. It is, alas, too early to assume that it will be.