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Friday, Apr 02, 2004

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Strong dollar keeps the US rich

Sudhanshu Ranade

MUCH OF the world was taken by surprise when the US began to let the dollar skid sharply last year against the world's major currencies. The official American argument was that this was necessary to bring down the trade deficit; and to boost employment figures in the US by making its exports more competitive in world markets, and by increasing the prices of imported commodities, cutting down on the outsourcing of labour.

As we all know, the officially stated version of the strategy `backfired' in the sense that though employment did not increase, prices did — as was only to be expected. What most of us do not know is that the policy was not intended to succeed either in the short run or in the simplistic form in which it was advertised.

The fall in the dollar was intended instead to eventually force a fall in the yen and yuan; that it was the euro and the British pound that took most of the hit was no part of the original intention, since it could have helped queer the pitch even further so far as UN bailout of the US from Iraq is concerned.

Why the former two currencies in particular? Well, if one is willing to take the official US argument at face value, because Japan and China between them accounted for about $300 billion of the $450-billion (of the fungible and non-value weighted) trade deficit of the US in 2000, and again in 2001. Moreover, both have stubbornly resisted US pressures to get them to `revalue' their currencies; in the case of Japan, supposedly to compensate for the `non-tariff' barriers on American imports into that country, and in the case of China to realign the value of the yuan to "accord with ground realities".

Let us now step backstage to understand what is really going on, behind the scenes. On October18, 1998 (less than three months before the scheduled launch of the `demat' euro, though more than three years before euro notes were actually to come on the market), the US Assistant Secretary of the Treasury (Financial Markets) appeared before the House Committee on Domestic and International Monetary Policy to "discuss the implications of European Monetary Union on US currency policy, especially on higher denomination notes".

The EU, the Secretary began by saying, had decided to issue notes of euro 500 denomination which, at the then-prevailing rates of exchange, would be worth about $600; six times as valuable as the highest denomination note issued by the US for circulation among the general public.

On the other hand, the Secretary reassured the Committee, since 1969 the amount of US currency in circulation had grown nine-fold, to about $450 billion; even as "the proportion of US currency held overseas has grown from about half to two-thirds", mostly in the form of $100 bills, approximately 75 per cent of which were held by people living outside the boundaries of the United States.

The dollar, the Secretary noted in 1998, then faced competition from, among others, Germany, Italy and Canada; all of which had high denomination notes in circulation with values in excess of $100. However, only about $50 billion worth of German marks circulated outside Germany; figures for Italy and Canada were negligible.

Meanwhile, "demand for $100 bills had continued to grow at about 5 per cent per year for the past ten years. If, however, higher denomination euro notes were to be used, by the world at large, instead of dollars as a store of value, it would reduce the amount of the Fed's earnings (in the form of being able to print large sums of money without having to pay anything for it; in the form of inflation or in any other way), and therefore increase Treasury's needs to raise money publicly", by borrowing and/or taxes.

However, there did not seem at that time to be any major threat lurking in that quarter of the horizon. Besides, the Treasury Department was worried that issuing $500 bills could facilitate money-laundering; particularly in respect of illicit trafficking in drugs. "If criminals had access to $500 bills," the Secretary went on to elaborate, "$1 million could weigh as little as 4.4 lbs, less than the average bag of sugar or flour available at the grocery store." Because of this, coupled with the lack of concern about the potential threat situation across the Atlantic, the US government had no plans to reissue $500 bills for general use.

The demand for dollar bills abroad seems not to have been significantly impacted in what we now know to have been the run-up to a 9/11 type of situation; at any rate that is the message any administration would naturally like to convey.

Accordingly, though no post-1998 figures were announced, an `ad' was placed in the Executive Summary of the January 2000 report of the Treasury Department, stating that: "Foreigners hold US currency for the same reasons that many once held gold coins. Dollars are a secure store of value when the purchasing power of the domestic currency is uncertain or when other assets lack sufficient anonymity, portability, divisibility, liquidity, or security. As a safe asset in an unpredictable world, dollars often flow into a country to displace part of the domestic currency during periods of economic and political upheaval and then remain there long after the crisis has passed."

