The Dollar - Benchmark
Of Declining American Power
By Terrell E. Arnold

The George W. Bush years in the White House have been branded by an almost paranoid focus on the trappings of American power.  The Project for a New American Century (PNAC), including among its authors and advocates the cream of the Bush team, set as the administration goal an outright global dominance to be achieved by military power. The assumption was that America, as the sole global superpower, could do this because, as stated by US Ambassador to Iraq, Zalmay Khalilzad in an April 2006 interview with the LA Times, "this is our destiny, given our preponderance in the world, our role in the world, and because of our successes."
But our "preponderance" in the world has slowly declined in recent decades.  Since the changes have been gradual, perhaps PNAC promoters may be forgiven for not having noticed, but the attributes of American power have changed remarkably, and it is prudent to examine closely just what those changes mean.  First, however, it is worth considering a pattern of counterintuitive actions.
The Bush team is bent on going deeper into debt.
Even in a situation of national danger underscored by 9/11 attacks, Bush went ahead with his planned tax cuts. With that gesture, of benefit largely to the wealthy, he turned a budget surplus bequeathed to him by Bill Clinton into a deficit virtually overnight. Even launched in an unnecessary war against Iraq, Bush has continued to defend his tax cuts while the costs of war have mounted, and the budget deficit has climbed with them.
Eager to have tax cut legislation on their records before the November elections, last week the Republican -led Congress passed a $70 billion tax cut, again mainly for the wealthy. Dubbed with customary flamboyance The Tax Increase Prevention Act, the law's immediate goals were to extend a low tax rate on capital gains and dividends, preserve certain tax incentives for businesses and reduce the exposure of the not so wealthy to the alternative minimum tax. Main benefits would flow to people in income brackets above $200,000 annually.  For people in a $50,000-100,000 income range, the action would save a taxpayer a few hundred to a thousand dollars; and that has some appeal to the 15 million or so taxpayers who might be affected.  Every member of the Congress has a plausible sounding rationale for the cuts, but in an election year tax cuts are as close to vote buying as you can get without handing out cash.
The tax breaks thus legislated are mere shameless pandering to the rich, but the pandering, politically corrupt nature of this action aside, the more serious problem is that it runs counter to the national interest.  Only days earlier Congress passed a bill to reduce the deficit by $40 billion, thereby maybe keeping the annual deficit below $400 billion for 2006.  However, the tax cuts more than offset the deficit reductions, and Bush indicates more tax cuts are in the offing.  Moreover, the White House immediately used its artful dodge of keeping Iraq war costs out of the budget by asking for upward of $100 billion new money for war-fighting.  All of these actions ballooned the probable annual deficit well above $400 billion. 
The US current account deficit is bigger than ever.
The US current account deficit, the net of US trade, investment, and borrowing abroad, has struck a new high of more than $800 billion. This makes the United States by far and away the most deeply indebted country on the planet.  That deficit could well approach a trillion dollars next year.  (1)US plans for continued occupation in Iraq and Afghanistan, (2) possible military moves against Iran, (3) design and development of new nuclear weapons, (4) creation of new offensive/defensive space weapons, and (5) continuing Congressional pork barreling  are all being pursued as if the current account deficit and the budget deficit are irrelevant to American power plans. The "preponderance" of the evidence is that the true elements of American power are being recklessly undercut.
The world economy is changing remarkably.
Global developments are keys to the outlook for American power.  As the United States moved on from the Vietnam War, the global economy changed in material ways.  First and foremost was the decline of the Soviet Union and the collapse of the Warsaw Pact, ending "the evil empire", but in practical terms temporarily reducing pressures on global resources.  Coming along rapidly, and consolidating its position after the fall of the Berlin Wall, the European Community has come to occupy a position of economic power at least equivalent to that of the United States. A third cluster of about equal weight also has emerged in East and Southeast Asia.  Although not frontally challenged, American power is in relative decline.
The global situation of the dollar is a proxy for all of this. The dollar faces exchange rate challenges especially vis a vis the Chinese yuan or RMB, the Korean won and the Japanese yen, and those problems are trade and debt related. However, it is well worth looking at the whole picture of the dollar as a medium of exchange in international uses, and as a store of value in various pockets and currency reserves.  This picture must be taken on board entirely for the United States to see what is actually happening to the status of the sole remaining superpower. 
A big source of change is the growing demand for resources.
