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Dollar Heads For
Dramatic Decline

By William Keegan
The Guardian - UK
11-9-4
 
The one small consolation for John Kerry and the Democrats is that it will not be their job to clear up the economic mess left by George Bush and Dick Cheney - the very same Dick Cheney who told an incredulous Paul O'Neill, the former US Treasury Secretary, that Reagan "proved deficits don't matter".
 
It is tempting to say that the Bush administration will have to clear up its own economic mess - tempting, but dangerous. Because from everything they have boasted about, both before and after their election victory, the president and his pals want to deepen the mess.
 
They will go ahead with making tax cuts for the rich "permanent". Their plan to impose US-style democracy on the rest of the world will involve a continuing high level of defence spending. And "privatising" part of the social security system will worsen the budget, according to all calculations, before it gets better.
 
Meanwhile, if there is one thing that most serious analysts agree on, it is that the vast and ever-expanding balance of payments deficit - requiring short term inflows of nearly $2bn (£1bn) a day from the rest of the world to sustain it - portends a dramatic decline in the dollar.
 
Is this a crisis? And if so, for whom? The past dollar crises that spring to mind are those of the 1970s and mid-1980s. Working backwards, the first problem in 1985 was not a declining dollar, but a dollar that was too strong for comfort, so much so that senior figures in the Reagan administration were concerned about the threat of US de-industrialisation and an associated outbreak of serious protectionism.
 
Such concerns led to the Plaza agreement of September 1985, under which the major finance ministers and central bank governors embarked on a plan for "an orderly decline of the dollar", with the object of restoring price competitiveness to US industry, and thereby warding off the threatened de-industrialisation and protectionism crises.
 
By early 1987, however, it was felt that enough was enough, and when the decline threatened to become disorderly, the G7 came up with the Louvre accord of February 1987, aimed at steadying the greenback. The really big dollar crisis, however, was that of the early 1970s, when the inflationary financing of the Vietnam war led to a run on the dollar, putting the post-1944 Bretton Woods system under pressure. First there was the 1971 Smithsonian agreement to devalue the US currency - an attempt to shore up the Bretton Woods system.
 
In 1973, the Smithsonian agreement in turn came under intolerable stress, and the world returned to a system of floating currencies. This contributed to the oil crisis of 1973-74. Although the major factor behind the oil crisis was the Arab use of the "oil weapon" in response to the 1973 Arab-Israeli war, oil was priced in dollars and the devaluation of Middle Eastern producers' oil earnings also played a role.
 
Yet, in the words of the then US Treasury Secretary, John Connally, to the Europeans, the dollar was "our currency" and "your problem".
 
The US embarked on a period of so called "benign neglect" of the dollar, and this in turn played an important part in the decision of Helmut Schmidt, the West German chancellor and Giscard d'Estaing, the French president, to set up the European Monetary System as a "zone of monetary stability" in an increasingly chaotic world.
 
The EMS led in due course to the European single currency or euro. Now here we are, with the dollar going down, an oil price that has risen substantially, and echoes of the Vietnam war in the invasion and occupation of Iraq and the so-called war on terror.
 
A dollar devaluation is necessary to restore some sort of equilibrium to the US balance of payments, but the impact on the euro has already been described by Jean-Claude Trichet, the president of the European Central Bank as "brutal".
 
The benign - or malign - neglect of the dollar is bad news for the eurozone, because it is bound to harm the zone's fledgling, export-led recovery. It is doubtful whether the old fashioned subject of "international monetary co-ordination" is anywhere near the neo-con agenda. From now on Europe is on its own, and had better rediscover the expansionary economic policies of John Maynard Keynes - and fast.
 
- William Keegan is the Observer's senior economics commentator
 
Guardian Unlimited © Guardian Newspapers Limited 2004 http://www.guardian.co.uk/economicdispatch/story/0,12498,1347076,00.html
 

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