Consecutively, The Jakarta Post (Saturday, May 26, and Monday, May 28) focused its attention on the destiny of Indonesia’s and other regional countries’ currencies in confronting recent global economic calamity.
The prolonged Greek sovereign debt crisis and the prominent eurozone countries’ leaders’ tug-of-war between the austerity-based “compact fiscal” policy championed by German Chancellor Angela Merkel and the spending-based “compact growth” policy persistently proposed by newly elected French President François Hollande have negatively impacted the world economy.
Until very recently, this tug-of-war had not ended. The New York Times editorial (May 28) expressed regret about the recent failure of the European leaders to share one language in quelling the eurozone crisis. The possibility of a chaotic Greek exit from eurozone membership is haunting news not only for Europe but also for the world as
What is at stake is the destiny of developing economies, such as Indonesia. Although the United States’ economy has ploddingly shown signs of recovery and, as stated by economist Manu Bhaskaran, “is not going to fall into another recession”, it remains fragile from external shocks for it is suffering fiscal weakness. In other words, the US cannot be expected to act as the engine of global economic growth.
Similarly, we cannot expect it of China either. Once acting as the sustaining pole of global growth for its huge foreign exchange reserves, it is now slowing sharply. Its April economic readings unveil that China’s domestic and external demands are, again, according to Bhaskaran, “weakening far more rapidly than expected”.
It is in view of this that the May 22 editorial of The Jakarta Post set forth its concerns about the fate of Indonesia’s economy, especially its financial aspects. “The financial contagion of a Greek crisis,” the editorial says, “could adversely hit Indonesia’s economy in view of the likelihood of bank runs in other European countries such as Spain, Italy and even Germany.” A front page story in the Post’s May 26 edition highlights how this current tumultuous eurozone crisis is exacerbating the scarcity of US dollars on the domestic market.
The question is, why is the US dollar is powerful despite the US’ continued struggle caused by its 2008 financial crisis?
Rereading Harry Su’s 2008 analysis on the fate of the rupiah against the US dollar (the Post, Oct. 29, 2008) brought me to the Nixon-era US Treasury secretary John Connally, who said: “The dollar is our currency, but your problem.” Columnist Krishna Guha in a Financial Times article (Nov. 10, 2007) quoted the same remark as he analyzed the dollar’s free fall several years ago.
But why Nixon? Let’s be brief. It concerns “the dollar standard” in the world monetary regime.
In the eyes of Richard Duncan, who — in his The Dollar Crisis: Causes, Consequences, Cures — coined this “exotic phrase”: the “dollar standard” is an international monetary system substituting the Bretton Woods one.
Responding to the Great Depression in the late 1920s and early 1930s, the 1944 Bretton Woods agreement not only established “the World Bankers” (World Bank and the IMF) but also endorsed the centuries-long gold standard in the international monetary system.
Although this gold-based system gave no total guarantee against global economic turmoil, it was equipped with an adjustment mechanism: the imbalance of payment of a country could not hit rock bottom as the international transactions were tightly controlled by the amount of gold the involved countries possessed.
Although it ran smoothly for more than 20 years, the Bretton Woods system was hit in the second half of the 1960s, when the US increased its worldwide role in economic as well as military and ideological politics: huge capital overseas investment of US corporations and its involvement in the Vietnam War.
Both of these needed an unprecedented amount of financial expenditure and thus created a deficit in the US balance of payment. Surely, this placed a great strain on its gold reserves.
Its gold reserves dried up rapidly, mainly because the British ambassador, as informed by Daniel Yergin and Joseph Stanislaw, turned up at the US Treasury Department in the second week of August 1971 to request that $3 billion be converted into gold. This forced Nixon in the same year to suspend the convertibility of dollars into gold. Failing to patch up the system, Nixon freed the dollar from the gold standard in 1973. Followed by other major trading countries, this move relegated the Bretton Woods gold-based international monetary system into the tomes of history.
It is in this context that the creation of the global bubble economy — that is, something insubstantial, groundless and ephemeral — can be understood. Under the “dollar standard”, the world financial regime profoundly shifted. With its gold reserves dried up, the US was pressured by its balance of payment deficit so much that it was prompted to launch a new financial strategy by spreading credit to cover its debts to exporting countries through issuing dollar-denominated assets (sovereign and corporate bonds as well as stocks and other financial instruments and their derivatives), instead of gold.
From this moment, the global economy took a new course. Under the “dollar standard” system, the world was thus torrentially inundated by the dollar liquidity as the US maintained its policy of paying for imported goods and services with credit to finance its balance of payment deficit.
It had surely triggered a surge in international reserve assets. “During the 20 years from 1949 to1969,” says Duncan, “the world’s reserve assets increased by 55 percent. During the next 20 years, they expanded by 700 percent. Altogether from 1969 and today, international reserve assets have increased approximately 20-fold.” The system also created new emerging markets in Asia and South America.
However, this fantastic development was essentially an “economic trap”, for almost every country worldwide directed exports to the US. The capital and financial surpluses these countries gained from the transactions were going nowhere. Instead, they were reinvested in dollar-denominated assets in the US. As a result, the US easily reaped huge capital from the world to finance its balance of payment deficit.
It is in this context that the problem of the global bubble economy lies. Gradually, the US grew as the world’s biggest debtor in the world. Since the 1980s, it had to bear current account deficit amounting to $50 million an hour, or 5 percent of its GDP. By 1982, for the first time the US budget deficit surpassed $100 billion, and in the early 2000s cumulatively had reached $3 trillion. Today, still suffering from the 2008 financial crisis, the bill borne by the US has certainly reached at an unimaginable level.
Yet, both its currency and US dollar-denominated assets remain sought after worldwide, as the headline news of the Post suggests above. It is in this that the US dollar secret lies.
On the one hand, continuing to hold US currency and dollar-denominated assets, one will inevitably increase to bloat US debts. But once those are redeemed collectively at the global level, the value of currencies of various countries holding US dollars and its denominated assets will appreciate.
This will eventually make them suffer economically. The appreciation of their currencies will negatively affect their export competitiveness and put downward pressure on their economic growth.
This complicated interconnectedness makes the global economy precarious to the US dollar-based boom and bust cycles. The bandwagoning effect of the today’s US financial crisis strongly indicates that the world-scale US dollar domination remains a sine qua non.
The writer is director of Jakarta-based Institute for the Study and Advancement of Business Ethics.