Demand for precious metals is on a volatile upward curve.  Some commentators say that the recent behavior of gold and other precious metal prices is driven by doubts about the health of the dollar, especially abroad, as a store of value.  How much that may enter into an individual investment calculus will vary by country situation.
Most experts attribute the recent sharply upward trend of precious metal prices to persistent upward pressure on demand for all key resources. Gold has risen from about $475 per ounce in October 2005 to more than $700 in recent days, while silver and platinum have risen as well.  That is due to growing demands for resources in the most actively growing economies--China, India, Brazil, and a number of Asian countries. While obviously a store of value in those and other economies, the upward trend of prices for precious metals is driven heavily by industrial demands for them,  while rising extraction costs due to rising energy bills are pushing up all resource prices.  
A new way of allocating resources is needed.
Just tinkering or even sharply altering exchange rates won't solve the problem. The fact is that more than ever the markets for resources are chaotic in behavior, driven by competitive/ acquisitive moves of the key players. Where imported resources are concerned, the practices of governments and businesses in user countries are to reach bilateral deals with the sources. Countries thereby get in each other's way.  In the case of oil and natural gas, the United States is now engaged on basically preemptive supply/source access controls in the Middle East and Central Asia. China is the present most visible competitor, showing up everywhere, but others are out there, because they do not dare stay out of the game if the resource supplies are essential to the welfare of their economies. 
Competitively pursued, this game is prone to hostility and conflict.  It is being played with at least implicit intent to use force if necessary. In literal ways, a militarily powerful player on the other side of the table suggests that he might simply take your resources if you don't cooperate.  That is a powerful bargaining tool.  Various cooperative resource sharing proposals go unheeded, while supplies shrink, prices rise, and competition grows more aggressive as well as more costly. .
Supplier countries are trying to maximize returns to their resource exports.
Economic pressures on the main resource supplier countries are enormous.  In economic development terms, most of the key resource source countries are decisively in the third world, and few are far from it.  With more populist governments in power, the goals of leadership, over time, have shifted away from arrangements with foreign buyers and developers that essentially give the bulk of resource returns to outsiders.  Beginning with OPEC, the effort has been to retain as much of the profit as possible from resource exports in the source country.  Common practice has moved toward national ownership of resources and contract payments for services to developers and marketers who are outsiders. Such "nationalization" moves as have occurred in Venezuela under Hugo Chaves, and more recently under Evo Morales in Bolivia, may well be anathema to the outsiders (countries and businesses) that held the leading profit positions before nationalization.  However, countries trying to pay their bills and get ahead, especially to deal with endemic poverty, simply can no longer afford the export of most of the market value of their key resources.
The plain fact is that previous arrangements served the developer/exporter countries far better than they served the source countries.  That is the ultimate flaw in historic colonial exploitation of resources: The source countries were always minor players whose small elites largely were co-opted and corrupted by outsiders. The people hardly benefitted. Open access to key resources obviously is preferred and is most beneficial to the developed economies, but what the source
countries want today is contract services from outsiders, not dominant resource ownership by outsiders.  Among other things, those developments reduce the returns on previous dollar investments in those countries.
Every significant global economic shift affects the dollar.
A giant shift was creation of the euro.  Since its coins and banknotes were circulated beginning January 1, 2002, the euro has become an increasing challenge to the dollar in all traditional dollar roles, but not in all areas of the world. At present, the euro is the official currency of 12 countries, all EU members.  It is the focus of exchange rate mechanisms (that is pegged within standard fluctuation margins) with 8 other EU countries. It is involved in unilateral exchange rate regimes (essentially a + or - range of 15% policed by each of the countries for itself) with 18 other countries, including Russia. As might be expected, penetration by the euro as a medium of exchange has been least effective in the Americas and in the Middle East.  However, surveys conducted by the European Commission indicate that, given the short period it has been in circulation, the euro is making significant inroads on the traditional roles of the dollar. Part of that pattern is the result of steady appreciation of the euro against the dollar, from about 90 US cents in January 2002 to about $1.27 cents in April 2006. The strength of the euro against the dollar no doubt is bolstering the use of the euro as a reserve currency by governments and as a store of value by individuals. That probably means also that the euro is penetrating both illicit drug traffic and the whole body of black market transactions in many areas of the world, thus displacing the dollar, even in illicit transactions.
A potential change of great weight could be creation of the Asian Currency Unit (ACU).