A high dollar allows Americans to buy labour, commodities and cheap tourist services in other countries of the world; and get good values on imported goods sold in stores at home. The first two are the reason, why, in spite of all the hue and cry about `outsourcing', it is American companies that are the biggest `offenders' in respect of both goods and services. In this connection, it is interesting to note that profits are rarely if ever repatriated as dividends; which would involve sizeable exchange losses! (Dividend flows back to the US on the — in all probability inflated — market value of US FDI abroad were as high as 5.5 per cent in 2000 and 2001. But current account inflows into the US in 2000 and 2001 were $3 billion and $25 billion respectively short of capital account outflows.) Instead, dividends return to the mother country as imports, and stock-market gains. It is interesting, too, to note that it is precisely the high value of the dollar that gives the US its enormous purchasing power for economic transactions; and political ones, be they national, bilateral, multilateral or global.

The official argument for engineering the slide of the dollar in order to keep jobs in and exports out was, of course, flawed from Day 1. Employment in the US could thereby be increased only slowly, if at all — given the enormous disparities in `living wages' and/or sheer technological sophistication in respect of a large proportion of relatively low-tech American labour working in the organised sector in the US.

On the other hand, a fall in the value of the dollar leads to an immediate increase in the cost of (largely imported) items of mass, `everyday', consumption, both at home and abroad. Nevertheless some sort of pretence was required; and was sincerely made, despite the huge costs it entailed. Now, over the past few weeks, the dollar has begun to rise, rather than fall; even as gas prices in the US threaten to touch a staggering $2 a gallon.

The question is whether this is a temporary phenomenon, or a sign of things to come. The answer seems to be that someone in the President, Mr George Bush's entourage has at last been able to muster the courage to, for once, give him good advice by drawing his attention to the bad news that, while, on the one hand Mr Bush cannot afford to desert his traditional constituency; on the other, there is no point keeping up the increasingly pointless pretence. In short, it is time for working out a viable compromise or compensatory mechanism to rally the nation as a whole behind him.

It may not work, but that would be the fault of the States, not Mr Bush's; and in any case the elections would by then be behind him. Accordingly, the Economic Report of the President, transmitted to the second session of the 108th (the current) Congress last February, read in conjunction with Chapter 12 of the Annual Report of Mr Bush's Council of Economic Advisers, submitted to the President on January 31, 2004 did a complete turnaround, which is worth quoting at length: "Free trade pushes American businesses to become as efficient as possible by exposing them to competition from foreign firms.

The creation and destruction of jobs is part of the way in which people and materials move from less-productive to more-productive functions in a free market economy. Businesses fail and jobs are lost for many reasons; for example, changes in technology or new domestic competition can shake up industries and communities. The job losses in the1980s were not primarily due to foreign trade pushing workers out of a sector, but to the changing nature of manufacturing.

Import competition, however, often receives a disproportionate share of the blame. This may be because there is less that can be done to prevent the dislocations associated with technological change.

"One facet of increased services trade is the increased use of outsourcing in which a company relocates labour-intensive functions to another country. The basic economic forces behind the transactions are the same, however. When a good or service is produced more cheaply abroad, it makes more sense to import it than to make or provide it domestically. American consumers are better off as a result of increased choice and better value.

"Barriers to trade, in contrast, tend to help a relatively small number of firms and their workers at the expense of harming a much larger number of consumers who pay more for their goods as a result of protection. Each consumer might pay only modestly more while the beneficiaries of the protection gain substantially.

The total financial costs of protection borne by consumers, however, are typically larger than the benefits that accrue to producers and workers. Although openness to trade provides substantial benefits to the nation as a whole, foreign competition can require adjustment on the part of some individuals, businesses, and industries."

The report added, therefore, that: "To help workers, the Administration has built upon and developed programmes to assist workers and communities that are negatively affected by trade. For example, the long-standing Trade Adjustment Assistance program was significantly enhanced by new legislation signed by the President in 2002 to extend eligibility to workers indirectly affected, such as upstream suppliers of the firms hurt by imports.

The new legislation also expanded the benefits to include a health insurance tax credit and a wage supplement for older workers who found new jobs that did not pay as well as the jobs they had lost.

"This assistance, which will total $12 billion over 10 years, helps ease the adjustment for displaced workers and helps them move into jobs where they are most needed. In addition, the President has proposed a pilot program for Personal Reemployment Accounts, which would offer an innovative approach to worker adjustment. These accounts would provide unemployed individuals funds they can use for training, for job-search assistance, or as a cash re-employment bonus if they find new work quickly."

One last thing: The one major change after 9/11 was a substantial increase in long-standing concerns about counterfeiting. Even the most carefully crafted `ads' are of little use if you cannot deter or prevent others from infringing on your brand. But that is another story.

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