The $US Dollar: "The Bubble To Beat All Bubbles"

May 28, 2002
Posted By: Rosalinda, Source: Guardian 27.5.02

The Guardian's Larry Elliott notes: "All good things come to an end, and for the mighty dollar the end is definitely in sight. The only surprise is that it has taken as long as it has for the financial markets to accept the inevitable.

Countries that live beyond their means eventually pay the price. Anybody who believes, however, that the overdue fall in the currency means a painless rebalancing of the global economy is in for a rude awakening. Soft landings are to the world of contemporary economics what snow leopards are to the world of nature: everybody has heard of them; few have actually encountered them."

The rise of the U.S. dollar in recent years helped to attract capital from abroad, worsened the imbalances of the U.S. economy, and generated "speculative asset-price bubbles."

Thailand experienced something of that sort in 1997, but that was "only an overture to America's bubble to beat all bubbles.

Greenspan is now in a fix, although his willingness to tolerate, even encourage, the stock market bubble means he only has himself to blame. Low interest rates are needed to keep the economy growing, but higher interest rates are needed to attract an inflow of funds needed to prevent a sharp fall in the dollar and fund the current account deficit." Could both aims be achieved at the same time? "The answer, almost certainly, is no."

[Source: Economist 18.5.02]

WIESBADEN, May 27 --"UNEXPLODED BOMBS--BEWARE OF FANNIE AND FREDDIE," READS ONE HEADLINE IN PART OF AN EXTENSIVE SPECIAL survey on "Capitalism and Its Troubles" in the latest issue of the London Economist The Economist notes:

"Banks may be busy trying to get rid of risk, but two huge American institutions cannot get enough of it. The Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation, known affectionately as Fannie Mae and Freddie Mac, have become the two most worrying concentrations of risk in the global financial system. This is because of their portfolio of mortgages and securitizations, their use of derivatives and the habit of many other borrowers, including hedge funds, of using their debt as collateral.

At the end of 2001, Fannie had a total credit risk of $1.56 trillion (a $705 billion mortgage portfolio and guarantees on securitized mortgages of $859 billion). Freddie's was $1.14 trillion ($492 billion plus $646 billion), adding up to a combined exposure of $2.7 trillion, nearly double the 1996 figure of $1.45 trillion." This exposure amounts "to a hefty 13.9% of the total credit risk in the non-financial sector of the American economy, and 49.8% of home-mortgage credit risk."

Once the housing bubble bursts--"say, a 25% fall in house prices, no home equity left, people defaulting on mortgages"--Fannie Mae and Freddie Mac would be in big trouble.

"The biggest danger may be counterparty risk: Fannie and Freddie are heavily dependent for their risk-management programs on a handful of big banks. If there were an unexpected sharp rise in interest rates, those banks might be unwilling or unable to provide the derivatives Fannie and Freddie need to hedge their risk. The chance of this is small, but if it ever came to pass, the consequences would be huge."

DANGER FOR THE DOLLAR by Lothar Komp

Big trouble is brewing on the foreign exchange markets. The soaring value of the American dollar against the European and Japanese currencies, maintained steadily since the mid-1990s, has come to a standstill since the beginning of this year. After an unbroken descent during April—when the leading American corporations presented, day after day, their generally catastrophic quarterly reports—the dollar fell at the beginning of May to its lowest level against the euro since October 2001.

Despite a warning by the Japanese government that it intended to intervene on the foreign exchange markets against its own currency, the dollar also slid downward against the yen, after the revelation of that the U.S. unemployment rate had hit its highest in seven and a half years. In comparison to the Swiss franc, the dollar has already shed 7% of its value since the start of this year. On May 7, in its global currency markets report, the Bank of America spoke of outright "panic selling" of dollars in Asia.

Mirroring the dollar's fall, the gold price has continually risen, and for some time now has been hovering at well above $300 per ounce.

Think of Autumn 1998

A slight drop in the dollar's value would certainly come in handy for the U.S. government, in order to help its prostrate economy back on its feet. But as all experience with speculative bubbles shows, trying to let only a little air out of the bubble never works very well. It is quite probable that the bubble will burst with a loud splat, causing the dollar to lose one-quarter or even one-third of its value within a few weeks or months.

Dramatic shifts and breakdowns in the financial markets would immediately follow. We are reminded of the global hedge-fund crisis in Autumn 1998, when the big funds had speculated against the Japanese yen with huge financial bets, and the dollar, in only four days, plunged by 18% against the yen.

This time, it may be much worse, because, from the mid-1990s proclamation of the American "economic miracle" onward, the U.S. economy has turned into a monster, which cannot survive without speculative bubbles to feed on.

Along with this has come not only a bubble in the domestic U.S. financial markets—first on the stock markets, and now in real estate—which has enabled private households to take in ever-growing quantities of credit, thus forcing a still greater expansion of debt; but also an externally driven dollar bubble, which has been indispensable for maintaining the flow of considerable capital from abroad into the United States.

The American economy is now just as addicted to both these speculative bubbles, as Count Dracula was addicted to the blood of his victims.

Trade Deficit Is Out of Control

Considering the spectacular decline in U.S. foreign trade, the question is not so much what the trigger will be for a full-scale dollar crash, but rather, why this crash hasn't already occurred long before now. It is worthwhile in this respect, to look at a few details from official U.S. statistics.

Last year, the United States exported goods valued at $721 billion, of which $322 billion were in capital goods, $160 billion in industrial materials and semi-finished products, $90 billion in consumer goods, $75 billion in automobiles and automotive parts, and $55 billion in agricultural products. But this export income fell far short of covering the bill for its much higher imports: In 2001, the United States imported $1.147 trillion in goods—$426 billion, or 59% higher than the volume of exports. The main components of these imports were capital goods ($298 billion), consumer goods ($284 billion), industrial materials and semi-finished products ($278 billion), automobiles and automotive parts ($190 billion), and oil products ($104 billion). In the areas of consumer goods and automobiles alone, America had a foreign trade deficit of over $300 billion.

The question arises: How are they able to import $1.147 trillion in goods, and only export $721 million worth? The answer: on credit. While the U.S. corporate sector is, to a certain extent, directly indebted to foreign institutions via international loans, private households are only able to maintain a level of consumption beyond their actual income, by means of injections of credit from banks, credit card companies, and mortgage institutions. The U.S. financial sector, in turn, can only keep this debt machine running by ensuring—at least up until recently—that the markets in the United States continue to be inundated with flows of capital from abroad. In the process, the U.S. financial sector itself takes on massive quantities of foreign debt.

To be specific: Last year, U.S. purchases of foreign securities and businesses stood at $440 billion, whereas capital flows of the same kind into the United States from abroad, were more than twice that—$896 billion, or $2.5 billion per day. This represents a total net influx of $456 billion into the United States during 2001—which pretty closely matches up with the figure given for the U.S. trade deficit.

In a nutshell, Americans are receiving $400 billion worth of consumer goods, automobiles, crude oil, steel, and other hard commodities every year, above and beyond what they pay for with their exports; and they are covering this deficit with an equal sum of stocks, securities, and other financial paper, bought by foreigners sending capital into the United States. ..... (analysis continues) http://www.larouchepub.com/other/2002/2920dollar.html