The ACU was discussed more than a year ago as a way of giving the member countries a regionally specific index of currency values. The ACU area as now discussed would include China, Japan and Korea, as well as the 13 members of the Association of South East Asian Nations (ASEAN).  While the strongest economies, Japan and China, have been politely vying for the lead, the probability is the ACU would be primarily keyed to the Chinese yaun, called the RMB (an acronym for Renminbi or "people's currency").  China had already moved in 2005 from pegging the yuan on the dollar to a basket of currencies. Regional adoption of such a peg probably will mean a basket currency unit based on some formula for the 16 countries involved, but there is no immediate expectation that the ACU would become an actual currency medium of exchange. It would remain for whatever period as an index that unhooks regional exchange rate behavior from the dollar, and it probably would stabilize fluctuations in exchange rates within agreed ranges around the ACU peg.
How do such changes affect the dollar?
A significant part of the stability of the dollar has depended on its utility as a medium of exchange and a store of value.  There is no doubt that the utility of the dollar in both respects has been reduced by the intrusion of the euro and, when such an instrument is issued, further reduction would occur with introduction of an ACU as an actual competing currency.  How much would depend on the strength of the ACU base, and that, of course, will be heavily dependent on the performance of China, Japan and Korea, plus the ASEAN group (a relatively small weight in the total, but growing).  That the US economy is growing at roughly 3%, while the Chinese economy bounds upward at near 10% gives the yuan more thrust as both a potential medium of exchange and a reserve currency in the region.
In gross purchasing power parity terms, the Gross Domestic Product (GDP) of the ACU group could be somewhat greater than that of either the United States or the European Community. In effect, creation of a currency unit ACU would, with the euro, direct two thirds of the world economy away from dependence on the dollar.  That shift is far more important globally than would be the redesignation of oil prices in euros, as now undertaken by Iran's bourse. However, a more narrowly used dollar in world transactions, plus an exposure of the dollar to exchange rate fluctuations around oil and other key resource prices, could be a significant negative impact on both the role and confidence in the dollar. 
The dollar simply faces growing competition.
There is no doubt that the foregoing developments describe a fundamental change in the global environment of the US dollar and the weight of the US economy. How weighty a change depends principally on how the US manages its affairs in a changing world monetary system.  In this regard, the burgeoning US current account deficit is a bad sign, as are continuing moves of the Bush administration, or whoever takes over from it, to run the country through deficit financing rather than through sensible public revenue, tax and expenditure policies. 
America needs to change its business model.
To change the situation very much, certainly to change it enough to right our financial ship of state, a new and honest public dialog on national finance is essential.  That dialogue is unlikely anytime soon, because every Washington politician of any standing in the current administration has "no new taxes" tattooed on the back of his hand. If you confronted any of them with a business model to run a corporation the way our leadership is running the largest single business on the planet, they would insist on firing the board of directors and all top management, because the model is an obvious failure.
Unfortunately, Washington political leaders confuse their own personal prosperity and that of their friends with the national interest, and our system is being driven into the ground. Expert judgments are that the present current account deficit of the United States should be cut at least in half.  There is no institutional reason for not eliminating it over time.  However, reducing that deficit means buying a great deal less abroad or selling a great deal more.  It certainly means borrowing less.  A growth model that is keyed to increases in demands for goods and services that are greater than population increase is essentially flawed.  If that model depends on borrowing money to sustain it, the whole system is flawed. That is where we are. 
Exchange rate changes alone are unlikely to help much.
Several experts, especially those allied with the current administration, believe that one key to US resolution of its problem is for other countries, especially China, to appreciate their currencies against the dollar. Others, outside of government, argue that China, as well as several countries in the formative ACU group, have been intervening to keep their rates lower than desirable in international monetary terms. If China and maybe other ACU countries were to appreciate their currencies, that would enable the US to sell more exports, but it would make imports more expensive, and the result could be a reduction of the current account deficit.
Our military strategy is self-defeating.
Heavy spending on defense, when we have no recognized enemy except individual small groups of "terrorists," is a luxury that we simply cannot afford.  Fortunately, it is one that we do not need in any sense from the national security point of view.  Rather, US arming to the teeth is likely to cause anybody who can to do likewise.  The coming arms race will be driven by American design, not by American enemies. By diverting key resources into military buildups, this race will exacerbate the resource demand/supply conditions that already experience declining supplies and rising prices. We will pay more for everything we buy, while wasting more on military expansion.
It is time we faced our real situation.
The dollar, and around it the US economy, has entered a new global environment.  While the dollar has held a unique solo stage for much of the past half century, it now faces the euro whose economic base is equal to the base of the dollar, and it is coming to face the ACU, first as index, probably eventually as currency, that will define a block equal if not greater in purchasing power parity than the US or European Community. Meanwhile, China alone can grow in the next four years to equal the US share of global domestic product. The global economy is growing materially larger, but the role of the dollar in it is shrinking. 
We need new rules.
It is essential to have rules that explicitly include debt management and government expenditure controls in addition to currency regimens. It appears unlikely that the international system would ever return to Bretton Woods rules, where everybody agrees to peg currencies closely to the price of gold.  Currency values and gold prices are now too far apart for that to make sense.  In any case, the price of gold is so volatile that it has lost its character as a solid citizen store of value, and its speculative price movements make it an unstable base for an international currency system.
On the other hand, the alignments of countries around the euro and the move toward an ACU suggest that at last two thirds of the global economy is moving toward pegs, less rigorous to be sure than Bretton Woods. Until and unless some global system can be achieved, the fact of separate euro, ACU and dollar blocs means that conditions for beggar thy neighbor national economic policies (including tariff and exchange rate tricks) still exist.  They must not be allowed to ferment into either competitive exchange management or unfair resource moves that favor the traditional powerful. It is not merely that the dollar cannot go home again; that home  simply does not exist anymore.
Global monetary leadership must become truly international.
National sovereignty is among the principal areas of change.   Beggar thy neighbor, preempt available resources, thumb your nose at other people who are affected negatively by exchange rate or other financial management decisions, are all unilateral strategies that held a place, whether rightly or wrongly, in past economic landscapes.  There is simply increasingly little room for them. Because the United States has been pressing the limits, it has not really accepted this reality, but it will be the first really to know this, because the rest of the system is now too powerful to ignore. The behavior of the euro makes it clear that there is wide interest in other, potentially more secure stores of value than the dollar, and in more stable exchange relationships than an un-pegged dollar would allow. The way to get there lies through uses of powers that already reside in the International Monetary Fund.
It could be, as some dream on, that America can have its cake and eat it too, go on over-spending, under-saving, over consuming, and wasting its resources on military adventures.  That would be, however, at the expense of other countries and peoples, and they grow increasingly intolerant of it.
The overall system model of the American economy continues to be valid.  National priorities are skewed and along with them national budgets, revenue habits, and attitudes toward the interests of third parties.  Listening to Bush team members, one would think that the United States has the same broad scope for self-interested economic behavior it has exercised for decades. That is no longer true, if it ever was. The demand now is for growth and change, and much of the disciplined work must be done by the United States itself.
America must adopt a simpler lifestyle.
A profligate lifestyle at the national level is reflected on the ground.  Compared to anyone else on earth, Americans simply live too well.  Using more than 30% of the world's annual output on the lifestyles of only 4.6% of the world's people, and going into debt to do it, is an obvious travesty when easily six times that many people live in poverty. People who have been around for more than the decades of post World War II know that life can be very pleasant, even optimal at lower cost. The most striking aspect of future less spendthrift lifestyles, however, is that they could well be forced on us by necessity. 
The changes we must make are vital but not drastic.
The facts of our situation do not describe a society whose choices are unlimited. Nor do they describe a superpower. When one looks closely at the details, "superpower" is more an attitude thing than a practical reality.  Significant changes must come, and the longer they are delayed the more costly and inconvenient will be the transition.  Modest adjustments now toward a stable, less extravagant lifestyle, can assure a future that is both tolerable and rewarding.  A world wracked by conflict to gather resources because people refuse to see the need for change is the kind of planet we now have. It is growing harder to stay even, and enormously difficult to acquire more. The dollar and its behavior are only bellwethers, symptoms of an imbalance that is dangerous to America and to the global economic system. It is time to see that and fix it. 
The writer is the author of the recently published work, A World Less Safe, now available on Amazon, and he is a regular columnist on  He is a retired Senior Foreign Service Officer of the US Department of State whose immediate pre-retirement positions were as Deputy Director of the State Office of Counterterrorism, and as Chairman of the Department of International Studies of the National War College.  He holds a master's degree in political science and economics from San Jose State University and he studied development economics at the University of California, Berkeley. He will welcome comment at



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